Chapter 4: Process Costing

Process costing is one of the two widely used cost accumulation procedures that are used
when products are manufactured under conditions of continuous processing or under
mass production methods. Process costing is a method for assigning product costs to units
of product when all units of product are virtually the same. Products are completed in a
short time, and costs for a single period can be averaged over the number of units
produced. These conditions exist in industries that produce such products as plastics,
textiles, petroleum, steel, sugar, drugs, etc. With process costing, costs are not traced to
units of product. Instead, all production costs (unit-level and otherwise) are assigned or
allocated based on total production costs and total units produced. Job costing and
process costing differ in the way costs are assigned, and they differ because of
differences in product characteristics. With job costing, many costs are traceable to jobs
or can be assigned to specific jobs using cost-driver rates. For products in a process
costing environment, all costs must be assigned using a cost-driver approach. The key
difference is that the only cost-driver is the actual number of units produced.
 In general, process costing is used:
 In homogeneous products
 In continuous processing
 In mass production techniques
Process costing is most commonly used in industries that produce essentially
homogeneous (i.e. uniform) products on a continuous basis.
 Firms producing distinct and unique products use job order costing where as firms
producing similar or identical units use process-costing system.
 Process costing system accumulate costs by department for a period of time, just
as a job order costing system accumulate costs by job, and the total cost then will
be assigned to the units produced during that period.
Similarities between job-Order and Process Costing
1. The same basic purposes exist in both systems, which are to assign material,
labor, and overhead cost to products and to provide a mechanism for computing
unit costs.

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 2. Both systems maintain and use the same basic manufacturing accounts, including
MO, Raw Materials, Work in Process, and Finished Goods.
3. The flow of costs through the manufacturing accounts is basically the same in
both systems.
Differences between Job-Order and Process Costing
Job-Order Costing Process Costing
1. Many different jobs are worked on 1. A single product is produced either on a
during each period, with each job having continuous basis for long periods of time.
different production requirements. All units of product are identical.
2. Costs are accumulated by identical job. 2. Costs are accumulated by department.
3. The job cost sheet is the key document 3. The department production report is the
controlling the accumulation of costs by a key document showing the accumulation
job. and disposition of costs by a department.
4. Unit costs are computed by job on the 4. Unit costs are computed by department
job cost sheet. on the department production report.

 In manufacturing process costing setting, each unit is assumed to receive the same
amount of direct materials cost, direct manufacturing labor costs, and indirect
manufacturing costs. Units are computed by dividing total costs by the number of
units.
 The principal difference between process costing and job costing is the extent of
averaging used to compute unit costs of products or services. In job-costing
system, individual jobs use different quantities of production resources. Thus, it
would be incorrect to cost each job at the same average production cost.
 In contrast, when identical or similar units of products or services are mass
produced, and not processed as individual jobs, process costing averages
production costs over all units produced.
The difference between job order and process costing system is, thus, the extent of the
averaging used to compute unit cost. In job order costing each job differs in terms of
material used, labor incurred, and manufacturing overhead. Hence, it is impossible to
assign the same cost for different jobs. On the contrary, identical units produced in mass

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took equal amount of direct material, direct labor, and manufacturing overhead. Thus,
the unit cost can be found by dividing total cost by the number of units produced.
There are three cases in process costing that will be considered in section.
Case 1: Process costing with zero beginning and zero ending work in process
inventory that is all units are started and fully completed by the end of the
accounting period.
Illustrating Process Costing
Haron Chemical Company makes different chemicals and uses process costing system to
account for its operation. One of its products, namely Product A, is produced in two
processing departments: the Mixing Department and the Bottling Department. Product A
is marketed in one-liter bottles.
Part I: Mixing Department
In the Mixing Department, various ingredients are added at the start of the process and
costs are accumulated in two pools, one for direct material and another for all conversion
costs. Direct material is added at the beginning of the process and conversion costs are
applied evenly through out the process. Data for the first month of operation
(September) of the Mixing Department is given below:
Physical Units, Costs and Stages of Completion

Beginning work in process 0 units

Started during the month 1,000 units
Completed during the month 1,000 units
Direct material costs Br. 80,000
Conversion costs Br. 40,000
Ending work in process 0 units

Total cost of production for the month is computed as follows:

