In process cost accounting manufacturing costs are summarized on a

Accounting

Process Costing

 CHAPTER PREVIEW 

As the Feature Story describes, the cost accounting system used by companies such as Jones Soda is process cost accounting. In contrast to job order cost accounting, which focuses on the individual job, process cost accounting focuses on the processes involved in mass‐producing products that are identical or very similar in nature. The primary objective of this chapter is to explain and illustrate process costing.

A chart lists learning objectives and do it practices in this chapter. Learning objective 1: discuss the uses of a process cost system and how it compares to a job order system covers uses of process cost systems, process costing for service companies, and comparing job order and process cost systems. Do it practice 1: compare job order and process cost systems. Learning objective 2: explain the flow of costs in a process cost system and the journal entries to assign manufacturing costs covers process cost flow and assigning manufacturing costs. Do it practice 2: manufacturing costs in process costing. Learning objective 3: compute equivalent units covers weighted-average method and refinements on the method. Do it practice 3: equivalent units. Learning objective 4: complete the four steps to prepare a production cost report covers physical unit flow, equivalent units of production, unit production costs, cost reconciliation schedule, and production cost report. Do it practice 4: cost reconciliation schedule. Go to the review and practice section at the end of the chapter for a targeted summary and exercises with solutions. Visit WileyPlus for additional tutorials and practice opportunities.

The Little Guy Who Could

It isn't easy for a small company to get a foothold in the bottled beverage business. The giants, The Coca‐Cola Company and PepsiCo Inc., vigilantly defend their turf, constantly watching for new trends and opportunities. It is nearly impossible to get shelf space in stores, and consumer tastes can change faster than a bottle of soda can lose its fizz. But Jones Soda Co., headquartered in Seattle, has overcome these and other obstacles to make a name for itself. Its corporate motto is, “Run with the little guy … create some change.”

The company started as a Canadian distributor of other companies' beverages. Soon, it decided to make its own products under the corporate name Urban Juice and Soda Company. Eventually, its name changed to Jones Soda—the name of its most popular product. From the very start, Jones Soda was different. It sold soda from machines placed in tattoo parlors and piercing shops, and it sponsored a punk rock band as well as surfers and snowboarders. At one time, the company's product was the official drink at the Seattle Seahawks' stadium and was served on Alaskan Airlines.

Today, Jones Soda makes a wide variety of products: soda‐flavored candy, energy drinks, and product‐promoting gear that includes t‐shirts, sweatshirts, caps, shorts, and calendars. Its most profitable product is still its multi‐flavored, pure cane soda with its creative labeling. If you've seen Jones Soda on a store shelf, then you know that it appears to have an infinite variety of labels. The bottle labels are actually created by customers and submitted on the company's website. (To see some of the best labels from the past, see the Gallery at www.jonessoda.com.) If you would like some soda with a custom label of your own, you can design and submit a label and order a 12‐pack.

Because Jones Soda has a dizzying array of product variations, keeping track of costs is of vital importance. Recently, management developed a reorganization plan that involved cost‐cutting from top to bottom and eliminating unprofitable products. No matter how good your products are, if you don't keep your costs under control, you are likely to fail. Jones Soda's managers need accurate cost information regarding each primary product and each variation to ensure profitability. So while its marketing approach differs dramatically from the giants, Jones Soda needs the same kind of cost information as the big guys.

LEARNING OBJECTIVE 1

Discuss the uses of a process cost system and how it compares to a job order system.

USES OF PROCESS COST SYSTEMS

Companies use process cost systems to apply costs to similar products that are mass‐produced in a continuous fashion. Jones Soda Co. uses a process cost system: Production of the 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 finished bottle of soda is indistinguishable from another.

A company such as USX uses process costing in the manufacturing of steel. Kellogg and General Mills use process costing for cereal production; ExxonMobil uses process costing for its oil refining. Sherwin Williams uses process costing for its paint products. At a bottling company like Jones Soda, the manufacturing process begins with the blending of ingredients. Next, automated machinery moves the bottles into position and fills them. The production process then caps, packages, and forwards the bottles to the finished goods warehouse. Illustration 16-1 shows this process.

An illustration shows manufacturing processes as ‘blending’, to ‘filling’, to ‘labeling’. ILLUSTRATION 16-1 Manufacturing processes

For Jones Soda, as well as the other companies just mentioned, once production begins, it continues until the finished product emerges. Each unit of finished product is like every other unit.

