PROCESS COSTING

Cost Accounting involves the determination and comparison of costs among a firm's divisions or
operations. It was first used by Louisville & Nashville Railroad in the late 1860s which enabled
the company to determine its cost per ton-mile among its branches. It was by these measures,
rather than earnings or net income that the company evaluated the performance of its managers.
The accounting methods developed by the railroads were adopted by the first large manufacturing
firms in the United States upon their formation in the last quarter of the 19th century. Thus the
historical development of cost accounting accommodated the development of the multidivisional
firm towards the end of the 19th century. The largest U.S. manufacturing firms in the 1870s were
textile producers. Because these years were a period of hardship for the industry, textile
producers devote more attention to the determination and control of costs.

Cost Accounting serves the ever-changing needs of management. Unlike Financial Accounting
where GAAP determines what must be reported and how it is reported, the guiding light for cost
accounting is usefulness. Managers find it useful to accumulate cost accounting data via a cost
accounting system. Cost accumulation refers to the manner in which costs are collected and
identified with specific costing object. The center of attention for cost accumulation can be
individual customers, batches of products that may involve several customers, the products
produced by individual segments, or the products produced by the entire plant for the period. The
company's cost accumulation method is influenced by the type of manufacturing operation and
the extent to which detailed cost accounting information is needed by management. The two (2)
commonly used cost accumulation methods are job order costing and process costing. The
objective of either job order or process costing is to match costs of a period with units produced
in the same period. In other words, they are used to determine the cost of producing a product or
the cost of providing a particular service.

In a process costing system, the flow of units is more or less considered a continuous flow. That
is, all units produced are identically made and a single production of goods is sold to various
customers. The output of one department or process may become the input to another
department or subsequent process until finally they are transferred to the warehouse awaiting
delivery. Under a job-order costing system, the goods produced are for different customers with
different requirements or job specifications (where each unit of production is customized) or where
there are very few units produced. Because of this, every production produces slightly different
products. A job order cost sheet tracks all accumulated costs pertaining to a particular job while
in process costing, a monthly cost of production report accumulates all production costs by
process or department instead of a particular job or customer's order. The difference between
job-order and process costing systems is that job-order costing collects costs by job, while
process costing collects costs for each process or stage of production separately and the product
usually passes through several operations or departments for a specified time period.

Define Process Costing

Companies make use of cost accounting system to obtain cost data. They will choose the
appropriate cost accumulation method that best matches the flow of work or production
processes. In a manufacturing process environment, production flow may involve two or more
departments, processes or work cells which will use and maintain a separate WIP account. Each
WIP account of every department, process or work cell contains costs of materials, labor and
overhead as well as costs transferred in from the previous department, process or work cell. At
the end of every accounting period, a monthly Cost of Production Report (CPR) assigns the costs

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that have been accumulated during the period to the units transferred out as well as to the units
that are still in process.

The official definition of process costing by Chartered Institute of Management Accountants

(CIMA) is that it is the method applicable where goods or services result from a sequence of
continuous or repetitive operations or processes. Costs are averaged over the units produced
during the period, being initially charged to the operation or process.

Kohler has defined process costing as a method of cost accounting whereby costs are charged
to processes or operations and averaged over units produced.

Process costing traces and accumulates direct costs, and allocates indirect costs of a
manufacturing process to products in a large batch such as an entire month's production, and
then divides this total cost with the number of units to get an average unit cost. In other words, it
is a method of accounting that accumulates, analyzes and summarizes production costs by
department or process whereby costs are averaged over the units produced for a specified time
period. It is used when costs to produce a product should be the same for all units. Production is
generally carried out for stock purposes and not for any specific order.

When to use Process Costing

Such cost accumulation method is commonly used by companies manufacturing homogeneous

or essentially identical and standardized products, the manufacture of which results from a
sequence of continuous or repetitive operations or processes as well as those entities producing
large quantities of identical units in a mass production setting such as in flour mills, paper mills,
chemical manufacturing companies, food processing, petroleum, and textile industries in which a
product passes through several processes. Hence, process costing is used where it is not
possible to identify separate units of production, or jobs, usually because of the continuous nature
of the production processes involved.

It is also employed in assembly-type operations as well as in utilities producing gas, water and
electricity. It works ideally for businesses that specialize in producing a single type of product or
in industries where the materials pass through two or more processes for conversion into a final
product. Process costing can also be used by service entities with homogeneous services and
repetitive processes such as check processing in a bank or mail sorting by a courier.

Any costing system used by a company should be designed to reflect the underlying operations
of that particular company. Costing systems serve three principal functions:
 Determining the cost of products or services,
 valuing inventory and cost of goods sold,
 controlling as well as managing costs and evaluating performance,

Job, costing and process costing are the principal cost accumulation methods used to determine
the cost of products or services through the assignment of costs to such cost object (either the
product or service). As noted, they form the ends of a continuum with hybrid costing available for
reflecting the underlying operations in a particular company appropriate for its use.

Absorption costing, variable costing, and throughput costing (otherwise known as

supervariable costing) are the alternative inventory costing methods to choose from. These
inventory costing methods were introduced in the study of job order costing, but they can be used
along with process costing or hybrid costing.

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Actual costing, normal costing, and standard costing are terms used to describe the
production costs used (whether you use actual costs or the so-called normal costs or standard
costs) within job order costing or process costing. Activity-based costing (or ABC) is applicable in
both job order costing and process costing wherein it emphasizes on charging the overhead
based on the activities done to produce the product or service.

