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					ACCG304 Lecture 9:

Process Costing
Lecture Objective
Process costing is applicable in those manufacturing industries where production is characterised by repetitive and continuous production of large volumes of like units (mass production). Upon completing this lecture students will understand accounting techniques used in the costing of products in those situations where industries utilise mass production procedures.

Learning Objectives 9.1 9.2 9.3 9.4 9.5 9.6 9.7 9.8
Production and Cost Flows under Process Costing Cost Flow in a Process Cost System Process Cost Accounting Procedures Equivalent Units Practical Process Costing Techniques Inventory Costing Procedures First In First Out (FIFO) Process Costing Procedures The Accounting Entries relevant to Process Costing

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9.1 Production and Cost Flows under Process Costing
Under process costing, production output is achieved via a number of processes (production steps) where the units move from one process to the next until production is finally completed. Each process performs a repetitive specialised task and transfers its output to another subsequent process for further processing until all production steps are completed and the output is transferred to finished goods inventory. The output of the first process becomes the input for the second process and so on with the last producing department transferring its output to finished goods inventory ready for sale. The accumulation and allocation of costs of materials, labour and overhead under a process cost system follow the same pattern as the physical production flow. Each producing department has a separate work in process account where: • The input costs of production (material, labour and overhead) are accumulated, and • Are then allocated to the physical output of the process.

As units of production move from process to process, the costs are transferred with it. For example, the output cost of Process 1 becomes the first input cost of Process 2 where additional materials, labour and overhead are applied to production with the total cost of output of Process 2 being transferred to Process 3 as input. The cost of production is cumulative as physical production moves from process to process, with the last processing department determining total cost of the finished item.

9.2 Cost Flow in a Process Cost System
Production and cost flows in a process costing situation may be illustrated as shown below: Process 1 Material Labour Applied Overhead $3 $2 $1 $6 Process 2 Process 1 Material Labour App. Overhead $6 $1 $2 $2 $11 Finished Goods

$11

In the above example, the cost of output in Process 1 is the input cost in Process 2 where additional production costs are incurred and the output cost of Process 2 becomes the cost of a finished unit of production.

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COMPARISON OF JOB COSTING AND PROCESS COSTING
JOB COSTING PROCESS COSTING

INPUTS

INPUTS

DIRECT LABOUR DIRECT MATERIAL FACTORY OVERHEAD

DIRECT LABOUR DIRECT MATERIAL FACTORY OVERHEAD

Costs accumulated by Job

Cost accumulated by production department / process

WIP Job 1

WIP Job 2

WIP Production Department 1

WIP Production Department 2

FINISHED GOODS

FINISHED GOODS

COST OF GOODS SOLD

COST OF GOODS SOLD

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9.3 Process Cost Accounting Procedures
In process costing, production quantities and costs thereof are summarised separately for each process in a "Cost Of Production Report". This report summaries physical units of production as well as total cost incurred which are collectively used to determine unit costs that facilitate the costing of units of output for each process. The "Cost of Production Report" serves as a source document supporting the accounting journal entries for the accumulation and allocation of factory production costs. More specifically, the "Cost of Production Report" discloses for each process in the production cycle: • The physical flow of units of production, • the accumulation of costs associated with the processing of units of production, • the calculation of the cost per "EQUIVALENT UNIT" of production, • the application of the Equivalent Unit Cost to units of production so as to determine the cost of output.

9.4 Equivalent Units
The major difficulty encountered in the preparation of the "Cost of Production Report" is the determination of the production achieved by a department when there exist Work In Process inventories at the start and at the end of the accounting period. Work in Process inventories represent partly manufactured goods which need to be costed. However, it is difficult to cost production that is at various stages of completion, hence it becomes necessary to convert the WIP inventory to "Equivalent Complete Units" on the basis of their degree of completion.

For example, 1,000 units that are 40 per cent completed resulting in 400 equivalent completed units.

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9.5 Practical Process Costing Techniques
The accounting techniques applicable to process costing production situations may be summarised as follows: Step 1 Diagrammatically represent the flow of production in each producing department, specifying material requirements and the application of conversion costs. Calculate the "equivalent complete units" of production for each producing department. Enter the costs of materials, labour and applied factory overhead for each department. Calculate the cost per equivalent unit. Using the cost per equivalent unit, determine the total cost of the Work In Process inventory on hand at the end of the period. The total cost of completed and transferred production is then determined and along with the physical output is transferred to either another processing department or finished goods.

Step 2

Step 3

Step 4 Step 5

Step 6

9.6 Inventory Costing Procedures
The costing of WIP inventory and completed output may vary depending upon the method used for costing WIP inventory. Two commonly used methods to cost closing WIP inventories are: • FIFO - (First in First Out) - where it is assumed that the units in WIP at the start of the period are completed and transferred out prior to the units started during the current period. Thus any production in process at the end of the period are from units that were started in the current period. • Weighted Average - Where unit costs are determined by taking an average of the costs of WIP at the start of the period as well as costs incurred during the current period. Under this method it is possible to complete current period production prior to the completion of the WIP at start.

