Managerial Accounting

1
Managerial Accounting

• B11-A681
• Chapter 23
• Process Costing

2
Learning Objectives

• Explain process operations and how they differ
  from job order operations
• Compare process cost accounting to job order cost
  accounting systems
• Record the flow of direct materials in process
  costing
• Record the flow of direct labour in process
  costing
• Record the flow of factory overhead in process
  costing
• Define equivalent units and explain their use in
  process cost accounting

3
Learning Objectives

• Compute equivalent units produced in a period
• Explain the four steps in accounting for
  production activity
• Define a process cost summary and describe its
  purposes
• Prepare a process cost summary
• Record the transfer of goods between departments
• Record the transfer of goods from finished goods
  to cost of goods sold
• Analyze cost per equivalent unit with and without
  spoiled units

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Process Costing

• Process costing is the mass production of many
  homogenous units.
• Examples of process costing include oil
  refineries, automobile production plants,
  carpeting, paint, hand tools and even Canada Post.

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Process vs Job Order

• Process Costing
• Repetitive production
• Homogenous products
• High production volume
• Low product flexibility
• High standardization

• Job Order Costing
• Custom orders
• Heterogeneous products
• Low production volume
• High product flexibility
• Low to medium standardization

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Objective

• The objective of job order costing was to
  determine the cost per unit of each finished
  product
• This is the same in process costing but the
  environment is completely different.
• In job order costing costs could be directly
  attributed to a batch or job.
• In process costing this is impossible.
• Instead the cost object is not the product but
  the process or more specifically departments or
  stages in the production process.

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Process Costing

• In process costing each process is identified as
  a separate department, workstation or work
  centre.
• A manager is usually responsible for at least one
  of these.
• With the exception of the first department each
  department receives the output from the prior
  department.
• As the product moves from one department to the
  next additional labour, overhead and sometimes
  material are added.

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Cost Objects

• In job order costing the cost object was the
  product being produced.
• Cost were accumulated to a particular product
  because material and labour could be traced
  directly to the product.
• In process costing the cost object is the process
  itself, or the departments which make up the
  process.
• Direct materials are materials that can be traced
  to a particular department
• Direct labour is the labour used in that
  department

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Cost Objects

• Whats the difference?
• A supervisor in a department in job order
  manufacturing would be indirect labour, as the
  work done could not be directly attributed to any
  particular job in production
• In process costing that same supervisor would be
  direct labour as the work is directly associated
  with the department.

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Materials Costs

• When 3,000 of materials are received in raw
  materials inventory
• Dr Raw materials inventory 3,000
• Cr Cash or A/P 3,000
• To record the requisition of 1,000 worth of raw
  materials into production for department A
• Dr Goods in process
• inventory department A 1,000
• Cr Raw materials inventory 1,000
• As each department will have separate costs, and
  it is these cost we track, each department has
  its own goods in process inventory account.
• Notice this is virtually identical to job order
  costing

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Labour Costs

• To record factory payroll of 15,000 for the
  factory the journal entry is
• Dr Factory payroll 15,000
• Cr Cash 15,000
• Based on time records 10,000 is for department A
  and 5,000 for department B
• Dr Goods in process dept A 10,000
• Dr Goods in process dept B 5,000
• Cr Factory payroll 15,000
• Notice the similarity to job order costing

12
Factory Overhead

• To record 500 of indirect materials the journal
  entry is
• Dr Factory Overhead 500
• Cr Raw materials inventory 500
• To record 800 of indirect labour the journal
  entry is
• Dr Factory Overhead 800
• Cr Factory payroll 800
• To record 2,500 in amortization, 1,000 in
  expired insurance, 3,500 in other miscellaneous
  overhead costs
• Dr Factory overhead 7,000
• Cr Accumulated amortization 2,500
• Cr Prepaid insurance 1,000
• Cr Accounts payable 3,500
• Notice the similarity to job order costing

13
Factory Overhead

• As was the case in job order costing, we also
  apply factory overhead in process costing.
• This can be done with one global or factory
  wide rate
• Some companies prefer to have a rate set by
  department.
• It is also possible to have separate factory
  overhead costs for every department to aid in
  having multiple rates

14
Factory Overhead

• Assume the predetermined rate is 50 of labour,
  the journal entry is
• Dr Goods in process dept A 5,000
• Dr Goods in process dept B 2,500
• Cr Factory Overhead 7,500

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Equivalent Units

• As examined so far the entry of inputs such as
  materials, labour and overhead is virtually
  identical to job order costing.
• The major problem in process costing is
  determining the cost of the outputs from each
  department.
• To approach this problem we must determine the
  cost per unit and then apply that cost to the
  number of units transferred.