In comparison, a job order cost system assigns costs to a specific job. Examples are the construction of a customized home, the making of a movie, or the manufacturing of a specialized machine. Illustration 16-2 provides examples of companies that primarily use either a process cost system or a job order cost system.

Image described by surrounding text ILLUSTRATION 16-2 Process cost and job order cost companies and products

PROCESS COSTING FOR SERVICE COMPANIES

When considering service companies, you might initially think of specific, nonroutine tasks, such as rebuilding an automobile engine, consulting on a business acquisition, or defending a major lawsuit. However, many service companies perform repetitive, routine work. For example, Jiffy Luberegularly performs oil changes. H&R Block focuses on the routine aspects of basic tax practice. Service companies that perform individualized, nonroutine services will probably benefit from using a job order cost system. Those that perform routine, repetitive services will probably be better off with a process cost system.

SIMILARITIES AND DIFFERENCES BETWEEN JOB ORDER COST AND PROCESS COST SYSTEMS

In a job order cost system, companies assign costs to each job. In a process cost system, companies track costs through a series of connected manufacturing processes or departments, rather than by individual jobs. Thus, companies use process cost systems when they produce a large volume of uniform or relatively homogeneous products. Illustration 16-3 shows the basic flow of costs in these two systems.

An illustration shows Job order cost and process cost flow as follows: • Job Order Cost Flow: Direct materials, direct labor, manufacturing and overhead leading to work in process inventory (job no. 101, job no. 102 and job no. 103), to finished goods inventory, to cost of goods sold. • Process Cost Flow: Direct materials, direct labor, manufacturing and overhead leading to Work in Process–Department A, to Work in Process–Department B, to finished goods inventory, to cost of goods sold. ILLUSTRATION 16-3 Job order cost and process cost flow

The following analysis highlights the basic similarities and differences between these two 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 debit raw materials to Raw Materials Inventory, factory labor to Factory Labor, and manufacturing overhead costs 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 totaled. 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. In a process cost system, the unit cost is total manufacturing costs for the period divided by the equivalent units produced during the period.

Illustration 16-4 summarizes the major differences between a job order cost and a process cost system.

Feature

Job Order Cost System

Process Cost System

Work in process accounts

One work in process account

Multiple work in process accounts

Documents used

Job cost sheets

Production cost reports

Determination of total manufacturing costs

Each job

Each period

Unit-cost computations

Cost of each job ÷ Units produced for the job

Total manufacturing costs ÷ Equivalent units produced during the period

ILLUSTRATION 16-4 Job order versus process cost systems

DO IT! 1

Compare Job Order and Process Cost Systems

Indicate whether each of the following statements is true or false.

1. A law firm 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.

Action Plan

✓ Use job order costing in situations where unit costs are high, unit volume is low, and products are unique.

✓ Use process costing when there is a large volume of relatively homogeneous products.

SOLUTION

1. False.

2. True.

3. False.

4. False.

Related exercise material: E16-1 and DO IT! 16-1.

LEARNING OBJECTIVE 2

Explain the flow of costs in a process cost system and the journal entries to assign manufacturing costs.

PROCESS COST FLOW

Illustration 16-5 shows the flow of costs in the process cost system for Tyler Company. Tyler manufactures roller blade and skateboard wheels that it sells to manufacturers and retail outlets. Manufacturing consists of two processes: machining and assembly. The Machining Department shapes, hones, and drills the raw materials. The Assembly Department assembles and packages the parts.

image described by surrounding text. ILLUSTRATION 16-5 Flow of costs in process cost system

As the flow of costs indicates, the company can add materials, labor, and manufacturing overhead in both the Machining and Assembly Departments. When it finishes its work, the Machining Department transfers the partially completed units to the Assembly Department. The Assembly Department finishes the goods and then transfers them to the finished goods inventory. Upon sale, Tyler removes the goods from the finished goods inventory. Within each department, a similar set of activities is performed on each unit processed.

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:

· Companies debit all raw materials to Raw Materials Inventory at the time of purchase.

· They debit all factory labor to Factory Labor as the labor costs are incurred.

· They debit overhead costs to Manufacturing Overhead as these costs are incurred.

However, the assignment of the three manufacturing cost elements to Work in Process in a process cost system is different from a job order cost system. Here we'll look at how companies assign these manufacturing cost elements in a process cost system.

Materials Costs

All raw materials issued for production are a materials 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.

