CHAPTER 17

Process Costing

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CHAPTER 17 LEARNING
OBJECTIVES
1. Identify the situation in which process-
costing systems are appropriate
2. Understand the basic concepts of
process-costing and compute average
unit costs
3. Describe the five steps in process
costing and calculate equivalent units
4. Use the weighted-average method and
first-in, first-out (FIFO) method of
process costing

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CHAPTER 17 LEARNING
OBJECTIVES, CONCLUDED
5. Apply process-costing methods to
situations with transferred-in costs
6. Understand the need for hybrid-
costing systems such as operation-
costing

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JOB VERSUS PROCESS
COSTING

Job-Costing Systems Process-Costing

Systems
Distinct, identifiable
units of a product Masses of identical
or service or similar units of a
product or service
Examples:
Custom-made Examples:
machines, Food,
houses chemical processing

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 PROCESS COSTING
 Process costing is a system where the unit
cost of a product or service is obtained by
assigning total costs to many identical or
similar units of output.
 Unit costs are computed by dividing total
costs incurred by the number of units of
output from the production process.
 Each unit receives the same or similar
amounts of direct materials costs, direct
labor costs, and manufacturing overhead.
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MORE ON JOB-VS-
PROCESS-COSTING
 In a job-costing system, individual jobs
use different quantities of resources, so
it would be incorrect to cost each job at
the same average production cost.
 In contrast, when identical or similar
units of products or services are mass-
produced, process costing is used to
calculate an average production cost for
all units produced.

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PROCESS-COSTING COST
CATEGORIES
 Process-costing systems separate costs
into cost categories according to when
costs are introduced into the process.
 1. Direct materials are usually added at
the beginning of the production process,
or at the start of work in a subsequent
department down the assembly line.
 2. Conversion costs are generally added
equally along the production process.

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PROCESS-COSTING:
THREE CASES
Let’s look at the process-costing process
three ways:
1. No beginning or ending work-in-
process inventories.
2. No beginning work-in-process
inventory and some ending work-in-
process inventory.
3. Both beginning and ending work-in-
process inventories are present.

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PROCESS COSTING – CASE
1
When using process costing without any
beginning or ending work-in-process
inventory, all costs that were introduced
to the process during the period will be
assigned to the finished units leaving
work-in-process inventory at the end of
the period.

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FIVE-STEP PROCESS-
COSTING ALLOCATION
1. Summarize the flow of physical units
of output.
2. Compute output in terms of equivalent
units.
3. Summarize total costs to account for.
4. Compute cost per equivalent unit.
5. Assign total costs to units completed
and to units in ending work-in-process.

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EQUIVALENT UNITS
 A derived amount of output units that:
1. Takes the quantity of each input in units
completed and in unfinished units of work
in process and
2. Converts the quantity of input into the
amount of completed output units that
could be produced with that quantity of
input.
 Are calculated separately for each input.
(direct materials and conversion cost)
 When calculating equivalent units in
step 2, focus on quantities and disregard
dollar amounts until after the equivalent
units are computed.
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STEPS 1 AND 2 EXAMPLE, CASE 2
(NO BEG WIP, SOME ENDING WIP)

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STEPS 3, 4, AND 5, EXAMPLE, CASE
2 (NO BEG WIP, SOME ENDING WIP)

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GENERAL LEDGER COST
FLOWS ILLUSTRATED

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WEIGHTED-AVERAGE
PROCESS-COSTING METHOD
 Process costing can be accomplished
using the weighted-average method or
the FIFO method. We’ll look first at
weighted-average.
 Calculates cost per equivalent unit of all
work done to date. (regardless of the
accounting period in which it was done)
 Assigns this cost to equivalent units
completed and transferred out of the
process, and to equivalent units in
ending work-in-process inventory.
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WEIGHTED-AVERAGE
PROCESS-COSTING METHOD
 The Weighted-average cost is the total
of all costs entering the work-in-process
account divided by the total equivalent
units of work done to date.
 The beginning balance of the work-in-
process account (work done in a prior
period) is blended in with current period
costs.
 Let’s look at Case 3 (with both
beginning and ending work-in-process
inventory using the Weighted Average
method.)
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STEPS 1 AND 2 EXAMPLE, CASE
3, WITH BEG & ENDING WIP

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STEPS 3, 4, AND 5, EXAMPLE,
CASE 3, WITH BEG & ENDING WIP

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RESULT OF THE PROCESS
 Two critical figures arise out of step 5
of the cost allocation process:
1. The amount of the journal entry
transferring the allocated cost of units
completed and sent from work-in-process
inventory to finished goods inventory
2. The ending balance of the work-in-
process inventory account that will
appear on the balance sheet.

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FIRST-IN, FIRST-OUT (FIFO)
PROCESS-COSTING METHOD
 Assigns the cost of the previous
accounting period’s equivalent units in
beginning work-in-process inventory to
the first units completed and
transferred out of the process.
 Assigns the cost of equivalent units
worked on during the current period
first to complete beginning inventory,
next to started and completed new
units, and finally to units in ending
work-in-process inventory.
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FIRST-IN, FIRST-OUT
PROCESS-COSTING METHOD
 A distinctive feature of FIFO process-
costing method is that work done on
beginning inventory is kept separate
from work done in the current period.
 There is no blending of costs as we saw
with the weighted-average method.

