Module No.

2 – Average Costing

Learning Outcome/s:
 Differentiate the average and FIFO costing method
 Understand and compute the equivalent units of production under the average costing method

Core Values/Biblical Principles:

Above all, keep loving one another earnestly, since love covers a multitude of sins. – 1 Peter 4:8 (ESV)

Introduction:
The procedures in the preparation of cost of production report with both beginning and ending work in
process inventory will be discussed below.

Body:
Inventory costing methods used to account for beginning work in process inventory

1. Average costing method – combines rather than separate completed units from beginning work
in process and from new production.

 All the completed units are given 100% equivalent production regardless of the stage of
completion of the beginning work in process inventory.
 The average unit cost is computed by adding the cost of each category (materials, labor,
overhead, and transferred in cost) to the cost incurred for that category in the current
month and dividing the resulting total by the equivalent units of production.
 Both completed units and ending work in process inventory are valued using the same
average unit cost.

2. First in, first out costing method – the units in the beginning work in process inventory are
presented separately from the units started in the current month.

 The units in process at the beginning are assumed to have been completed first.
 The work done on the beginning work in process last month is kept separate from the
work done during the current month.
 Two equivalent units of production for completed units are computed: (1) units in
process beginning completed this month and (2) units started in process completed this
month.
 Costs incurred in the current month and units produced in the current month are used
to compute equivalent unit cost.

Comparison of average and FIFO costing methods

Average Method FIFO Method
Overview No distinction is made between Units in the beginning work in
completed units from beginning process inventory are reported
work in process inventory and separately from units started in
completed units from the the current period.
current period.
Cost of production report
1. Quantities Same procedures for both methods.
2. Equivalent production All units completed during the Beginning work in process
period are 100% complete, inventory is included in the
regardless of the stage of equivalent production only to
completion of the beginning the extent of the work done to
work in process inventory. complete these units during the
current period.
3. Costs to be accounted Cost of beginning work in Costs of beginning work in
 for process inventory is added to process inventory are not
the current costs. included in the computation of
unit costs.
4. Costs accounted for Cost of completed units is Cost of completed units is
determined by multiplying assumed to come first from
equivalent units by one unit beginning work in process
cost. inventory and then from
current production (there are
two equivalent unit costs –
beginning work in process
inventory and current
production).

Illustration
The manufacturing operations of Star Paper Company will be continued to illustrate the application of
the average cost method of accounting for beginning work in process inventories and costs added
during the month.

Cutting Department
Before recording the costs of the units transferred out to the Assembly Department, the Work in
Process – Cutting Department in the general ledger shows a balance of Php 351,294 on February 28,
2020 as shown below:
Date Explanation Debit Credit Balance
1/31/2020 Materials 77,280 77,280
1/31/2020 Labor 95,616 172,896
1/31/2020 Overhead 156,632 329,528
1/31/2020 Transferred to Assembly Dept. 264,480 65,048
2/28/2020 Materials 69,944 134,992
2/28/2020 Labor 82,416 217,408
2/28/2020 Overhead 133,886 351,294

The balance of 351,294 is broken down into cost categories as follows:

 The cost last month of the beginning work in process
Materials Php 22,650
Labor 13,536
Overhead 28,952
Total Last Month’s Costs Php 65,048

 The costs incurred in the current month

Materials Php 69,944
Labor 82,416
Overhead 133,886
Total Last Month’s Costs Php 286,246

Cutting Department
Monthly Production Report
February 2020
Quantity
- Work in Process – Beginning 3,760
- Started in Process 11,160
- Transferred Out to Next Department 9,600
- Work in Process – End 5,320
Stage of Completion of Work in Process Beginning Ending
- Materials 100% 100%
- Labor 40% 45%
- Overhead 55% 55%
 Cutting Department
Equivalent Units of Production Computations
February 2020
Materials
- Transferred Out to Next Department 9,600
- Work in Process – Ending (5,320 x 100%) 5,320
Equivalent Units for Materials 14,920
Labor
- Transferred Out to Next Department 9,600
- Work in Process – Ending (5,320 x 45%) 2,394
Equivalent Units for Labor 11,994
Overhead
- Transferred Out to Next Department 9,600
- Work in Process – Ending (5,320 x 55%) 2,926
Equivalent Units for Overhead 12,526