At the beginning of the first process, a company usually adds most of the materials needed for production. However, other materials may be added at various points. For example, in the manufacture of Hershey candy bars, the chocolate and other ingredients are added at the beginning of the first process, and the wrappers and cartons are added at the end of the packaging process. Tyler Company adds materials at the beginning of each process. Tyler makes the following entry to record the materials used.

Work in Process—Machining

XXXX

Work in Process—Assembly

XXXX

 Raw Materials Inventory

XXXX

  (To record materials used)

Ice cream maker Ben & Jerry's adds materials in three departments: milk and flavoring in the mixing department, extras such as cherries and dark chocolate in the prepping department, and cardboard containers in the pinting (packaging) department.

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.

Labor costs for the Machining Department include the wages of employees who shape, hone, and drill the raw materials. The entry to assign labor costs to machining and assembly for Tyler Company is:

Work in Process—Machining

XXXX

Work in Process—Assembly

XXXX

 Factory Labor

XXXX

  (To assign factory labor to production)

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. Tyler Company's entry to allocate overhead to the two processes is:

Work in Process—Machining

XXXX

Work in Process—Assembly

XXXX

 Manufacturing Overhead

XXXX

  (To assign overhead to production)

 MANAGEMENT INSIGHT 

Caterpillar

Choosing a Cost Driver

In one of its automated cost centers, Caterpillar feeds work into the cost center, where robotic machines process it and transfer the finished job to the next cost center without human intervention. One person tends all of the machines and spends more time maintaining machines than operating them. In such cases, overhead rates based on direct labor hours may be misleading. Surprisingly, some companies continue to assign manufacturing overhead on the basis of direct labor despite the fact that there is no cause‐and‐effect relationship between labor and overhead.

What is the result if a company uses the wrong “cost driver” to assign manufacturing overhead? (Go to WileyPLUS for this answer and additional questions.)

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, and Tyler makes the following entry.

Work in Process—Assembly

XXXXX

Work in Process—Machining

XXXXX

  (To record transfer of units to the Assembly Department)

Transfer to Finished Goods

When the Assembly Department completes the units, it transfers them to the finished goods warehouse. The entry for this transfer is as follows.

Finished Goods Inventory

XXXXX

 Work in Process—Assembly

XXXXX

  (To record transfer of units to finished goods)

Transfer to Cost of Goods Sold

When Tyler Company sells the finished goods, it records the cost of goods sold as follows.

Cost of Goods Sold

XXXXX

 Finished Goods Inventory

XXXXX

  (To record cost of units sold)

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

Action Plan

✓ In process cost accounting, keep separate work in process accounts for each process.

✓ When the costs are assigned to production, debit the separate work in process accounts.

✓ Transfer cost of completed units to the next process or to Finished Goods.

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 labor 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—Bottling

19,000

 Work in Process—Blending

19,000

  (To record transfer of units to the Bottling Department)

Finished Goods Inventory

11,000

 Work in Process—Bottling

11,000

  (To record transfer of units to finished goods)

Related exercise material: BE16-1, BE16-2, BE16-3, E16-2, E16-4, and DO IT! 16-2.

LEARNING OBJECTIVE 3

Compute 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 following information.

Costs:

 Total cost of instruction

$9,000,000

Student population:

 Full-time students

900

 Part-time students

1,000

ILLUSTRATION 16-6 Information for full‐time student example

Part‐time students take 60% of the classes of a full‐time student during the year. To compute the number of full‐time equivalent students per year, you would make the following computation.

Full‐Time Students+Equivalent Units of Part‐Time Students=Full‐Time Equivalent Students900+(1,000×60%)=1,500Full‐Time Students+Equivalent Units of Part‐Time Students=Full‐Time Equivalent Students900+(1,000×60%)=1,500ILLUSTRATION 16-7 Full‐time equivalent unit computation

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 ($9,000,000÷1,500)$6,000 ($9,000,000÷1,500).

A process cost system uses the same idea, called equivalent units of production. Equivalent units of production measure the work done during the period, expressed in fully completed units. Companies use this measure to determine the cost per unit of completed product.

WEIGHTED‐AVERAGE METHOD

The formula to compute equivalent units of production is as follows.

Units Completed and Transferred Out+Equivalent Units of Ending Work in Process=Equivalent Units of ProductionUnits Completed and Transferred Out+Equivalent Units of Ending Work in Process=Equivalent Units of Production ILLUSTRATION 16-8 Equivalent units of production formula

To better understand this concept of equivalent units, consider the following two separate examples.

· 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 are therefore 2,400 units (4,000×60%)(4,000×60%).

