MANAGERIAL ACCOUNTING MANUAL

Module 3

Process Costing
LEARNING OBJECTIVES

1. Discuss the uses of a process cost system and how it compares to a job order
system;
2. Explain the flow of costs in a process cost system and the journal entries to
assign manufacturing costs;
3. Compute equivalent units; and
4. Complete the four steps to prepare a production cost report.

LO1. 3.1 Uses of Process Cost Systems

Discuss the
uses of a
process cost Companies use process cost systems to apply costs to similar products
system and that are mass-produced in a continuous fashion. The processing is the same
how it
for the entire production run—with precisely the same amount of materials,
compares to
a job order labor, and overhead.
system
The production process then caps, labels, packages, and forwards the
bottles to the finished goods warehouse. Illustration 3.1 shows this process.

Illustration 3.2 provides examples of companies that primarily use either

a process cost system or a job order cost system.

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3.2 Similarities and Differences Between Job Order Cost

and Process Cost Systems

Similarities

Job order cost and process cost systems are similar in three ways:

1. The manufacturing cost elements. Both costing systems track three

manufacturing cost elements—direct materials, direct labor, and
manufacturing overhead.

2. The accumulation of the costs of materials, labor, and overhead. Both

costing systems record the acquisition of raw materials as a debit to Raw
Materials Inventory, incurred factory labor as a debit to Factory Labor, and
manufacturing overhead costs as debits to Manufacturing Overhead.

3. The flow of costs. As noted above, both systems accumulate all

manufacturing costs by debits to Raw Materials Inventory, Factory Labor,
and Manufacturing Overhead. Both systems then assign these costs to the
same accounts—Work in Process, Finished Goods Inventory, and Cost of
Goods Sold. The methods of assigning costs, however, differ significantly.
These differences are explained and illustrated later in the chapter.

Differences

The differences between a job order cost and a process cost system are as
follows.

1. The number of work in process accounts used. A job order cost system
uses only one work in process account. A process cost system uses multiple
work in process accounts.

2. Documents used to track costs. A job order cost system charges costs
to individual jobs and summarizes them in a job cost sheet. A process cost
system summarizes costs in a production cost report for each department.

3. The point at which costs are total. A job order cost system totals costs
when the job is completed. A process cost system totals costs at the end
of a period of time.

4. Unit cost computations. In a job order cost system, the unit cost is the
total cost per job divided by the units produced for that job. In a process
cost system, the unit cost is total manufacturing costs for the period divided
by the equivalent units produced during the period.

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Illustration 3.3 shows the basic flow of costs in these two systems.

Illustration 3.4 summarizes the major differences between a job order cost
and a process cost system.

EXAMPLE 1: Indicate whether each of the following statements is true or

false.

1. A law fi rm is likely to use process costing for major lawsuits.

2. A manufacturer of paintballs is likely to use process costing.

3. Both job order and process costing determine product costs at the end
of a period of time, rather than when a product is completed.

4. Process costing does not keep track of manufacturing overhead.

ANSWER: 1. False. 2. True. 3. False. 4. False.

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LO2.
Explain the 3.3 Process Cost Flow and Assigning Costs
flow of costs
in a process Process Cost Flow
cost system
and the Illustration 3.5 shows the flow of costs in the process cost system. The
journal manufactures roller blade and skateboard wheels that it sells to
entries to manufacturers and retail outlets. Manufacturing consists of two processes:
assign machining and assembly. The Machining Department shapes, hones, and
manufacturi drills the raw materials. The Assembly Department assembles and
ng costs.
packages the wheels.

3.4 Assigning Manufacturing Costs—Journal Entries

As indicated, the accumulation of the costs of materials, labor, and
manufacturing overhead is the same in a process cost system as in a job
order cost system. That is, both systems follow these procedures:

• Debit all raw materials acquired to Raw Materials Inventory at the time of
purchase.

• Debit all factory labor to Factory Labor as labor costs are incurred.

• Debit overhead costs to Manufacturing Overhead as these costs are

incurred

3.4.1 Materials Costs

All raw materials issued for production are a material cost to the
producing department. A process cost system may use materials requisition
slips, but it generally requires fewer requisitions than in a job order cost
system. The materials are used for processes rather than for specific jobs
and therefore typically are for larger quantities.