Similarities Between Process Costing and Job Order Costing

Both cost accounting systems maintain perpetual inventory records and use the same basic
manufacturing accounts such as Materials, Factory Overhead Control, Work In Process and
Finished Goods. They both assign material, labor and overhead costs to products, thus providing
a mechanism of computing unit cost as well as providing data essential for planning, control and
decision making. The flow of costs moves in the same way in both job order and process costing
systems.

Distinctions between Process Costing and Job Order Costing

The differences between job order and process costing occur because the flow of units in a
process costing system is more or less continuous and these units are essentially
indistinguishable from one another. In process costing, it makes no sense to try to identify
materials, labor, and overhead costs with a particular customer's order since each order is just
one of the many orders that are filled from a continuous flow of virtually identical units from the
production line. That is why in process costing, costs are accumulated by department or process
rather than by individual job or customer's order, assign these costs uniformly to all the units that
pass through the department or process during a period. Process costing cannot be calculated
until all processes are complete while in job-order costing, cost is calculated throughout a
particular job while it is being worked on.

Process costing is used by companies that produce a single homogenous product, produced on
a continuous basis over a long period of time. This differs from job-order costing in which many
different products may be produced in a single period and is therefore used by companies
producing heterogeneous products. The departmental cost of production report is the key
document used in process costing, showing the accumulation and disposition of costs while in job
order costing, the production costs are summarized in the job order cost sheet which is its key
document.

In terms of overhead, it varies from one job order to another since customer's orders are unique
in nature (products or services are customized or tailored fit to a specific customer, meeting their
specifications such as yacht making). However, process costing does not have this concern, a
key difference between the two, as process costing incurs the same factory overhead with every
production run made through its assembly-line process. Aside from this, job order costing is more
time-intensive than process costing. These distinctions are summarized in Table 1-1 below:

Distinction as to Process Costing Job-order Costing

Cost accumulation Per process or department Per job or customer order
Key document used Cost of Production Report Job-Order Cost sheet (JOCS)
Type of product produced Homogeneous products in a Heterogeneous products in a
continuous process non-continuous process

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Advantages of Process Costing

The primary advantage of process costing is the ease and simplicity of accounting. In other words,
cost determination is simpler and easier and such costs are computed at regular intervals, usually
at the end of every month. It is a simple and direct method of cost accumulation that collects the
overall costs of production from each department. Process costing does not need as much data
as job order costing, thus lesser expense is incurred. This reduces the volume of data, and makes
data collection easy and quick. The analysis is likewise simple and straightforward, and does not
require any specialized skills other than the traditional accounting skills.

The uses of process costing extend to help establish effective control over the production process.
It allows or enables budgeting standard costs, making it possible to track deviations from such
standard costs with ease. It becomes possible to track the inefficiency or discrepancy to a specific
process or department even without checking each department or process. It makes it easy to
obtain the average cost of a product, allowing accurate estimates to customers. Compared to
other costing methods such as activity based costing (ABC), process costing is inexpensive and
does not drain the organization's time and resources.

Disadvantages of Process Costing

Instead of recording the actual costs incurred to produce a product, process costing averages
many types of costs together. This will result to an assignment of an average cost much higher
than what some products actually cost to manufacture. Uniformity of cost is unrealistic because
no matter how similar two things are, they cannot have the same cost. If actual costs are used,
the cost of production is determined only at the end of the month.

This review of the advantages and disadvantages of process costing indicates that process
costing is a useful management accounting tool for large companies such as Coca Cola that mass
produce homogeneous products.

Difficulties or Limitations in a Process Costing Procedure

In actual practice, certain difficulties are encountered in applying process costing procedures such
as:

1. The determination of equivalent production (EP) and their stage of completion poses a
problem since these data generally come from production personnel often working under
circumstances that make a precise count difficult, a certain amount of double counts and
unreliable estimates are bound to exist and such submitted data will likewise form the
basis for the determination of product costs.
2. Computation of material cost frequently requires careful analysis. Generally, materials are
applied in the first department. However, in certain industries, material costs are not even
found on the cost of production reports. When material prices are influenced by fluctuating
market quotations, the material cost may be recorded in a separate report designed to
facilitate management decisions in relation to the materials market.

3. Units lost by shrinkage, spoilage, or evaporation indicate that the time when the loss
occurs influences the final cost calculation. Different assumptions concerning the loss
would result in departmental unit costs, which, in turn affects inventory costs, cost of units
transferred, as well as the cost of the completed units. Another consideration involves the
possibility of treating the cost of avoidable losses as an expense of the current period.

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 4. Industries using process costing are generally producing multiple types of product wherein
joint processing costs must be allocated to the products resulting from the processes.
Weighted average or other bases are used to prorate the joint costs to several products.
If units produced are used as the basis for cost allocation, additional clerical expenses are
necessary if the labor hour or machine hour basis is used for charging overhead to work
in process. Management must decide whether economy and low operational costs are
compatible with increased information based on additional cost computations, and
procedures.

In some companies, they use hybrid or operation costing which is a modified method of process
costing that applies both process costing and job order costing procedures at the same time in
different departments. This occurs when a parallel or selective cost flow format is required. Each
system or method employed by a company must be based on reliable production and
performance data which, when combined with output, budget, or standard cost data, will provide
the foundation for effective cost control and analysis.

Physical Flow of Production

As a business grows the scale of its operations, it often needs to change its method of production
to allow greater production сарacity. A small business might use job or batch production to provide
a personalized or distinctive product. However, if the product is intended for much larger, mass
markets, then alternative method of production may be required to produce it efficiently. A key
production method in this case is mass production which involves a continuous movement of
items through the production process. This means that when one task is finished, the next task
must start immediately. Therefore, the time taken on each task must be the same.