· 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 are therefore 13,500 [10,000+(5,000×70%)]13,500 [10,000+(5,000×70%)].

This method of computing equivalent units is referred to as the weighted‐average method . It considers the degree of completion (weighting) of the units completed and transferred out and the ending work in process.

REFINEMENTS ON THE WEIGHTED‐AVERAGE METHOD

Kellogg Company has produced Eggo® Waffles since 1970. Three departments produce these waffles: Mixing, Baking, and Freezing/Packaging. The Mixing Department combines dry ingredients, including flour, salt, and baking powder, with liquid ingredients, including eggs and vegetable oil, to make waffle batter. Illustration 16-9 provides information related to the Mixing Department at the end of June.

MIXING DEPARTMENT

Percentage Complete

Physical Units

Materials

Conversion Costs

Work in process, June 1

100,000

100%

70%

Started into production

800,000

Total units

900,000

Units transferred out

700,000

Work in process, June 30

200,000

100%

60%

Total units

900,000

ILLUSTRATION 16-9 Information for Mixing Department

▼ HELPFUL HINT

Separate unit cost computations are needed for materials and conversion costs whenever the two types of costs do not occur in the process at the same time.

ETHICS NOTE

An unethical manager might use incorrect completion percentages when determining equivalent units. This results in either raising or lowering costs. Since completion percentages are somewhat subjective, this form of income manipulation can be difficult to detect.

Illustration 16-9 indicates that the beginning work in process is 100% complete as to materials cost and 70% complete as to conversion costs. Conversion costs are the sum of labor costs and overhead costs. In other words, Kellogg adds both the dry and liquid ingredients (materials) at the beginning of the waffle‐making process, and the conversion costs (labor and overhead) related to the mixing of these ingredients are incurred uniformly and are 70% complete. The ending work in process is 100% complete as to materials cost and 60% complete as to conversion costs.

We then use the Mixing Department information to determine equivalent units. In computing equivalent units, the beginning work in process is not part of the equivalent‐units‐of‐production formula. The units transferred out to the Baking Department are fully complete as to both materials and conversion costs. The ending work in process is fully complete as to materials, but only 60% complete as to conversion costs. We therefore need to make two equivalent unit computations: one for materials, and the other for conversion costs. Illustration 16-10 shows these computations.

MIXING DEPARTMENT

Equivalent Units

Materials

Conversion Costs

Units transferred out

700,000

700,000

Work in process, June 30

 200,000 × 100%

200,000

 200,000 × 60%

120,000

Total equivalent units

900,000

820,000

ILLUSTRATION 16-10 Computation of equivalent units—Mixing Department

We can refine the earlier formula used to compute equivalent units of production ( Illustration 16-8 , page 796) to show the computations for materials and for conversion costs, as follows.

Units Completed andTransferred Out—Materials+Equivalent Units ofEnding Work inProcess—Materials=Equivalent Units ofProduction—MaterialsUnits Completed andTransferred Out—Conversion Costs+Equivalent Units ofEnding Work inProcess—ConversionCosts=Equivalent Units ofProduction—Conversion CostsUnits Completed andTransferred Out—Materials+Equivalent Units ofEnding Work inProcess—Materials=Equivalent Units ofProduction—MaterialsUnits Completed andTransferred Out—Conversion Costs+Equivalent Units ofEnding Work inProcess—ConversionCosts=Equivalent Units ofProduction—Conversion CostsILLUSTRATION 16-11 Refined equivalent units of production formula

 PEOPLE, PLANET, AND PROFIT INSIGHT 

General Electric

Haven't I Seen That Before?

For a variety of reasons, many companies, including General Electric, are making a big push to remanufacture goods that have been thrown away. Items getting a second chance include cell phones, computers, home appliances, car parts, vacuum cleaners, and medical equipment. Businesses have figured out that profit margins on remanufactured goods are significantly higher than on new goods. As commodity prices such as copper and steel increase, reusing parts makes more sense. Also, as more local governments initiate laws requiring that electronics and appliances be recycled rather than thrown away, the cost of remanufacturing declines because the gathering of used goods becomes far more efficient. Besides benefitting the manufacturer, remanufacturing provides goods at a much lower price to consumers, reduces waste going to landfills, saves energy, reuses scarce resources, and reduces emissions. For example, it was estimated that a remanufactured car starter results in about 50% less carbon dioxide emissions than making a new one.

Source: James R. Hagerty and Paul Glader, “From Trash Heap to Store Shelf,” Wall Street Journal Online (January 24, 2011).