Direct material costs-------------------------------80,000
Conversion costs-------------------------------------40,000
Total cost--------------------------------------------120,000

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Unit cost
Direct material------------------80(80,000/1000)
Conversion cost-----------------40(40,000/1000)
Total------------------------------120(120,000/1000)
Case 2: Process Costing with zero beginning but some ending work in process
inventory
Data for the second month of operation (October) of the Mixing Department is given
below:
Physical Units, Costs and Stages of Completion
Beginning work in process 0 units
Started during the month 2,000 units
Completed during the month 800 units
Ending work in process (60% completed as to 1,200 units
conversion costs.)

Direct material costs Br. 160,000

Conversion costs Br. 91,200

How should the co. calculate the cost of fully assembled units in and the cost of
partially assembled units still in process at the end of September?
Steps:
 Summarize the flow of physical units of output.
 Compute output in terms of equivalent units.
 Compute equivalent unit costs.
 Summarize total costs to account for.
 Assign total costs to unit’s completed and to units in
ending work in process.
Step 1: Summarize the flow of physical units of output (Quantity schedule)
This schedule shows the physical flow of units into and out of departments. The total
units to account for must equal to the total units accounted for.
Step 2: Equivalent Units (EUs) Schedule:

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 Equivalent units are the number of units for which periodic manufacturing cost is
incurred. Equivalent units equal the total units completed plus incomplete unit restated in
terms of completed units.
Step 3: Equivalent unit costs
This is computed by dividing costs incurred by the related equivalent units
Step 4: Cost to Account for Schedule:
This schedule shows which costs are charged to or accumulated by the department. Unit
costs broken down by the cost elements are also presented in this section.
Step5: Assign total costs to unit’s completed and to units in ending work in process
This schedule shows the distribution of accumulated costs to units completed &
transferred and to units still in process. The total cost to account for must equal to the
total cost accounted for.
Usually process costing system is illustrated under three cases. These cases are: -
Physical units and Equivalent units (Step 1&2)
Step-1 Step-2 Equivalent units
Flow of production Physical units Direct Material Conversion costs
Beginning work in 0 units
process
Started during the month 2,000 units
Total units to Account for 2,000 units
Completed during the 800 800 800
month
Work in process ending 1,200 1,200 720
Total units accounted for 2,000
Work done current period 2,000 1,520

Production cost report Total production Direct material Conversion cost

cost cost
Costs added this 251,200 Br. 160,000 Br. 91,200
period
Equivalent units 2,000 1,520
Equivalent unit cost 80 60
(Step-3)

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Total cost to account 251,200
for(st-4)
Assignment of cost
(step-5)
Completed& 112,000 800*80 800*60
transferred out
W/P ending: Direct 96,000 1,200*80
material
Conversio 43,200 720*60
n cost
Total W/P ending 139,200
Total cost accounted 251,200
for

Journal entries
 W/P mixing department------------160,000
A/P------------------------------------------160,000
 W/P mixing department-----------------91,200
Various accounts-----------------------------------------91,200

Case 3: Process costing with some beginning and some ending work in process
inventory.
Data for the third month of operation (November) of the Mixing Department is given
below:
Beginning work in process 1,200 units
Started during the month 1,000 units
Completed during the month 1,600 units
Ending work in process (50% completed as to 600 units*
conversion costs.)

Direct material costs Br. 69,000

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 Conversion costs Br. 70,800

Weighted-Average process costing method

This method calculates the equivalent unit cost of the work done to date (regardless of
the period in which it was done) and assigns this cost to equivalent units completed and
transferred out of the process and to equivalent units in ending work in process inventory.
The weighted average cost is the total of all costs entering in the work in process account
(regardless of whether it is from the beginning work in process or from work started
during the period) divided by total equivalent units of work done to date.
Using the weighted average method, the cost of partially and fully computed units
can be computed as follows:
Step-1 Step-2 Equivalent units
Flow of production Physical units Direct Conversion
Material costs
Beginning work in 1,200
process
Started during the month 1,000
Total units to Account for 2,200
Completed during the 1,600 1,600 1,600
month
Work in process ending 600 600 300
Total units accounted for 2,200
Work done to date 2,200 1,900