Mass production involves the use of production lines such as in a car manufacturing where
doors, engines, bonnets and wheels are added to a chassis as it moves along the assembly line.
It is capital intensive as it uses a high proportion of machinery in relation to workers, as in the
case of an assembly line. The advantage of this is that a high number of products can roll off
assembly lines at very low cost. This is because production can continue at night and over the
weekends and also firms can benefit from economies of scale, which lowers the cost per unit of
production. It is appropriate when firms produce a high volume of similar items. Some of the big
brand names that have consistently high demand are most suitable for this type of production.

With a process-costing system, a company works in a repetitive production environment,

manufacturing a large number of similar units in a continuous flow and the costs are accumulated
by department or process. The flow of costs through general ledger accounts is similar in both job
order and process costing systems: through Work in Process, then to Finished Goods, and finally
to Cost of Goods Sold. In a sequential production operation, each department establishes its own
Work-in-Process account.

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 One Production Department

Work-in-process Finished Goods Cost of

Inventory Inventory Goods Sold
Direct materials

Direct Labor Cost of goods completed Cost of goods sold

and transferred to During current period
Applied Manufacturing finished goods
Overhead

Exhibit 1-1
Flow of Costs in One Production Department

Exhibit 1-1 displays the flow of costs in two process-costing situations: one with a single
production department and on with two production departments use in sequence. The same
accounts are used in this process-costing illustration as were used in job-order costing. As the
illustration shows, direct-material, direct-labor, and manufacturing-overhead costs are added to a
Work-in-Process Inventory account. As goods are finished, costs are transferred to Finished-
Goods Inventory. During the period when goods are sold, the product costs are transferred to
Cost of Goods Sold.

Two Sequential Production Departments

Work-in-process Inventory Work-in-process Inventory

Production Department A Production Department B
Direct materials
Cost of goods completed Cost of goods completed
Direct Labor
Transferred to And transferred to
Applied Manufacturing department B finished goods
Overhead
Direct materials

Direct Labor

Applied Manufacturing
Overhead

Finished-Goods Inventory Cost of Goods sold

Cost of goods completed

During current period

Exhibit 1-2
Flow of Costs in a Two Sequential Production Departments

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In Exhibit 1-2, when goods are completely processed in the first production department, costs
accumulated in the Work-in-Process Inventory - Department A are transferred to the Work-in-
Process Inventory - Department B. The costs assigned to these completed units are transferred
to the next production department's Work-in-Process Inventory account (if it will be processed
further in another production department) or to Finished-Goods Inventory (if no subsequent
processing will take place) upon transfer to the warehouse or stockroom.

A product can flow through a factory in various ways. Three (3) product flow formats are
associated with process costing, namely: sequential, parallel, and selective. Basically, the same
costing procedures can be applied to all types of product flow situations.

Sequential Product Flow. Each product is processed in the same series of steps as it
goes through the same set of operations. This is illustrated in Exhibit 1-1 as shown below where
materials are placed into production in Department A, after which conversion costs are added.
When the work is done completely in Department A, the completed units in Department A will now
be transferred to Department B for another processing where it may add more materials or simply
work on the partially completed input from the previous department, adding only labor and factory
overhead. After the product has been processed in Department B, it becomes a completed
product and recorded as part of finished goods inventory. This is done in an automobile assembly,
where almost all variants of the same model require the same sequence of processes. Another
example is paper making. Although different types of paper can be manufactured, all types have
the same processing requirements.

Parallel Product Flow. In a parallel product flow, certain portion of the work are done
simultaneously and then brought together in a final process for completion and ultimately
transferred to the warehouse. As in the previous illustration, materials may be added in
subsequent processes.

Selective Product Flow. Each product moves to different departments within the plant,
depending upon the desired final output. For example, in meat processing, after the initial
butchering process, some of the product goes directly to the Packaging Department and then to
Finished Goods Inventory; some goes to the Smoking Department and then to the Packaging
Department and finally to Finished Goods Inventory; while others may be processed in the
Grinding Department, then to the Packaging Department and finally to Finished Goods Inventory.

Finished
Goods
Smoking Inventory
Packaging
Butchered Meat Grinding

Flow of Costs in Process Costing

In process costing, costs flow through different processes or departments. The output of one
process forms an input to the next process. Transferring the output to the next process continues
until the final process produces finished products. A separate WIP account is used to record costs
of each production department. When Department A finishes its work, the costs of the goods

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completed are transferred to WIP- Department B's account as transferred-in costs or Costs from
Previous Department (CPD). The transfer of units completely done in one department and passed
on to the subsequent department for further processing, carries with it the accompanying costs
from one department to another. In sequential production processes, the cost of the goods
transferred from one production department to another is called transferred-in cost. After
processing has been done in all the departments, the costs of the completed goods and
transferred out to the bodega or warehouse are then transferred to the Finished Goods Inventory
account.

Either actual, normal or standard costing may be used along with process costing. When normal
costing is used, overhead variance (either under or overapplied overhead) may arise • which will
either be closed to CGS account (if immaterial or insignificant) or alternatively closed to the Work
in process, Finished Goods and CGS accounts (if material or significant). However, the process
costing procedures used under actual, normal or standard costing are likewise identical.

To illustrate the preparation of journal entries for a manufacturing company with two sequential
production departments, (please refer to Exhibit 1-1):

Production Costs in Department A:

Materials used P50,000
Payroll 20,000
Applied Factory Overhead 30,000

 80% of its work-in process during the period were completed and transferred to Department B.