In what ways might the relative composition (materials, labor, and overhead) of a remanufactured product's cost differ from that of a newly made product? (Go to WileyPLUS for this answer and additional questions.)

DO IT! 3

Equivalent Units

The Fabricating Department for Outdoor Essentials has the following production and cost data for the current month.

Beginning Work in Process

Units Transferred Out

Ending Work in Process

–0–

15,000

10,000

Materials are entered at the beginning of the process. The ending work in process units are 30% complete as to conversion costs. Compute the equivalent units of production for (a) materials and (b) conversion costs.

Action Plan

✓ To measure the work done during the period, expressed in fully completed units, compute equivalent units of production.

✓ Use the appropriate formula: Units completed and transferred out + Equivalent units of ending work in process = Equivalent units of production.

SOLUTION

(a) Since materials are entered at the beginning of the process, the equivalent units of ending work in process are 10,000. Thus, 15,000 units+10,000 units=25,00015,000 units+10,000 units=25,000 equivalent units of production for materials.

(b) Since ending work in process is only 30% complete as to conversion costs, the equivalent units of ending work in process are 3,000 (10,000 units×30%)3,000 (10,000 units×30%). Thus, 15,000 units+3,000 units=18,00015,000 units+3,000 units=18,000 equivalent units of production for conversion costs.

Related exercise material: BE16-4, BE16-5, E16-5, E16-6, E16-8, E16-9, E16-10, E16-11, E16-13, E16-14, E16-15, and DO IT! 16-3.

LEARNING OBJECTIVE 4

Complete the four steps to prepare a production cost report.

As mentioned earlier, companies prepare a production cost report for each department. A production cost report is the key document that management uses to understand the activities in a department; it shows the production quantity and cost data related to that department. For example, in producing Eggo® Waffles, Kellogg Company uses three production cost reports: Mixing, Baking, and Freezing/Packaging. Illustration 16-12 shows the flow of costs to make an Eggo® Waffle and the related production cost reports for each department.

An illustration shows Flow of costs in making Eggo® Waffles. There are three red outgoing arrows from a block Raw Materials, Factory Labor, and Manufacturing Overhead, pointing to three blocks in the same line below. The blocks contain Mixing Department, Baking Department, and Freezing/Packaging. Another red arrows, labelled WIP, go from Mixing Department to Baking Department to Freezing/Packaging. A red arrow from Freezing/Packaging is pointing to Finished Goods. There are three block arrows from Mixing Department, Baking Department, and Freezing/Packaging, pointing to three blocks below, each of which contains Production Cost Report. ILLUSTRATION 16-12 Flow of costs in making Eggo® Waffles

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 16-13 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.

MIXING DEPARTMENT

Units

Work in process, June 1

100,000

 Direct materials: 100% complete

 Conversion costs: 70% complete

Units started into production during June

800,000

Units completed and transferred out to Baking Department

700,000

Work in process, June 30

200,000

 Direct materials: 100% complete

 Conversion costs: 60% complete

Costs

Work in process, June 1

 Direct materials: 100% complete

$ 50,000

 Conversion costs: 70% complete

35,000

Cost of work in process, June 1

$ 85,000

Costs incurred during production in June

 Direct materials

$400,000

 Conversion costs

 170,000

Costs incurred in June

$570,000

ILLUSTRATION 16-13 Unit and cost data—Mixing Department

COMPUTE THE PHYSICAL UNIT FLOW (STEP 1)

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 .

The total units then are accounted for by the output of the period. The output consists of units transferred out during the period and any units in process at the end of the period. This amount is referred to as the total units accounted for . Illustration 16-14 shows the flow of physical units for Kellogg's Mixing Department for the month of June.

MIXING DEPARTMENT

Physical Units

Units to be accounted for

 Work in process, June 1

100,000

 Started (transferred) into production

800,000

Total units

900,000

Units accounted for

 Completed and transferred out

700,000

 Work in process, June 30

200,000

Total units

900,000

ILLUSTRATION 16-14 Physical unit flow—Mixing Department

The records indicate that the Mixing Department must account for 900,000 units. Of this sum, 700,000 units were transferred to the Baking Department and 200,000 units were still in process.

COMPUTE THE EQUIVALENT UNITS OF PRODUCTION (STEP 2)

Once the physical flow of the units is established, Kellogg must measure the Mixing Department's productivity in terms of equivalent units of production. The Mixing Department adds materials at the beginning of the process, and it incurs conversion costs uniformly during the process. Thus, we need two computations of equivalent units: one for materials and one for conversion costs. The equivalent unit computation is as follows.