Production cost Total production Direct material Conversion

report cost cost cost
Beginning W/P Br139,200 Br. 96,000 Br. 43,200
Current period cost 139,800 69,000 70,800
Cost incurred to date 165,000 114,000

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Equivalent units 2,200 1,900
Equivalent unit cost 75 60
(Step-3)
Total cost to account 279,000
for(st-4)
Assignment of cost
(step-5)
Completed& 216,000 1,600*75 1,600*60
transferred out
W/P ending: Direct 45,000 600*75
material
Conversio 18,000 300*60
n cost
Total W/P ending 63000
Total cost accounted 279,000
for

Journal entries
 W/P mixing department------------69,000
A/P------------------------------------------69,000
 W/P mixing department-----------------70,800
Various accounts-----------------------------------------70,800
 W/P bottling department-----------------216,000
W/P mixing department --------------------------------216,000
First-in, First-out Method
The FIFO process costing method assigns the cost of the previous period’s equivalent
units in beginning work-in process inventory to the first units completed and transferred
out of the process, and assigns the cost of equivalent units worked on during the current
period first to complete beginning inventory, then to start and complete new units in
ending work in process inventory. This method assumes that the earliest equivalent units
in the work in process account are completed first. A distinct feature of the FIFO process-

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 costing method is that work done on beginning inventory before the current period is kept
separate from work done in the current period. Costs incurred in the current period and
units produced in the current period are used to calculate costs per equivalent unit of
work done in the current period. In contrast equivalent unit and cost per equivalent unit
calculations in the weighted average method merge the units and costs in beginning
inventory with units and costs of work done in the current period.

Using the FIFO method, the cost of partially and fully computed units can be
computed as follows:
Step-1 Step-2 Equivalent units
Flow of production Physical units Direct Conversion
Material costs
Beginning work in 1,200
process
Started during the month 1,000
Total units to Account for 2,200
Completed during the
month
From beginning 1,200 480
Started and completed 400 400 400
Work in process ending 600 600 300
Total units accounted for 2,200
Work done only current 1,000 1,180
period

Production cost report Total production Direct material Conversion

cost cost cost
Beginning W/P Br139,200 Br. 96,000 Br. 43,200
Current period cost 139,800 69,000 70,800

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Work done only current 1,000 1,180
period
Equivalent unit cost (Step- 69 60
3)
Total cost to account for(st- 279,000
4)
Assignment of cost (step-5)
Completed:
From the beginning WIP:
Cost in the beginning WIP 139,200
Cost to complete these
units:
Direct Materials 0 0*69
Conversion costs 28,800 480*60
Total cost from beginning 168,000
Started and completed 51,600 400*69 400*60
Total Completed& 219,600
transferred out
W/P ending: Direct 41,400 600*69
material
Conversion 18,000 300*60
cost
Total W/P ending 59,400
Total cost accounted for 279,000

Journal entries
 W/P mixing department------------69,000
A/P------------------------------------------69,000
 W/P mixing department-----------------70,800

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 Various accounts-----------------------------------------70,800
 W/P bottling department-----------------219,600
W/P mixing department --------------------------------219,600
Transferred-in Costs in Process Costing
Transferred-in costs also called previous department costs are the costs incurred in a
previous department that are carried forward as the product’s cost when it moves to a
subsequent process in the production cycle. That is as the units move from one
department to the next, their costs are transferred with them. Transferred in costs are
treated as if they are a separate type of direct material added at the beginning of the
process. In other words, when successive departments are involved, transferred units
from one department become all or a part of the direct materials of the next department;
however they are called transferred-in costs, not direct material costs.
Assume the following data for Haron Chemicals during the month of November in
the Bottling department
In the Bottling Department, where the product is bottled, labeled, and placed in cartons,
costs are accumulated in the two cost pools (materials and conversion) as that of the
Mixing Department plus a transferred-in cost pool. However, direct material is added at
the end of the process and conversion costs are incurred evenly through-out the process.
Physical Transferred in Direct material Conversion
units costs costs costs
Beginning work in 1,200 100% complete 0% complete 75% complete
process units
Transferred-in during the 1,600
month units
Completed during the 2,000
month units
Ending work in process 800 units 100% complete 0% complete 50% complete
Costs incurred
Beginning work in process:
Transferred in costs (1,200 x Br. Br. 204,000
170) 0
Direct material costs 90,000