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Equivalent Units

• This problem is simple if there is no inventory.
• Costs transferred out costs transferred in.
• However, we often have inventory and must come to
  a measure of how complete the inventory is.
• If we have 100 units of inventory that are 40
  complete how many units is that?
• We have created a theoretical measure called
  equivalent units.
• 100 units 40 complete 100 x40 40 equivalent
  units
• Equivalent units is the theoretical measure of
  how many whole units would have been completed.

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Equivalent Units

• The logic of this is
• If a department had only worked on 40 units in
  the same time they would have been 100 complete.
• Equivalent units are often different for
• Materials
• Labour
• Example
• A production department adds all its material at
  the beginning of the production process
• Labour and overhead take place evenly throughout
  the process
• In this case if ending inventory is 50 complete
  the 50 would apply only to labour and overhead
• Materials would be 100 complete, material is
  added only at the beginning of the process.
• Anytime after that materials are 100 complete.

18
Equivalent Units

• Critical to the computation of equivalent units
  is how we assume the department actually
  processes units.
• We will assume that units are produced on a FIFO
  (first in first out) basis.
• This is a very common assumption and is used
  widely in industry.
• There is an alternative called weighted average.
• In this course, and in this text, we will only
  concern ourselves with FIFO.

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Accounting for a Periods Activity

• To account for a periods activity we examine a
  four step process
• Physical flow
• Equivalent units
• Cost per equivalent unit
• Cost reconciliation

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Physical Flow of Units

• Step 1 of the 4 step process
• A simple reconciliation of the units started in
  the period to the physical units completed.
• Units to account for
• Beginning inventory plus
• Units started in the period
• Total units to be accounted for
• Units accounted for as
• Units transferred out plus
• Ending inventory
• Total units to be accounted for

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Physical Flow of Units

• The two total must always agree.
• Effectively the units to account for are the
  units the department is responsible for.
• The department is responsible for those units in
  opening inventory plus those units transferred in
  (units started)
• Those units can only be in one of two places
• Either the units are still in the department
  (ending inventory) or
• The units were transferred out to the next
  department

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Example

• Consider the following example of Fort Garry
  Potato Chips
• Fort Garry has a four step process
• Peeling
• Cutting
• Frying
• Packaging
• Assume the following for the peeling department
• Opening inventory is 5,000 kg.
• Units transferred in is 100,000 kg.
• Ending inventory is 3,000 kg.
• Units transferred out is 102,000 kg.

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Example

• Units to account for
• Beginning inventory 5,000
• Units started during the month 100,000
• Total number of units 105,000
• Units accounted for as
• Units transferred from peeling to
  cutting 102,000
• Ending inventory 3,000
• Total number of units 105,000

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Example

• A key number used in subsequent calculations is
  the number of units started and completed this
  month.
• Completed this month is 102,000 units
• Under the FIFO assumption, the oldest inventory
  is processed first.
• Therefore 102,000 5,000 97,000 units started
  and completed this month.

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Equivalent Units of Production Overview

• In this step we need to multiply the by the
  whole units for
• Beginning inventory
• Started and completed
• Ending inventory

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Equivalent Units of Production Beginning Inventory

• Recall that beginning inventory this month was
  ending inventory last month
• The given is always based on the complete for
  ending inventory last month
• This oddity is always true
• If beginning inventory was 20 complete
• This means ending inventory last month was 20
  complete
• Under FIFO costing we assume we work on this
  inventory first
• If it was 20 complete last month, and if we
  assume it was completed this month (a reasonable
  assumption), that means we completed the rest
  which is 100 - 20 80.
• This is always true for beginning inventory, the
  to be used is always 100 - the percent given.
• The reason is that the given related to ending
  inventory complete last month.

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Equivalent Units of Production

• Started and Completed
• By definition, units that are both started and
  completed in the month are 100 complete
• This is always true
• Ending Inventory
• Ending inventory are those units started but not
  yet completed
• The complete is almost always the given.