▼ HELPFUL HINT

Materials are not always added at the beginning of the process. For example, materials are sometimes added uniformly during the process.

Equivalent Units

Materials

Conversion Costs

Units transferred out

700,000

700,000

Work in process, June 30

 200,000 × 100%

200,000

 200,000 × 60%

120,000

Total equivalent units

900,000

820,000

ILLUSTRATION 16-15 Computation of equivalent units—Mixing Department

▼ HELPFUL HINT

Remember that we ignore the beginning work in process in this computation.

COMPUTE UNIT PRODUCTION COSTS (STEP 3)

Armed with the knowledge of the equivalent units of production, we can now compute the 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 to Eggo® Waffles is as follows.

Work in process, June 1

 Direct materials cost

$ 50,000

Costs added to production during June

 Direct materials cost

400,000

Total materials cost

$450,000

ILLUSTRATION 16-16 Total materials cost computation

The computation of unit materials cost is as follows.

Total Materials Cost÷Equivalent Units of Materials=Unit Materials Cost$450,000÷900,000=$0.50Total Materials Cost÷Equivalent Units of Materials=Unit Materials Cost$450,000÷900,000=$0.50ILLUSTRATION 16-17 Unit materials cost computation

Work in process, June 1

 Conversion costs

$  35,000

Costs added to production during June

 Conversion costs

170,000

Total conversion costs

$205,000

ILLUSTRATION 16-18 Total conversion costs computation

The computation of unit conversion cost is as follows.

Total Conversion Costs÷Equivalent Units of Conversion Costs=Unit Conversion Cost$205,000÷820,000=$0.25Total Conversion Costs÷Equivalent Units of Conversion Costs=Unit Conversion Cost$205,000÷820,000=$0.25ILLUSTRATION 16-19 Unit conversion cost computation

Total manufacturing cost per unit is therefore computed as shown in Illustration 16-20 (page 802).

Unit Materials Cost+Unit Conversion Cost=Total Manufacturing Cost per Unit$0.50+$0.25=$0.75Unit Materials Cost+Unit Conversion Cost=Total Manufacturing Cost per Unit$0.50+$0.25=$0.75 ILLUSTRATION 16-20 Total manufacturing cost per unit

PREPARE A COST RECONCILIATION SCHEDULE (STEP 4)

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 follows.

Costs to be accounted for

 Work in process, June 1

$ 85,000

 Started into production

570,000

Total costs

$655,000

ILLUSTRATION 16-21 Costs charged to Mixing Department

The company then prepares a cost reconciliation schedule to assign these costs to (a) units transferred out to the Baking Department and (b) ending work in process.

MIXING DEPARTMENT Cost Reconciliation Schedule

Costs accounted for

 Transferred out (700,000 × $0.75)

$ 525,000

 Work in process, June 30

  Materials (200,000 × $0.50)

$100,000

  Conversion costs (120,000 × $0.25)

30,000

130,000

Total costs

$655,000

ILLUSTRATION 16-22 Cost reconciliation schedule—Mixing Department

Kellogg uses the total manufacturing cost per unit, $0.75, in costing the units completed and transferred to the Baking Department. In contrast, the unit cost of materials and the unit cost of conversion are needed in costing ending units in process. The cost reconciliation schedule shows that the total costs accounted for ( Illustration 16-22 ) equal the total costs to be accounted for ( Illustration 16-21 ).

PREPARING THE PRODUCTION COST REPORT

At this point, Kellogg is ready to prepare the production cost report for the Mixing Department. As indicated earlier, this report is an internal document for management that shows production quantity and cost data for a production department. Illustration 16-23 shows the completed production cost report for the Mixing Department and identifies the four steps used in preparing it.

Production cost reports provide a basis for evaluating the productivity of a department. In addition, managers can use the cost data to assess whether unit costs and total costs are reasonable. By comparing the quantity and cost data with predetermined goals, top management can also judge whether current performance is meeting planned objectives.

DECISION TOOLS Decision Tool

A production cost report helps managers evaluate overall profitability by comparing costs to previous periods, competitors, and expected selling price.