Cutting Department
Cost of Production Report
February 2020
Quantity Schedule Units
a. Quantity to be accounted for:
Work in process – beginning 3,760
Started in process 11,160
Total to be accounted for 14,920
b. Quantity accounted for:
Transferred out to next department 9,600
Work in process – ending 5,320
Total accounted for 14,920

Cost Schedule Total Cost EUP Unit Costs

c. Costs to be accounted for:
Costs incurred in this department
Materials: Beginning work in process Php 22,560
Added this month 69,944
Total materials Php 92,504 14,920 Php 6.20
Labor: Beginning work in process Php 13,536
Added this month 82,416
Total labor Php 95,952 11,994 Php 8.00
Overhead: Beginning work in process Php 28,952
Added this month 133,886
Total overhead Php 162,838 12,526 Php 13.00
Total costs to be accounted for Php 351,294 Php 27.20
d. Costs accounted for:
Transferred out Php 261,120 9,600 Php 27.20
Work in process – end
-Materials 32,984 5,320 Php 6.20
-Labor 19,152 2,394 Php 8.00
-Overhead 38,038 2,926 Php 13.00
Total work in process Php 90,174
Total costs accounted for Php 351,294

Work in Process – Assembly Department 261,120

Work in Process – Cutting Department 261,120
Assembly Department
On February 28, the Work in Process – Assembly Department account shows a balance of Php 469,391.
This amount is composed of the following:
 Cost last month
Costs Transferred In Php 28,130
Materials 1,455
Labor 5,529
Overhead 4,656
Total Last Month’s Costs Php 39,770
 Cost incurred during the current month
Costs Transferred In Php 261,120
Materials 23,128
Labor 70,638
Overhead 74,735
Total Last Month’s Costs Php 429,621

Assembly Department
Monthly Production Report
February 2020
Quantity
- Work in Process – Beginning 970
- Transferred In – Current Month 9,600
- Transferred Out to Next Department 9,470
- Work in Process – End 1,100
Stage of Completion of Work in Process Beginning Ending
- Transferred In Cost 100% 100%
- Materials 60% 55%
- Labor 60% 55%
- Overhead 60% 55%

Assembly Department
Equivalent Units of Production Computations
February 2020
Transferred In Cost from Prior Department
- Transferred Out to Next Department 9,470
- Work in Process – Ending (1,100 x 100%) 1,100
Equivalent Units for Transferred In Costs 10,570
Materials
- Transferred Out to Next Department 9,470
- Work in Process – Ending (1,100 x 55%) 605
Equivalent Units for Materials 10,075
Labor
- Transferred Out to Next Department 9,470
- Work in Process – Ending (1,100 x 55%) 605
Equivalent Units for Labor 10,075
Overhead
- Transferred Out to Next Department 9,470
- Work in Process – Ending (1,100 x 55%) 605
Equivalent Units for Overhead 10,075
 Assembly Department
Cost of Production Report
February 2020
Quantity Schedule Units
a. Quantity to be accounted for:
Work in process – beginning 970
Started in process 9,600
Total to be accounted for 10,570
b. Quantity accounted for:
Transferred out to next department 9,470
Work in process – ending 1,100
Total accounted for 10,570

Cost Schedule Total Cost EUP Unit Costs

c. Costs to be accounted for:
Costs transferred in from prior department
Work in process – beginning Php 28,130
Transferred in – current month 261,120
Total transferred in costs Php 289,250 10,570 Php 27.37
Costs incurred in this department
Materials: Beginning work in process 1,455
Added this month 23,128
Total materials Php 24,583 10,075 Php 2.44
Labor: Beginning work in process 5,529
Added this month 70,638
Total labor Php 76,167 10,075 Php 7.56
Overhead: Beginning work in process 4,656
Added this month 74,735
Total overhead Php 79,391 10,075 Php 7.88
Total costs incurred in this department Php 180,141 Php 17.88
Total costs to be accounted for Php 469,391 Php 45.25
d. Costs accounted for:
Transferred out* Php 428, 467 9,470 Php 45.25
Work in process – end
Costs from prior department 30,107 1,100 Php 27.37
Costs incurred in this department
-Materials 1,476 605 Php 2.44
-Labor 4,574 605 Php 7.56
-Overhead 4,767 605 Php 7.88
Total work in process Php 40,924
Total costs accounted for Php 469,391
*Php 51 rounding