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 Conversion costs

Transferred in during the month:

Weighted average 216,000
First-in, first-out 219,600

Direct material costs incurred during the 60,000

month
Conversion costs incurred during the 150,000
month
Transferred-in Costs and Weighted average method
Step-1 Step-2 Equivalent units
Flow of production Physical units Transferred-in Direct Conversion
costs Material costs
Beginning work in 1,200
process
Transferred in during 1,600
the month
Total units to Account 2,800
for
Completed during the 2,000 2,000 2,000 2,000
month
Work in process ending 800 800 0 400
Total units accounted 2,800
for
Work done to date 2,800 2,000 2,400

Production cost report Total production Transferred-in Direct material Conversion

cost costs cost cost
Beginning W/P Br294,000 204,000 0 Br. 90,000
Current period cost 426,000 216,000 60,000 150,000

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Cost incurred to date 420,000 60,000 240,000
Equivalent units 2,800 2,0 00 2,400
Equivalent unit cost 150 30 100
(Step-3)
Total cost to account 720,000
for(st-4)
Assignment of cost
(step-5)
Completed& 560,000 2000*150 2,000*30 2,000*100
transferred out
W/P ending: 120,00 800*150
Transferred-in
Direct 0 0*30
material
Conversio 40,000 400*100
n cost
Total W/P ending 160,000
Total cost accounted 720,000
for

Journal entries
 W/P bottling department------------60,000
A/P------------------------------------------60,000
 W/P bottling department-----------------150,000
Various accounts-----------------------------------------150,000
 Finished goods-----------------560,00
W/P Bottling department --------------------------------560,000
Transferred-in Costs and FIFO method
Step-1 Step-2 Equivalent units

Flow of production Physical units Transferred-in Direct Conversion

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 costs Material costs
Beginning work in 1,200
process
Transferred-in during the 1,600
month
Total units to Account for 2,800
Completed during the
month
From beginning 1,200 0 1,200 300
Transferred-in and 800 800 800 800
completed
Work in process ending 800 800 0 400
Total units accounted for 2,200
Work done only current 1,600 2,000 1,500
period

Production cost report Total production Transferred-in Direct material Conversion

cost costs cost cost
Beginning W/P Br294,000 Br204,000 Br. 0 Br. 90,000
Current period cost 429,600 219,600 60,000 150,000
Work done only current 1,600 2,000 1,500
period
Equivalent unit cost 137..25 30 100
(Step-3)
Total cost to account 723,600
for(st-4)
Assignment of cost (step-
5)
Completed:
From the beginning WIP:

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Cost in the beginning 294,000
WIP
Cost to complete these
units:
Transferred-in costs 0 0*137.25
Direct Materials 36,000 1,200*30
Conversion costs 30,000 300*100
Total cost from beginning 360,000
Started and completed 213,800 800*137.25 800*30 800*100
Total Completed& 573,800
transferred out
W/P ending: Transferred- 109,800 800*137.25
in
Direct 0 0*30
material
Conversion 40,000 400*100
cost
Total W/P ending 149,800
Total cost accounted for 723,600

Journal entries
 W/P bottling department------------60,000
A/P------------------------------------------60,000
 W/P bottling department-----------------150,000
Various accounts-----------------------------------------150,000
 Finished goods-----------------573,80
W/P Bottling department --------------------------------573,800

Process Costing and Spoilage

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A key issue in accounting for spoilage in process-costing systems is how to count spoiled
units. Units of abnormal spoilage should be counted and recorded separately. But what
units of abnormal spoilage should be counted and recoded? Theses units can either be
counted (Approach A) or not counted (Approach B). Approach A leads to more accurate
product costs because it makes visible the costs associated with normal spoilage and
spreads it over good units. Approach B is less accurate because it spreads the costs of
normal spoilage over all units.

Inspection Points and Allocating Costs of Normal Spoilage

Most illustrations in this material assume inspection upon completion. Spoilage might
actually occur at various stages of the production cycle, but it typically detected only at
one or more specific inspection points.