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STEPS 1 AND 2, EXAMPLE, CASE 3,
WITH BEG & ENDING WIP (FIFO)

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STEPS 3, 4, AND 5, EXAMPLE, CASE
3, WITH BEG & ENDING WIP (FIFO)

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RESULT OF THE PROCESS
(NO CHANGE FROM
WEIGHTED AVERAGE)
 Two critical figures arise out of step 5
of the cost-allocation process:
1. The amount of the journal entry
transferring the allocated cost of units
completed and sent from work-in-process
inventory to finished goods inventory.
2. The ending balance of the work-in-
process inventory account that will
appear on the balance sheet.

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COMPARING WEIGHTED-
AVERAGE AND FIFO METHODS
 FIFO assumes that all the higher-cost
units (from our example) from the
previous period in beginning wip are the
first to be completed and transferred
out and that ending wip consists of only
the lower-cost current-period units.
 The weighted-average method smooths
out the cost per equivalent unit by
assuming that more lower-cost units are
transferred out and some higher-cost
remain in ending wip.
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COMPARING WEIGHTED-AVERAGE
AND FIFO METHODS, CONCLUDED
 Managers use information from process-
costing systems to make pricing and
product-mix decisions and understand
how well a firm’s processes are
performing.
 FIFO provides managers with
information about changes in the costs
per unit from one period to the next.
 In a period of rising prices, the
weighted-average method will decrease
taxes because cost of goods sold will be
higher and
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TRANSFERRED-IN COSTS
 Are costs incurred in previous
departments that are carried forward
as the product’s cost when it moves to
a subsequent process in the
production cycle.
 Are also called previous department
costs.
 Journal entries are made to mirror the
progress in production from
department to department.
 Transferred-in costs are treated as if
they are a separate type of direct
material added
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beginning 17-27
of the
STEPS 1 AND 2, EXAMPLE FOR
BEGINNING AND ENDING WIP
AND TRANSFERRED-IN COSTS,
WEIGHTED AVERAGE

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STEPS 3, 4, AND 5, EXAMPLE FOR BEG
& ENDING WIP AND TRANSFERRED-IN
COSTS, WEIGHTED AVERAGE

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STEPS 1 AND 2, EXAMPLE FOR BEG
& ENDING WIP AND TRANSFERRED-
IN COSTS, FIFO

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STEPS 3, 4, AND 5, EXAMPLE FOR
BEG & ENDING WIP AND
TRANSFERRED-IN COSTS, FIFO

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POINTS TO REMEMBER ABOUT
TRANSFERRED-IN COSTS
1. Be sure to include the transferred-in
costs from previous departments in
your calculations.
2. When calculating the costs to be
transferred using the FIFO method, do
not overlook costs that were in
beginning wip which may now be part
of the units transferred.
3. Unit costs may fluctuate between
periods so transferred units may
contain batches accumulated at
different
Copyright costs
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Education, Inc. FIFO).
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POINTS TO REMEMBER ABOUT
TRANSFERRED-IN COSTS,
CONCLUDED
4. Those unit costs discussed in item #3
on the prior slide will be transferred to
the next department at ONE AVERAGE
UNIT cost.
5. Units may be measured in different
denominations in different
departments (feet in one department
and yards in another or kilos vs. liters).
In this case, measurements must be
converted to the correct measure.
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HYBRID COSTING
SYSTEMS
 Product-costing systems do not always fall
neatly into either job-costing or process-
costing categories.
 A Hybrid-costing system blends
characteristics from both job-costing and
process-costing systems.
 Many actual production systems are in fact
hybrids.
 Examples include manufacturers of
televisions, dishwashers, and washing
machines, and shoes who tend to use
hybrid-costing systems.
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HYBRID-COSTING
SYSTEMS, CONCLUDED
 The hybrid-costing systems use process
costing to account for the conversion
costs and job costing for the material
and customizable components.
 One specific type of hybrid-costing
system is known as the Operation-
Costing System

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OPERATION-COSTING
SYSTEM
 An operation is a standardized method or
technique that is performed repetitively
resulting in different finished goods.
 An operation-costing system is a hybrid-costing
system applied to batches of similar, but not
identical, products.
 Within each operation, all product units are
treated exactly alike, using identical amounts
of the operation’s resources.
 Managers find operation costing useful in cost
management because operation costing
focuses on control of physical processes or
operations of a given production system.
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TERMS TO LEARN
TERMS TO LEARN PAGE NUMBER REFERENCE
Equivalent units Page 668
First-in, first-out (FIFO) Page 676
process-costing method
Hybrid-costing system Page 685
Operation Page 686
Operation-costing system Page 686
Previous-department costs Page 681
Transferred-in costs Page 681
Weighted-average process- Page 673
costing method

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