Work in Process – Packaging Department 428,467

Work in Process – Assembly Department 428,467

Packaging Department
On February 28, the Work in Process – Packaging Department account shows a balance of Php 604,922.
This amount is composed of the following:
 Cost last month
Costs Transferred In Php 133,280
Materials 0
Labor 2,230
Overhead 1,020
Total Last Month’s Costs Php 136,530
  Cost incurred during the current month
Costs Transferred In Php 428,467
Materials 2,560
Labor 20,480
Overhead 16,885
Total Last Month’s Costs Php 468,392

Packaging Department
Monthly Production Report
February 2020
Quantity
- Work in Process – Beginning 2,720
- Transferred In – Current Month 9,470
- Transferred Out to Finished Goods 6,370
- Work in Process – End 5,820
Stage of Completion of Work in Process Beginning Ending
- Transferred In Cost 100% 100%
- Materials 0% 0%
- Labor 20% 20%
- Overhead 15% 15%

Packaging Department
Equivalent Units of Production Computations
February 2020
Transferred In Cost from Prior Department
- Transferred Out to Finished Goods 6,370
- Work in Process – Ending (5,820 x 100%) 5,820
Equivalent Units for Transferred In Costs 12,190
Materials
- Transferred Out to Finished Goods 6,370
- Work in Process – Ending (5,820 x 0%) 0
Equivalent Units for Materials 6,370
Labor
- Transferred Out to Finished Goods 6,370
- Work in Process – Ending (5,820 x 20%) 1,164
Equivalent Units for Labor 7,534
Overhead
- Transferred Out to Finished Goods 6,370
- Work in Process – Ending (5,820 x 15%) 873
Equivalent Units for Overhead 7,243
 Packaging Department
Cost of Production Report
February 2020
Quantity Schedule Units
a. Quantity to be accounted for:
Work in process – beginning 2,720
Started in process 9,470
Total to be accounted for 12,190
b. Quantity accounted for:
Transferred out to next department 6,370
Work in process – ending 5,820
Total accounted for 12,190

Cost Schedule Total Cost EUP Unit Costs

c. Costs to be accounted for:
Costs transferred in from prior department
Work in process – beginning Php 133,280
Transferred in – current month 428,467
Total transferred in costs Php 561,747 12,190 Php 46.08
Costs incurred in this department
Materials: Beginning work in process 0
Added this month 2,560
Total materials Php 2,560 6,370 Php 0.40
Labor: Beginning work in process 2,230
Added this month 20,480
Total labor Php 22,710 7,534 Php 3.01
Overhead: Beginning work in process 1,020
Added this month 16,885
Total overhead Php 17,905 7,243 Php 2.47
Total costs incurred in this department Php 43,175 Php 5.88
Total costs to be accounted for Php 604,922 Php 51.96
d. Costs accounted for:
Transferred out* Php 331,076 6,370 Php 51.96
Work in process – end
Costs from prior department 268,186 5,820 Php 46.08
Costs incurred in this department
-Materials 0 0 Php 0.40
-Labor 3,504 1,164 Php 3.01
-Overhead 2,156 873 Php 2.47
Total work in process Php 273,846
Total costs accounted for Php 604,922
*Php 91 rounding

Finished Goods 331,076

Work in Process – Packaging Department 331,076

Recording sales and cost of goods sold

Assume that Star Paper Company sold 6,300 units in February at Php 80 each or at a selling price of Php
504,000.

Units Unit Price Total Cost

January (5,430 – 5,300) 130 Php 56 Php 7,280
February 6,370 Php 51.96 Php 331,076
Total 6,500 Php 52.06 Php 338,356

Therefore, the 6,300 units sold has a total cost of Php 327,978 (6,300 x Php 52.06 rounded), and the
ending inventory has a total cost of Php 10,412 (200 x Php 52.06).
Accounts Receivable 504,000
Sales 504,000

Cost of Goods Sold 327,978

Finished Goods 327,978

Summary:
Under the average cost method, all costs of each category are combined and average unit costs is
computed. The cost in beginning work in process inventory are combined with the cost added in the
current month for each category. The total is then divided by the equivalent units of production to
compute the average unit cost.

References:
Cost Accounting Principles and Procedural Applications by Pedro P. Guerrero, 2014-2015 edition