Production Costs in Department B:

Materials used P40,000
Payroll 15,000
Applied Factory Overhead 20,000

 Finished goods inventory during the period amounts to P130,000.

 Cost of goods sold amounts to P125,000.

As direct materials and direct labor are used in Department A, these costs are added to the Work-
In-Process Inventory account of Department A. Overhead is applied using a predetermined
overhead rate. The predetermined overhead rate is computed in the same way as in job-order
costing.

Work in Process Inventory – Department A P 100,000

Materials P 50,000
Payroll 20,000
Applied Factory Overhead 30,000
Production costs charged to Department A

When Department A completes its work on some units of product, these units are transferred to
Department B for subsequent processing. The costs assigned to these goods are transferred from
the Work-In-Process Inventory – Department A to the Work-In-Process Inventory – Department
B. In Department B, the costs assigned to these partially completed products are called
transferred-in costs.

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Work in Process Inventory – Department B P 80,000
Work in Process Inventory - Department A P 80,000
Costs transferred out to Department B

Direct materials and direct labor are used in Department B, and factory overhead is applied using
a predetermined overhead rate. In manufacturing operations with sequential product flow, the
costs assigned to the units transferred out of one department remain assigned to those units as
they enter the next department.

Work in Process Inventory – Department B P 75,000

Materials P 40,000
Payroll 15,000
Applied Factory Overhead 20,000
Production costs charged to Department B

Goods completed in Department B are finally transferred to the warehouse. So the entry will be:

Finished Goods Inventory P 130,000

Work in Process Inventory - Department B P 130,000
Transferred finished goods from Department B

The cost of the completed and sold units are recorded as follows:

Cost of Goods Sold P 125,000

Finished Goods Inventory P 125,000
Cost of goods sold for the month

Two (2) Alternative Methods of Costing Inventories in Process Costing

Under the FIFO method, it is assumed that units which are first placed into process are the ones
to be completed first and those completed first are the ones to be transferred out first. Cost flow
that uses FIFO method follows the logical physical flow of production. This method looks at the
input as well as the output of the production process.

Under the Weighted Average method, the unit in process at the beginning is combined with the
units started and completed this month. This means that the work done on the units in process
beginning (last month) is treated as if it were work done this month. Both prior period costs and
current period costs are averaged and looks only at the output of the production process.

The selection of either method depends entirely upon management's opinion regarding the most
appropriate and practical cost determination procedures. The basic difference between the 2
methods lies on the treatment of work in process inventory beginning. The FIFO method
separates the units started last month from the units started this month. The weighted average
method makes no separate treatment of the units in WIP beginning. The FIFO method separates
costs incurred last month from the costs incurred this month and it uses only the current
production costs and work effort to calculate the equivalent unit cost. The weighted average
method generally is easier to use because the calculations are simpler. This method is most
appropriate when WIP is relatively small, or direct material prices, conversion costs and inventory

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levels are stable. The FIFO method is most appropriate when direct material prices, conversion
costs and inventory levels fluctuate.

Other firms prefer to use the FIFO method for purposes of cost control and performance
evaluation because the cost per equivalent unit under FIFO represents the cost for the current
period's efforts only. Firms often evaluate department manager's performance based only on the
current period costs without mixing the effects of performance during different periods. Under the
weighted average method, the costs of the prior period and the current period are mixed, and
deviations in performance in the current period could be concealed by inter-period variations in
unit costs.

The principal disadvantage of FIFO costing is that if several unit cost figures are used at the same
time, extensive detail is required within the Cost of Production Report (CPR), which can lead to
complex procedures and even inaccuracy. Whether the extra detail yields more representative
Unit Cost than the average costing method is debatable, especially in a firm where production is
continuous and more or less uniform and appreciable fluctuations in Unit Cost are not expected
to develop. Under such conditions, the average costing method leads to more satisfactory cost
computations, that is why it is commonly used in practice.

Steps in Process Costing

1. Trace the physical flow of units.

2. Convert the physical units determined in Step 1 into equivalent units of production (EUP)
for each cost element
3. Calculate the total cost for each cost element for the period
4. Divide the total costs by equivalent units of production to get the cost per equivalent unit
produced
5. Multiply equivalent units by the cost per equivalent unit to determine the value of Finished
Goods and Work in Process Inventory Account

The first step in generating a cost of production report is to prepare a quantity schedule, which
involves the total number of physical units to be accounted for during the period. It is expressed
in terms of how the final output of that department, process or work cell is being measured (either
in units, kilos, pounds, tons, etc.). This shows the units started last month and still in process
(known as WIP beginning) plus the units started this month (whether they originated or first started
in this department, process or work cell or whether they are received from a previous department,
process or work cell). It allows the manager to see at a glance how many units moved through
the department during the period. Such quantity schedule is based on the equation: Sources =
Targets.

There are three (3) possible sources of the units assigned to be worked on for the month in a
particular production department: From WIP beginning or units started last month but still in
process + those arising from current month's production or units started this month and placed
into process + those received from previous department or process. So these sources are
considered as the total number of units to be accounted for by a particular production department
or process for the current month.

Targets are those possible outcome of the units worked on for the current month and that includes
the following: those units finished and transferred out to the next department for subsequent
processing + those units completed but still on hand + those units still in process at the end of the
current month (where their percentage of completion is less than 100%). Even the lost or spoiled

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units will be reported as part of the targets. Always remember to maintain the equality of the two
sides of this equation otherwise an erroneous quantity schedule will result to an erroneous
computation of the equivalent units of production or EP.