An illustration shows a screenshot of production cost report. The report displays a three line heading consisting of the name of the department, Mixing Department; the type of report, Production Cost Report; and the time period the statement covers, For the Month Ended June 30, 2017. There are three sections and four columns. In the first section, the first column has Quantities, with the amounts in the next three numeric columns Physical Units, Materials, and Conversion Costs, presented in the Equivalent Units. Immediately below Quantities, there is Units to be accounted for displayed with Step 1 and Step 2 written in the next columns. Work in process, June 1 and Started into production are listed below, slightly indented with the amounts in the second column as: 100,000 and 800,000. The total is shown as Total units, 900,000. The next lines show Units accounted for, with the following entries listed slightly indented as follows Transferred out, 700,000, 700,000, 700,000; and Work in process, June 30, 200,000, 200,000, and 200,000. In the next column, the calculation is given as 200,000 ® 60%. In the second section, the first column has Costs, and Unit costs, immediately below it with Step 3 written next to it and the amounts are shown in the next three numeric columns Materials, Conversion Costs, and Total. Immediately below Unit cost there are following entries: Total cost, $450,00, $205,000, $655,000 with (a) written next to the amount; Equivalent units, 900,000, 820,000 with (b) written next to the amount. The next line shows Unit costs [(a) ÷ (b)] with the amounts as follows: $0.50, $0.25, $0.75. The next lines display Costs to be accounted for with Work in process, June 1 and Started into production listed slightly indented below, with the amounts $85,000 and 570,000 in the last column. The Total costs, in the next line, is calculated as $655,000. In the third section, the first column has Cost Reconciliation Schedule with Step 4 written next to it and the amounts are shown in the next three numeric columns. The next lines display Costs to be accounted with the following entries: Transferred out (700,000 ® $0.75), $525,000 in the last column; Work in process, June 30 with the following entries listed slightly indented: Materials (200,000 ® $0.50), $100,000 and Conversion costs (120,000 ® $0.25), 30,000, 130,000. The last line shows the Total cost in the first column with $655,000 in the last column. and Started into production listed slightly indented below, with the amounts $85,000 and 570,000 in the last column. The Total costs, in the next line, is calculated as $655,000. ILLUSTRATION 16-23 Production cost report

▼ HELPFUL HINT

The four steps in preparing a production cost report:

1. Compute the physical unit flow.

2. Compute the equivalent units of production.

3. Compute unit production costs.

4. Prepare a cost reconciliation schedule.

COSTING SYSTEMS—FINAL COMMENTS

Companies often use a combination of a process cost and a job order cost system. Called operations costing , this hybrid system is similar to process costing in its assumption that standardized methods are used to manufacture the product. At the same time, the product may have some customized, individual features that require the use of a job order cost system.

DECISION TOOLS Decision Tool

A cost‐benefit trade‐off helps managers determine which costing system to use.

Consider, for example, Ford Motor Company. Each vehicle at a given plant goes through the same assembly line, but Ford uses different materials (such as seat coverings, paint, and tinted glass) for different vehicles. Similarly, Kellogg's Pop‐Tarts® toaster pastries go through numerous standardized processes—mixing, filling, baking, frosting, and packaging. The pastry dough, though, comes in different flavors—plain, chocolate, and graham—and fillings include Smucker's® real fruit, chocolate fudge, vanilla creme, brown sugar cinnamon, and s'mores.

A cost‐benefit trade‐off occurs as a company decides which costing system to use. A job order cost system, for example, provides detailed information related to the cost of the product. Because each job has its own distinguishing characteristics, the system can provide an accurate cost per job. This information is useful in controlling costs and pricing products. However, the cost of implementing a job order cost system is often expensive because of the accounting costs involved.

On the other hand, for a company like Intel, is there a benefit in knowing whether the cost of the one‐hundredth computer chip produced is different from the one‐thousandth chip produced? Probably not. An average cost of the product will suffice for control and pricing purposes.

In summary, when deciding to use one of these systems or a combination system, a company must weigh the costs of implementing the system against the benefits from the additional information provided.

DO IT! 4

Cost Reconciliation Schedule

In March, Rodayo Manufacturing had the following unit production costs: materials $6 and conversion costs $9. On March 1, it had no work in process. During March, Rodayo transferred out 12,000 units. As of March 31, 800 units that were 25% complete as to conversion costs and 100% complete as to materials were in ending work in process. Assign the costs to the units transferred out and in process.

Action Plan

✓ Assign the total manufacturing cost of $15 per unit to the 12,000 units transferred out.

✓ Assign the materials cost and conversion costs based on equivalent units of production to units in ending work in process.

SOLUTION

The assignment of costs is as follows.