As to which method is to be adopted depends on the specific nature of the production process. However, the cost of in process inventories, finished goods and subsequently profit will differ in times of rising or falling prices for inputs depending upon whether FIFO or Weighted Average method is used.

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9.7 First In First Out (FIFO) Process Costing Procedures
Under FIFO product costing, the units in process at the Start of the period are costed separately from those units started during the Current period. The Current production and Current costs for materials, labour and applied overhead are used to determine Unit production costs, which are then applied to units in process at the END of the period as well as the completed and transferred production. As WIP units are assumed to be completed first, prior to any of the current period's production, the units in process at the END of the period emanate from the current period's production. The procedures for FIFO process costing differ from Weighted Average in two respects: • the calculation of UNIT COSTS, and • the costing of WIP inventory at end and transferred and completed production.

Lecture Demonstration Exercise
Clan McLeod Ltd manufacture Big-O in a single process. Chemical A is introduced at the beginning of the process. Chemical B is added at a point where Big-O is 85% complete. Conversion costs are added evenly throughout the process. The following information relates to March 2002 Work-In-Process 01/3/2002: Material cost Conversion cost Work-In-Process 31/3/2002: Costs Incurred during March: Chemical A Chemical B Conversion costs 3,000 units 50% complete $2,000 $ 300 5,000 units 90% complete

$80,000 $10,250 $40,600

During March 202,000 units were commenced. Required: (a)

Using the FIFO method of valuing closing inventory, complete the attached Cost of Production Report at the end of the examination paper clearly showing Equivalent Units for Materials and Conversion, as well as the dollar values of Finished Goods Transferred and the Closing Balance of Work In Process inventory. Repeat (a) using the WEIGHTED AVERAGE method. What is the unit cost of one finished unit of Big-O produced in March 2002, under (i) FIFO, (ii) Weighted Average. Show all relevant Journal entries relating to the month’s production activities.

(b) (c)

(d)

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Solution to Lecture Demonstration Exercise
FIFO Costing Terchniques

Cost of Production Report
Total Units WIP @ Start Current $ Material “A” Units $ Material “B” Units $ Conversion Units $

Unit Costs

Transfers Out WIP @ End

UNIT COST Calculations:

Weighted Average Costing Techniques

Cost of Production Report
Total Units WIP @ Start Current $ Material “A” Units $ Material “B” Units $ Conversion Units $

Unit Costs

Transfers Out WIP @ End

UNIT COST Calculations:

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9.8 The Accounting Entries Relevant to Process Costing
The cost of production report is the source document to be used in the generation of Journal entries supporting the flow of costs into and out of each manufacturing department. The journal entries relevant to each department under both Weighted Average and FIFO costing are as shown below: F.I.F.O Debit Credit Weighted Average Debit Credit

Particulars Work In Process Raw Materials (A + B) Labour Applied Overhead
Being costs incurred in the Mixing Department.

Finished Goods Work In Process
Being units completed in Baking dept. transferred to finished goods.

Lecture Exercise 2:
The Westbank Company manufactures money boxes for distribution to schools in the Sydney metropolitan area. The money boxes are made of aluminium, and all necessary materials are added at the beginning of the process. The goods are made in a single process and completed production is transferred to the Bank’s finished goods warehouse awaiting distribution. The following information relates to the production of money boxes for June, 2002: Work in process Inventories 6,000 money boxes 40% complete • June 1st 3,600 money boxes 25% complete • June 30th During the month, materials were added sufficient to commence production on 33,600 money boxes. Details of costs for the process are as follows: • Opening balance of Work In Process: Materials Conversion Costs • Costs added during June: Material Conversion Costs

$2,250 $ 900

$15,120 $13,800

Required: (a)

Using the FIFO method of valuing closing inventory, complete the attached Cost of Production Report at the end of the examination paper clearly showing Equivalent Units for Materials and Conversion, as well as the dollar values of Finished Goods Transferred and the Closing Balance of Work In Process inventory. Repeat (a) using the WEIGHTED AVERAGE method. What is the unit cost of one finished unit (that is, a single money box) produced in June, 2002, under (i) FIFO, (ii) Weighted Average.

(b) (c)

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Cost of Production Report
Total Units WIP @ Start Current $ Materials Units $ Labour Units $ Overhead Units $

Unit Costs

Transfers Out WIP @ End

Cost of Production Report
Total Units WIP @ Start Current $ Materials Units $ Labour Units $ Overhead Units $

Unit Costs

Transfers Out WIP @ End


				
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