Define Equivalent or Effective Production (EP)

The most important feature of process costing is that the direct material costs and conversion
costs are assigned to equivalent units rather than to physical units. The company's cost
accountant will calculate the equivalent units of production. Equivalent units of production (EUP)
or equivalent production (EP) for short is defined as the measure of work done expressed in terms
of finished units. EP represents the number of units for which materials, labor and overhead (MLO)
issued or used during a period were sufficient to complete those units. It applies a percentage of
completion factor to partially completed units to compute the equivalent number of whole units
produced in an accounting period for each type of production input. Such stage of completion
must be analyzed by a supervisor or by the use of formulas.

Since the costs of labor and overhead are often incurred uniformly throughout the production
process, they are combined upon computing the equivalent units of production (EUP) for the sake
of convenience and are identified as conversion costs.

In order to calculate the average cost per unit, the total number of units must be determined.
Partially completed units pose a difficulty which is overcome by using the concept of equivalent
units of production. Equivalent units are the number of complete, whole units one could obtain
from the materials and effort contained in partially completed units.

Computation of EP

Equivalent units are the equivalent, in terms of completed units, of partially completed units. The
formula for computing equivalent units is:

EP = # of fully or partially completed units x % of completion

Equivalent units are not the same as the physical units. For example, suppose in a given month,
a chemical company had in process 30,000 gallons of a chemical, of which 20,000 gallons were
complete at the end of the month but the remaining 10,000 gallons were only 50% complete.
Thus, the equivalent units produced equal to 25,000 gallons only. The equivalent units should be
calculated separately for each cost element because the proportion of the total work done on the
product is not always the same for each cost element.

Under the weighted average method, the equivalent units of production (EUP or EP) for a
particular cost element is computed by adding together the number of units completed and
transferred out to the next department and the equivalent units in ending work in process inventory
in that department.

EP under Weighted Average = Units transferred out + EP in IPE

Where: IPE = in process end

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If the company uses FIFO method, the equivalent units of production (EUP or EP) for a particular
cost element is computed by deducting the equivalent units in Work in process, beginning from
the EP computed under weighted average method.

EP under FIFO = EP under Weighted Average - EP in IPB

The computation of EP depends on how the cost elements (MLO) are applied in the process.
There are two (2) cases of costs application, namely: 1) uniform or even application and 2) uneven
application of MLO.

There is even or uniform application of materials, labor or overhead when the percentage applied
to each cost element is the same. Likewise, there is uneven application of materials, labor or
overhead when the percentage applied varies from one cost element to another.

The significance of knowing whether there is even or uneven application of MLO is that it will
serve as your guide in determining how many columns shall be provided in preparing your
schedule for the computation of equivalent production (EP). If there is even or uniform application
of MLO, then only one column shall be provided in your EP schedule because the resulting EP
will be the same for the three (3) cost elements as the percentage applied to them are the same.
However, if there is uneven application of MLO, then you provide a separate column for each cost
element with a different percentage applied to it. So either you provide two (2) or three (3) columns
as it calls for it.

Cost of Production Report (CPR)

The key document in process costing is the departmental cost of production report. The purpose
of this monthly cost of production report is to summarize all of the production activities that take
place in a department's work in process account for a period. In other words, it summarizes the
physical flow of units, equivalent units of production, cost per equivalent unit, and analysis of total
departmental costs. This may be compiled by using either the weighted-average method or the
FIFO method.

Such report will show a quantity schedule and a computation of equivalent production along with
the computation of cost per equivalent unit and a reconciliation of all cost flows into and out of the
department during the period.

Accounting for Production Costs in Process Costing

Materials are charged to departments rather than to jobs and the number of departments using
materials is usually less in number than those jobs in which a firm handles at a given time. A
material requisition slip will be filled up by the requisitioning department to draw the materials from
the storeroom. These materials can be added in any department but most often they are given in
the first processing department. If a soda manufacturing firm has two (2) processing departments,
namely Formulating and Bottling Department, the entry to record the materials (i.e. water, flavors,
sugar, and carbon dioxide) used or applied in the first department will be:

Work in Process Formulating Department P xx

Materials P xx

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If additional materials like bottles, caps and packing materials are subsequently added by the
Bottling Department (the 2nd processing department), then the entry shall be:

Work in Process – Bottling Department P xx

Materials P xx

If material requisition forms are not priced individually, the cost of materials used may be
determined at the end of the production period through inventory difference procedures, ie. adding
purchases to beginning inventory and deducting ending inventory. Consumption reports which
state the cost or quantity of materials put into process by various departments may also be used.
The costs or quantities charged to departments may be based on formulas or proration. Labor
costs are traced to departments or processes rather than to individual jobs in process costing
while overhead is applied to these departments or processes using a predetermined overhead
rate.

In both job order and process costing, factory overhead incurred is preferably accumulated in the
Factory Overhead subsidiary ledger for both producing and service departments. The use of
predetermined rates for charging overhead to jobs and products is recommended.

However, in various process and job order costing systems, actual overhead rather than applied
overhead is sometimes used for product costing. This practice is feasible when production is
stable, that is when factory overhead will remain about the same from one period to another or
when the factory overhead is not considered an important part of total production costs. However,
departmental predetermined overhead rates should be used if production is not stable and/or
factory overhead, especially fixed overhead, is considered a significant cost of production.
Fluctuations in production can lead to unequal incurrence of actual overhead from month to
month. In such cases, factory overhead shall be applied to production using predetermined
overhead rates, so that units produced receive proper charges for factory overhead. The use of
predetermined rate is highly recommended for improving cost control and facilitating cost
analysis. Prior to charging factory overhead to departments via their respective Work in Process
accounts, expenses must be accumulated in Factory Overhead Control (FOC) account. As
expenses are incurred, they are recorded in FOC account and posted to departmental expense
analysis sheets, which is the subsidiary ledger for factory overhead items. At the end of each
period, departmental expense analysis sheets are totaled which represent factory overhead for
each department.