Tyler Company adds materials at the beginning of each process. Suppose

at the beginning of the current period that Tyler adds $50,000 of direct
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materials to the machining process and $20,000 of direct materials to the

assembly process.

Tyler makes the following entry to record the materials used.

3.4.2 Factory Labor Costs

In a process cost system, as in a job order cost system, companies may

use time tickets to determine the cost of labor assignable to production
departments. Since they assign labor costs to a process rather than a job,
they can obtain, from the payroll register or departmental payroll
summaries, the labor cost chargeable to a process.

Suppose that Tyler Company incurs factory labor charges of $20,000 in

the machining process and $13,000 in the assembly process. The entry to
assign labor costs to machining and assembly for Tyler is:

3.4.3 Manufacturing Overhead Costs

The objective in assigning overhead in a process cost system is to

allocate the overhead costs to the production departments on an objective
and equitable basis. That basis is the activity that “drives” or causes the
costs. A primary driver of overhead costs in continuous manufacturing
operations is machine time used, not direct labor. Thus, companies widely
use machine hours in allocating manufacturing overhead costs using
predetermined overhead rates.

Assume that based on machine hours that Tyler Company allocates

overhead of $45,000 to the machining process and $17,000 to the assembly
process. Tyler’s entry to allocate overhead to the two processes is:

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3.4.4 Transfer to Next Department

At the end of the month, Tyler Company needs an entry to record the
cost of the goods transferred out of the Machining Department. In this case,
the transfer is to the Assembly Department. Suppose Tyler transferred
goods with a recorded cost of $87,000 from machining to assembly. Tyler
makes the following entry.

3.4.5 Transfer to Finished Goods

Suppose the Assembly Department completes units with a recorded cost

of $114,000 and then transfers them to the fi nished goods warehouse. The
entry for this transfer is as follows.

3.4.6 Transfer to Cost of Goods Sold

Suppose Tyler Company sells finished good with a recorded cost of

$27,000. It records the cost of goods sold as follows.

EXAMPLE 2: Manufacturing Costs in Process Costing

Ruth Company manufactures ZEBO through two processes: blending and

bottling. In June, raw materials used were Blending $18,000 and Bottling
$4,000. Factory labor costs were Blending $12,000 and Bottling $5,000.
Manufacturing overhead costs assigned were Blending $6,000 and Bottling
$2,500. The company transfers units completed at a cost of $19,000 in the
Blending Department to the Bottling Department. The Bottling Department
transfers units completed at a cost of $11,000 to Finished Goods. Journalize

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the assignment of these costs to the two processes and the transfer of units
as appropriate.

SOLUTION;

The entries are:

Work in Process-Blending 18,000

Work in Process-Bottling 4,000
Raw Materials Inventory 22,000
(To record materials used)

Work in Process-Blending 12,000

Work in Process-Bottling 5,000
Factory Labor 17,000
(To assign factory to Production)

Work in Process-Blending 6,000

Work in Process-Bottling 2,500
Manufacturing Overhead 8,500
(To assign Overhead to Production)

Work in Process-Blending 19,000

Work in Process-Bottling 19,000
(To record transfer of units to the Bottling Dept)

Finished Goods Inventory 11,000

Work in Process-Bottling 11,000
(To reord transfer of units to finished goods)

LO3.
Compute 3.5 Equivalent Units
equivalent
units. Suppose you have a work-study job in the office of your college’s
president, and she asks you to compute the cost of instruction per full-time
equivalent student at your college. The college’s vice president for finance
provides the information shown in Illustration 3.6.

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Part-time students take 60% of the classes of a full-time student during

the year. Illustration 3.7 shows how to compute the number of full-time
equivalent students per year

The cost of instruction per full-time equivalent student is therefore the

total cost of instruction ($9,000,000) divided by the number of full-time
equivalent students (1,500), which is $6,000

3.6 WEIGHTED-AVERAGE METHOD

The formula to compute equivalent units of production is shown in

Illustration 3.8.

Example 1. In a specific period, the entire output of Sullivan Company’s

Blending Department consists of ending work in process of 4,000 units which
are 60% complete as to materials, labor, and overhead.

The equivalent units of production for the Blending Department:

4,000 x 60% = 2,400 units

Example 2. The output of Kori Company’s Packaging Department during the

period consists of 10,000 units completed and transferred out, and 5,000 units
in ending work in process which are 70% completed.