Costs accounted for

 Transferred out (12,000 × $15)

 $180,000

 Work in process, March 31

  Materials (800 × $6)

$4,800

  Conversion costs (200 * × $9)

1,800

6,600

Total costs

$186,600

* 800×25%800×25%

Related exercise material: BE16-6, BE16-7, BE16-8, BE16-9, E16-3, E16-5, E16-6, E16-7, E16-8, E16-9, E16-10, E16-11, E16-13, E16-14, E16-15,and DO IT! 16-4.

USING DECISION TOOLS—JONES SODA

Jones Soda Co. 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.

JONES SODA Blending Department Production Cost Report For the Month Ended May 31, 2017

Equivalent Units

Quantities

Physical Units

Materials

Conversion Costs

Units to be accounted for

Step 1Step 1

Step 2Step 2

 Work in process, May 1

1,000

 Started into production

2,000

Total units

3,000

Units accounted for

 Transferred out

2,200

?

?

 Work in process, May 31

  800

?

?

Total units

3,000

?

?

Costs

Materials

Conversion Costs

Total

Unit costs Step 3Step 3

 Total cost

(a)

?

?

?

 Equivalent units

(b)

?

?

 Unit costs [(a)÷(b)][(a)÷(b)]

?

?

?

Costs to be accounted for

 Work in process, May 1

$ 56,300

 Started into production

 119,320

Total costs

$175,620

Cost Reconciliation Schedule Step 4Step 4

Costs accounted for

 Transferred out

?

 Work in process, May 31

  Materials

?

  Conversion costs

?

?

Total costs

?

Additional information:

 Work in process, May 1, 1000 units

  Materials cost, 1,000 units (100% complete)

$49,100

  Conversion costs, 1,000 units (70% complete)

  7,200

$ 56,300

 Materials cost for May, 2,000 units

$100,000

 Work in process, May 31, 800 units, 100% complete as to materials and 50% complete as to conversion costs

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) A completed production cost report for the Blending Department is shown below. Computations to support the amounts reported follow the report.

JONES SODA Blending Department Production Cost Report For the Month Ended May 31, 2017

Equivalent Units

Quantities

Physical Units

Materials

Conversion Costs

Units to be accounted for

Step 1Step 1

Step 2Step 2

 Work in process, May 1

1,000

 Started into production

2,000

Total units

3,000

Units accounted for

 Transferred out

2,200

2,200

2,200

 Work in process, May 31

800

800

400

(800×50%)(800×50%)

Total units

3,000

3,000

2,600

Costs

Materials

Conversion Costs

Total

Unit costs Step 3Step 3

 Total cost

(a)

$149,100 *

$26,520 **

$175,620

 Equivalent units

(b)

3,000 

2,600  

 Unit costs [(a)÷(b)][(a)÷(b)]

$49.70 

$10.20  

$59.90

Costs to be accounted for

 Work in process, May 1

$ 56,300

 Started into production

119,320

Total costs

$175,620

* Materials cost—$49,100+$100,000Materials cost—$49,100+$100,000

** Conversion costs—$7,200+$19,320 ($119,320−$100,000)Conversion costs—$7,200+$19,320 ($119,320−$100,000)

Cost Reconciliation Schedule Step 4Step 4

Costs accounted for

 Transferred out (2,200 × $59.90)

$131,780

 Work in process, May 31

  Materials (800 × $49.70)

$39,760

  Conversion costs (400 × $10.20)

4,080

43,840

Total costs

$175,620

(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.

LEARNING OBJECTIVE *5

APPENDIX 16A: Compute equivalent units using the FIFO method.

In this chapter, we demonstrated the weighted‐average method of computing equivalent units. Some companies use a different method, referred to as the first‐in, first‐out (FIFO) method, to compute equivalent units. The purpose of this appendix is to illustrate how companies use the FIFO method to prepare a production cost report.

EQUIVALENT UNITS UNDER FIFO

Under the FIFO method, companies compute equivalent units on a first‐in, first‐out basis. Some companies favor the FIFO method because the FIFO cost assumption usually corresponds to the actual physical flow of the goods. Under the FIFO method, companies therefore assume that the beginning work in process is completed before new work is started.

Using the FIFO method, equivalent units are the sum of the work performed to:

1. Finish the units of beginning work in process inventory.

2. Complete the units started into production during the period (referred to as the units started and completed).

3. Start, but only partially complete, the units in ending work in process inventory.

Normally, in a process cost system, some units will always be in process at both the beginning and end of the period.