Computation of Unit Cost (UC)

After the cost of materials, labor and overhead have been accumulated in a particular processing
department, the department's output must be determined so that unit cost can be computed. The
department may have some partially completed units in its ending inventory and it is not
reasonable to count them as equivalent to fully completed units in determining the department's
output. So these partially converted units are mathematically converted into an equivalent number
of units produced. The cost per equivalent unit is computed for a particular cost category (i.e.,
materials, labor, overhead, or conversion costs) by dividing its total cost by its total equivalent
units. Note that under the weighted average method, the costs include both the costs.already in
beginning inventory as well as the costs added by the department during the current period. The
calculation of the unit cost will depend on what method of inventory costing is used by the
company.

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 Weighted Average Method First-in First-Out (FIFO method)

Ave. UC of M: UC of M:
Material Cost last Month + Material Cost this Material Cost this Month
Month
EP for Material under Weighted Average EP for Materials under FIFO method
Method

Ave. UC of L: UC of L:
DL Cost last month + DL Cost this Month DL Cost this Month
EP for Labor under Weighted Average Method EP for Labor under FIFO method

Ave. UC of OH: UC of OH:

OH Cost last month + OH Cost this Month OH Cost this Month
EP for OH under Weighted Average Method EP for OH under FIFO method

Even versus Uneven Application of Production Costs

There is uneven application of costs when materials, labor, or overhead is applied to production
at a rate different from the rate of progress in the manufacturing process. On the other hand, if
the application of the cost elements (M,L,O) is synchronized with the production process, then it
is termed as even application of costs and the computation of the equivalent units of production
(EUP or EP) would be much simpler.

Uneven application happens when the portion added does not comply with the stage of
completion of a unit. This would result in a different equivalent unit of production for a particular
cost element (MLO).f

Illustrative Problem 1.1 (Uneven Application of Costs- One department)

The following data pertain to the Assembly Department of Bryan Ryan for November 2020:

Percent Complete
Units Materials Conversion
Work in process, November 1 ………………………… 800 55% 10%
Units started into production in November 8,200
Units completed in November and transferred to
the next department………………………….. 7,300
Work in Process, November 30………………………. 1,700 75% 25%

It may be noted that for the WIP-November 1, materials and conversion costs were 55% and 10%
complete respectively. Hence, for the month of November, work that needs to be done in relation
to the WIP from previous month would only be 45% for the materials and 90% for conversion
costs. This percentage of work done in the current month to the WIP beginning would matter most
if the company uses FIFO method but not much if weighted average is used. In the latter method,
it must be remembered that the beginning inventory is combined with the units started and
completed in the current month.

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This is emphasized in the following diagram:

WORK IN PROCESS, NOV. 1

MATERIAL Cost

CONVERSION Cost

In relation to WIP-November 30, it can also be gleaned that it is 75% complete as to materials
and 25% as to conversion cost. This percentages of completion represents the work done by the
department for the month that must be included in the EUP computation. This is further
emphasized in the following diagram:

WORK in PROCESS, NOV. 30

MATERIAL Cost 75 % Completed (Nov)

CONVERSION Cost 25% (Nov)

Computation of the EUP is as follows:

Materials Conversion
Units transferred to the next department........... 7,300 7,300
Work in process, November 30:
1,700 units × 75%.................................... 1,275
1,700 units x 25%..................................... 425
EUP under weighted average method.................. 8,575 7,725
Less: EP in WIP, Nov. 1
800 units x 55% ......................................... 440
800 units x 10% ......................................... 80
EUP under FIFO 8,135 7,645

Cost Reconciliation

The purpose of a cost reconciliation is to show how the costs from beginning work in process
inventory and costs that have been added during the period are accounted for. Costs come into
the department from units in beginning inventory, from material, labor, and overhead costs that
are added during the period, and from any units that might have been transferred in from a
previous department. A department's costs are accounted for by showing the costs that are
transferred out to the next department (or to finished goods) and by specifying the costs that
remain in the ending work in process inventory.

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Process Costing in a Multidepartment Setting

Most manufacturing firms have multiple processing department facilities. In such environment,
units are transferred from a previous or preceding department to a subsequent department where
they will be processed further. This transfer from one production department to another production
department carries with it the costs from preceding department (CPD) otherwise known as Costs
Transferred-In (CTI). This Cost from Preceding Department is treated as input costs in the
subsequent department/s. This cost component is always considered 100% complete in terms of
MLO applied by the previous department because these units would not have been transferred
out of the previous department if processing there were not complete. The subsequent
department may add raw materials to the units transferred in or may add the conversion costs
only to them. These units transferred in are treated similarly in computing EP as those units that
were initially processed in this subsequent department.