The equivalent units of production:

[10,000 + (5,000 × 70%)]=13,500

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LO4.
Complete 3.7 The Production Cost Report
the four
A production cost report is the key document that management uses to
steps to
prepare a understand the activities in a department; it shows the production quantity
production and cost data related to that department.
cost report.
In order to complete a production cost report, the company must perform
four steps, which as a whole make up the process cost system.

1. Compute the physical unit flow.

2. Compute the equivalent units of production.

3. Compute unit production costs.

4. Prepare a cost reconciliation schedule.

Illustration 3.13 shows assumed data for the Mixing Department at

Kellogg Company for the month of June. We will use this information to
complete a production cost report for the Mixing Department.

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(Step 1) Compute the Physical Unit Flow

Physical units are the actual units to be accounted for during a period,
irrespective of any work performed. To keep track of these units, add the units
started (or transferred) into production during the period to the units in process
at the beginning of the period. This amount is referred to as the total units to
be accounted for. Illustration 3.14 shows the flow of physical units.

(Step 2) Compute the Equivalent Units of Production

The Mixing Department adds materials at the beginning of the process,

and it incurs conversion costs uniformly during the process. The equivalent unit
computation is shown in Illustration 3.15.

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(Step 3) Compute Unit Production Costs

Unit production costs are costs expressed in terms of equivalent units

of production. When equivalent units of production are different for materials
and conversion costs, we compute three unit costs:

(1) materials,
(2) conversion, and
(3) total manufacturing.
The computation of total materials cost related shown in Illustration 3.16

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(Step 4) Prepare a Cost Reconciliation Schedule

We are now ready to determine the cost of goods transferred out of the
Mixing Department to the Baking Department and the costs in ending work in
process. Kellogg charged total costs of $655,000 to the Mixing Department in
June, calculated as shown in Illustration 3.21.

The company then prepares a cost reconciliation schedule (see

Illustration 3.22) to assign these costs to (a) units transferred out to the
Baking Department and (b) ending work in process.

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Preparing the Production Cost Report

Production cost reports provide a basis for evaluating the productivity

of a department. Illustration 3.23 shows the completed production cost report
for the Mixing Department and identifies the four steps

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EXAMPLE 1. faces many situations where it needs to apply the decision tools learned
in this chapter, such as using a production cost report to evaluate profitability. For
example, suppose Jones Soda manufactures a high-end organic fruit soda, called
Eternity, in 10-ounce plastic bottles. Because the market for beverages is highly
competitive, the company is very concerned about keeping its costs under control.
Eternity is manufactured through three processes: blending, filling, and labeling.
Materials are added at the beginning of the process, and labor and overhead are
incurred uniformly throughout each process. The company uses a weighted-average
method to cost its product. A partially completed production cost report for the month
of May for the Blending Department is shown below.

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Instructions

a. Prepare a production cost report for the Blending Department for the month of
May.

b. Prepare the journal entry to record the transfer of goods from the Blending
Department to the Filling Department.

c. Explain why Jones Soda is using a process cost system to account for its costs.

SOLUTION:

a.

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b. Work in Process—Filling 131,780

Work in Process—Blending 131,780

c. Companies use process cost systems to apply costs to similar products that are
mass-produced in a continuous fashion. Jones Soda uses a process cost system
because production of the fruit soda, once it begins, continues until the soda emerges.
The processing is the same for the entire run—with precisely the same amount of
materials, labor, and overhead. Each bottle of Eternity soda is indistinguishable from
another.

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Name: _______________________________ Score: _____________

Section/Course Code: _________________ Date: ______________

Exercise No. 3

1. Armando Company manufactures pizza sauce through two production departments:

Cooking and Canning. In each process, materials and conversion costs are incurred
evenly throughout the process. For the month of April, the work in process accounts
show the following debits.

Cooking Canning
Beginning work in process $–0– $ 4,000
Materials 25,000 8,000
Labor 8,500 7,500
Overhead 29,000 25,800
Costs transferred in 55,000

Instructions
Journalize the April transactions.

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2. The Sanding Department of Jo Furniture Company has the following production and
manufacturing cost data for March 2020, the first month of operation.

Production: 11,000 units finished and transferred out; 4,000 units started that
are 100% complete as to materials and 25% complete as to conversion costs.

Manufacturing costs: Materials $48,000; labor $42,000; and overhead $36,000.

Instructions
Prepare a production cost report.

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