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Equivalent Units of Production

• Step 2 of 4 step process
• In the peeling process all (materials) are added
  at the beginning of the process
• As far as direct materials is concerned an item
  is 100 complete the instant it enters the
  department
• Beginning inventory had to have entered
  production last month, therefore no additional
  costs were added this month.
• complete is therefore 0 (100 - 100 0)
• Items added in the month are 100 complete as
  they were added this month
• Ending inventory, because of the FIFO assumption,
  must have been added this month.
• Therefore they are 100 complete with respect to
  materials

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Equivalent Units of Production

• For labour and overhead they behave similarly
  since overhead is applied based on labour
• Assume opening inventory is 40 complete.
• Following our rule 100 - 40 60 is added this
  month.
• For items started and completed this month, by
  definition are 100 complete
• If ending inventory is 70 complete, under the
  FIFO assumption those costs were added this
  month, therefore ending inventory is 70 complete.

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Equivalent units

• Material
• Beginning inventory 5,000 x 0 0
• Started and completed 97,000 x 100 97,000
• Ending inventory 3,000 x 100 3,000
• Labour Overhead
• Beginning inventory 5,000 x 60 3,000
• Started and completed 97,000 x 100 97,000
• Ending inventory 3,000 x 70 2,100

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Cost Per Equivalent Unit

• Step 3 of 4
• Material equivalent units
• Beginning inventory 0
• Started and completed 97,000
• Ending inventory 3,000
• Total equivalent units 100,000
• Labour Overhead
• Beginning inventory 3,000
• Started and completed 97,000
• Ending inventory
  2,100
• Total equivalent units 102,100

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Cost Per Equivalent Unit

• Assume the following data
• Direct materials costs
• Dr Goods in process peeling 100,000
• Cr Raw materials inventory 100,000
• Direct Labour costs
• Dr Goods in process peeling 306,300
• Cr Factory payroll 306,300
• Factory overhead applied (50 of direct labour)
• Dr Goods in process peeling 153,150
• Cr Factory payroll 153,150

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Cost Per Equivalent Unit

• Materials
• 100,000 / equivalent units 100,000 1.00
• Labour
• 306,300 / equivalent units 102,100 3.00
• Overhead
• 153,150 / 102,100 equivalent units 1.50

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Cost Reconciliation

• Step 4 of 4
• Reconcile costs to account for with the costs
  accounted for in the period.
• Cost to account for are similar conceptually to
  units to account for in step 1
• Beginning inventory plus
• Costs assigned in the month
• Total Costs to account for

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Cost Reconciliation

• Costs accounted for
• Beginning inventory plus
• Costs assigned during the current period
• (equivalent units beginning inventory x cost per
  equivalent unit)
• For each of Direct Material, Labour and Overhead
• Plus Cost of units started and completed in the
  month
• (equivalent units started and completed x cost
  per equivalent unit)
• For each of Direct Material, Labour and Overhead
• Plus Ending inventory
• (equivalent units ending inventory x cost per
  equivalent unit)
• For each of Direct Material, Labour and Overhead
• Total costs to be accounted for.
• Total costs to be accounted for must equal total
  costs to be accounted for.

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Cost Reconciliation

• To pull everything together a process cost
  summary report is produced.
• Different companies will use different forms of
  the report but they all serve the same function
• Helps managers control departments
• Helps managers evaluate performance
• Provide cost information for financial statements

37
Process Cost Summary

• The Process Cost Summary is too large and
  cumbersome to show using PowerPoint.
• Please refer to the demonstration excel
  spreadsheet.
• Assume that opening inventory is 10,000

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Transferring Goods Between Departments

• As per the report 557,000 is to be transferred
  to the cutting department (the next department in
  processing order)
• The journal entry to record this is
• Dr Goods in process-cutting 557,000
• Cr Goods in process-peeling 557,000

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Cutting Department Data

• Beginning inventory
• Units of product 12,000
• Percent complete 25
• Units received from peeling department 102,000
• Units transferred to frying 98,000
• Ending inventory
• Units of product 16,000
• Percentage complete 65

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Spoiled Units

• In our example we assume no spoiled units.
• This is of course unrealistic
• There is considerable discussion on whether the
  cost of the spoiled units should be included in
  the cost per equivalent units
• Some argue that it should be included so that
  proper pricing to cover all costs is achieved
• Others argue including it will make the product
  to expensive and uncompetitive