Illustrative Problem 1.2 (Multi-department Process Costing)

Rizza Co. manufactures a product in two (2) departments: Cutting and Assembly. The company
uses a process cost system and all materials are applied at the start of the process. The product
is cut out of metal sheet, bent to shape and painted in the Cutting Department. Then it is
transferred to the Assembly Department where purchased parts are added to the unit. Data
related to September operations in the Assembly Department are:

Units in beginning inventory (40% labor and overhead) 1,200

Units received from Cutting Department this month 2,800
Units transferred to the warehouse this month 3,000
Units still in process at the end of the month (80% labor and overhead) 1,000

Beginning Costs
Inventory Added This
Month
Costs transferred in ………………………………………… 17,280 40,600
Materials ……………………………………………………….. 5,600 22,400
Labor …………………………………………………………….. 980 19,920
Factory Overhead ………………………………………… 3,102 25,398

Required: Prepare the September, 2020 Cost of Production Report for Assembly Department
using:
a) Weighted Average Method
b) FIFO Method

16
 Rizza Company
Cost of Production Report – Weighted Average Method
For September, 2020
Equivalent Production
Quantity Schedule: Materials Conversion Costs
In process, beginning (100% M; 40% CC) 1,200
Received from previous department (RPD) 2,800
Finished and transferred out 3,000 3,000 3,000
In process, end (100% M; 80% CC) 1,000 1,000 800
4,000 3,800

Costs Charged to Assembly Department: Total Cost Unit Cost

WIP beginning or Costs last month………… P26,962 -
Costs from Previous Department (CPD)…. 40,600 P14.47 (17,280 + 40,600)
Cost Added This Month: 1200 u + 2800 u
Materials ………………………………… 22,400 7.00 (5,600 + 22,400)
4,000 u
Labor 19,920 5.50
(980 + 19,920)
……………………………………….
3,800 u
Overhead ……………………………….. 25,398 7.50 (3,102 + 25,398)

Cost Assignment:
Finished & Transferred (3,000 u x P 34.47) ………………………………………………….. P 103,410
WIP End:
CPD (1,000 u x P 14.47) = P 14,470
M (1,000 u x P 7) = 7,000
CC (800 u x [5.50 + 7.50]) = 10,400 31,870
Total Costs as accounted for P135,280

Cost of production reports will serve as the basis for evaluating the processing department’s
productivity and efficiency. Its cost data can be used to assess whether unit costs and total costs
are reasonable. By comparing the quantity and cost data with predetermined goals, top
management will be able to judge whether current performance meets with their planned
performance target.

Regardless of what inventory costing method was used, you will notice that the Costs Charged to
the Department is always equal to the sum of the Costs assigned to Finished & Transferred and
WIP, end. The quantity schedule will be reported at which the final output of a production
department is measure (either in units, tons, kilograms, pounds, etc.). Both the quantity schedule
and the EP schedule are not reported in peso amounts.

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 APPENDIX 1: An Alternative Approach or Presentation

Weighted Average vs. FIFO Method in Process Costing

The weighted average method is a method of computing production quantity (the denominator) in
process costing that focuses on the total work done to date. In computing the average cost per
equivalent unit produced, the production costs incurred last month to WIP, beginning of this month
is added to the current production costs of a particular producing department or process as its
numerator.

The FIFO method is a method of computing production quantity (the denominator) in process
costing that computes the cost per equivalent unit produced using only current production costs
or costs of MLO added this month as numerator. It reflects the way in which the units will flow into
the production system. Under the FIFO method, the work in the prior period cannot be
commingled with work performed in the current period. It focuses on the work done this month to
those units currently processed regardless of what month they were initially placed into process
(whether the units were started last month or started just this month). The only difference between
FIFO and weighted average methods is that the work done in the previous month for WIP,
beginning is not included in the EP computation using FIFO.

The total units to account for is the sum of whole and partial units worked on in the department
during the current period. In other words, it is the sum of the units that were started last month
and still in process at the beginning of this month plus the units just started this month in this
department.

The total cost to account for is the sum of the WIP, beginning (otherwise known as costs
incurred last month) plus material, labor and overhead (MLO) added in the current period.

Weighted Average Method

Use the following information for the illustrative problem of Marina Merced Company for May:

Beginning Work in Process Inventory

(25% complete as to conversion) 10,000 Units
Started 120,000 Units
Ending Work in Process Inventory
(30% complete as to conversion) 30,000 Units

Beginning Work in Process Inventory Costs:

Material P 2,100
Conversion Costs 2,030

Current Period Costs of Production:

Material P 33,000
Conversion Costs 109,695

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All material is added at the start of production and all products completed are transferred out.
Step 1: Calculate the total physical units to account for.

Beginning Work in Process 10,000

Units Started 120,000
Units to account for 130,000

Step 2: Calculate the physical units accounted for. Units were either completed transferred out or
remain (partially completed) in ending WIP.

Transferred Out 100,000 *

Ending Work in Process 30,000
Units accounted for 130,000

 Units to account for should be equal with total units accounted for.
 *Beginning Inv + units started - ending WIP = 10,000 + 120,000 - 30,000
= 100,000 units

Step 3: Calculate the Equivalent Units of Production (EUP) using the weighted average method.

The units started and completed is the difference between the number of units completed for
the period and the units in beginning inventory; it can also be computed as the number of units
started during the period minus the units in ending inventory.

All DM are added at the beginning of the production process. Therefore, ending WIP inventory is
100% complete as to material. Ending inventory is only 30% complete as to labor and overhead
(conversion costs).

 Therefore, two sets of EUPs are computed: Direct materials and Conversion (Labor and
overhead).

Materials Conversion
Costs

Transferred Out 100,000 100,000

Ending Inventory 30,000 9,000 (30%)
EUP 130,000 109,000

Step 4: Calculate the total costs to account for.

The total costs to account for consist of the cost of beginning inventory P4,130 plus the costs
P142,695 (DM + Conversion Costs) added during the period: P146,825.

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The beginning inventory cost and the costs added must be segregated by cost component:
 Beginning inventory: DM costs of P2,100 and conversion costs of P2,030 = P4,130
 Costs added: DM costs of P33,000 and conversion costs of P109,695 = P142,695

Step 5: Calculate the cost per equivalent unit of production.

The cost per equivalent unit of production is found dividing the total costs to date by the EUP
quantity for each cost category:

Materials Conversion
Costs

Costs 35,100 * 111,125 **

Divide by EUP 130,000 109,000
P .27 /EUP + P 1.025 /EUP = P1.295/EUP

*Mat. Cost: P2,100 + 33,000 = 35,100

** Conversion Cost: P2,030 + 109,695 = 111,725

The EUP being used are those computed in step 3.

Step 6: Assign costs to inventories.

The amount of cost transferred to the next department is found by multiplying the number of
units transferred by the total cost per equivalent unit: 100,000 units x P1.295 = P129, 500

The amount of costs assigned to ending WIP Inventory is found by summing the cost of each
equivalent unit in ending inventory:

Materials 30,000 x P 0.27 = P 8,100

Divide by EUP 9,000 x P 1.025 = 9,225
P 17,325

The total cost accounted for is the sum of the costs transferred out (P129,500) and the ending
inventory cost (P17,325): P146,825

Remember: "total costs to account for" must be equal with "total costs accounted for"

The six steps listed above may be combined to generate a Cost of Production Report as follows:

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 First-in First-out Method (FIFO)

(Refer to Marina Merced Company)

Steps 1 and 2 are the same for FIFO as they are for the Weighted Average Method.

Beginning Work in Process 10,000

Units Started 120,000
Units to Account For 130,000

Beginning Work in Process 10,000

Started and Completed 90,000 *
Ending Work in Process 30,000
Units Accounted For 130,000

* Units started – ending WIP = 120,000 – 30,000

= 90,000 units

Step 3: Calculate the equivalent units of production using the FIFO Method.

 The work required to complete the beginning inventory equals the whole units in beginning
inventory x (1 - % of work done in the prior period).
 Since all DM were added at the beginning of the production process, no additional
material is needed.
 Since WIP, beginning was 25% complete as to conversion costs, the company needs
to apply the remaining 75% of the conversion costs in the current period.

Materials Conversion Costs

EP under WA 130,000 109,000

Less: EP in IPB 10,000 2,500 (25 % x 10,000)
EP under FIFO 120,000 P 106,500

Alternative Approach:

Materials Conversion Costs

BWIP -0- 7,500 (75% x 10,000)

S&C 90,000 90,000
EWIP 30,000 9,000 (30 % x 10,000)
EP under FIFO 120,000 P 106,500

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Step 4: Determine the total cost to account for.

Both FIFO and weighted average methods reported the same amount of Total Costs to
account for which is P146,825.

Step 5: Calculate the cost per equivalent unit of production.

The cost per equivalent unit (P4.85) is found by dividing the DM current period cost by DM EUPs
and by dividing the CC current period cost by CC EUPs:

Materials Conversion
Costs

Costs 35,000 109,695

Divide by EUP or 120,000 106,500
EP
Cost per EUP P .275 /EUP + P 1.03 /EUP = P1.305/EUP

Step 6: Assign costs to inventories:

Beginning Work in Process P 4,130

To complete (7,500 x P1.03) = 7,725
11,855

Started and Completed

90,000 x P1.305 = 117,450
Total costs transferred out P 129,305

Ending Work in Process

30,000 x P.275 = P 8,250

9,000 x P1.03 = 9,270
17,520

Total costs accounted for P 146,825

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 APPENDIX 2

Alternative Calculations of EUP

1. Alternatively, EUP under the weighted average method may be calculated as follows:

Units transferred out (whole units)

+ Ending WIP (equivalent units)
= Weighted average EUP

2. Alternatively, EUP under the FIFO method may be calculated as follows:

Weighted average EUP

- Beginning WIP (equivalent units)
= FIFO EUP

3. The distinct relationship between the WA and FIFO methods can also be used in another
manner to generate EUPs:

a. Weighted average method:

Total units to account for

- EUP to be completed in the next period (EI x % NOT completed)
= Weighted average EUP

b. Alternatively, EUP under the FIFO method may be calculated as follows:

Weighted average EUP

- EUP completed in the prior period (BI x % completed last period)
= FIFO EUP

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Terminologies

Continuous process: a production that occurs fairly uniformly through the production process.

Cost of production report: a process costing document that details all manufacturing quantities
and costs, shows the computation of cost per equivalent unit of production, and indicates the cost
assigned to goods produced during the period.

Economies of scale: are the cost advantages that a business can exploit by expanding their
scale of production. The effect of economies of scale is to reduce the average unit cost of
production.

Equivalent units of production (EUP): approximations of the number of whole units of output
that could have been produced during a period from the actual effort expended during that period;
used in process costing systems to assign costs to production.

FIFO method (of process costing): a method that separates beginning work in process
inventory and current period production and their costs so that a current period cost per unit can
be calculated.

Hybrid costing system: a costing system that combines characteristics of both job order and
process costing systems.

Total cost to account for: the sum of the balance in Work in Process Inventory at the beginning
of the period plus all current costs for direct material, direct labor, and overhead.

Total units to account for: the total number of units (whole and partial) worked on in the
department during the current period; it is sum of the actual beginning inventory units and the
units started during the current period.

Units started and completed: the number of units completed during the period less the units in
beginning inventory.

Weighted average method (of process costing): a method of cost assignment that computes
a single average cost per unit of the combined beginning work in process inventory and current
period production.

24