An inspection point is the stage of the production cycle where products are checked to
determine whether they are acceptable or unacceptable units. The cost of spoiled units is
assumed to be all costs incurred by spoiled units prior to inspection. When spoiled units
have a disposal value, the net cost spoilage is computed by deducting disposal value from
the costs of the spoiled goods accumulated to the inspection point

Illustration
A company manufactures a wooden recycling container in its formatting department.
Direct material for this product is added at the start of the process and conversion costs
are added evenly through out the process. Some units of the product are spoiled as a
result of defects which are detectable only up on the inspection of finished units.
Normally, spoiled units are 10% of good units completed.
The following data relate to the company for July, 2008
Physical units:
W/P-Beginning (60% complete as conversion costs) -----------------------------1,500 units
Started during July----------------------------------------------------------------------8,500
Completed and transferred out--------------------------------------------------------7,000
W/P-Ending (50% complete as conversion costs) --------------------------------2,000
Total cost for July:
W/P Beginning

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 Direct material-----------------------------------$12,000
Conversion costs-----------------------------------9,000
Direct material costs added in July--------------------76,500
Conversion costs added in July------------------------89,100
Note: Total spoilage= Beginning W/P Started in July-(Completed Ending W/P)
=1,500+8,500-(7,000+2,000) =1,000
Normal spoilage=10%*7,000=700
Abnormal spoilage=1,000-700=300
The cost of fully and partially completed units can be computed using the usual 5 step
procedure.
A. Weighted average method of process costing with spoilage
Step-1 Step-2 Equivalent units
Flow of production Physical units Direct Conversion
Material costs
Beginning work in 1,500
process
Started during the month 8,500
Total units to Account for 10,000
Good units completed 7,000 7,000 7,000
Normal spoilage 700 700 700
Abnormal spoilage 300 300 300
Work in process ending 2,000 2,000 1,000
Total units accounted for 10,000
Work done to date 10,000 9000

Production cost Total production Direct material Conversion

report cost cost cost
Beginning W/P Br21,000 Br. 12,000 Br.9,000
Current period cost 165,600 76,000 89,100
Cost incurred to date 85,500 98,100

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Equivalent units 10,000 9,000
Equivalent unit cost 8.85 10.9
(Step-3)
Total cost to account 186,800
for(st-4)
Assignment of cost
(step-5)
Good units
Completed& trans
Cost before Normal 138,250 7,000*8.85 7,000*10.9
spoilage
Normal spoilage 13,825 700*8.85 800*10.9
Total cost of good 152,075
units
Abnormal spoilage 5,925 300*8.85 300*10.9
W/P ending: Direct 17,700 2,000*8.85
material
Conversio 10,900 1,0000*60
n cost
Total W/P ending 28,600
Total cost accounted 186,800
for

Journal entries: To record normal and abnormal spoilage

 Finished goods--------------------------152,075
Work in process-----------------------------------------152,075
 Loss from abnormal spoilage-----------------5,925
Work in process----------------------------------------5,925

B. FIFO method of process costing with spoilage

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 Step-1 Step-2 Equivalent units
Flow of production Physical units Direct Conversion
Material costs
Beginning work in 1,500
process
Started during the month 8,500
Total units to Account for 10,000
Completed during the
month
From beginning 1,500 0 600
Started and completed 5,500 5,500 5,500
Normal spoilage 700 700 700
Abnormal spoilage 300 300 300
Work in process ending 2,000 2,000 1,000
Total units accounted for 10,000
Work done only current 8,500 8,180
period

Production cost report Total production Direct material Conversion

cost cost cost
Beginning W/P Br21,000 Br. 12,000 Br. 9,000
Current period cost 165,600 76,500 89,100
Work done only current 8,500 8,100
period
Equivalent unit cost 9 11
(Step-3)
Total cost to account 186,800
for(st-4)
Assignment of cost (step-
5)

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 Completed:
From the beginning WIP:
Cost in the beginning 21,000
WIP
Cost to complete these
units:
Direct Materials 0 0*9
Conversion costs 6,600 600*11
Total cost from beginning 27,700
Started and completed 110,000 5,500*9 5,500*11
Normal spoilage 14,000 700*9 700*11
Total cost of good units 151,600
Abnormal spoilage 6,000 300*9 300*11
W/P ending: Direct 18,000 2000*9
material
Conversion 11,000 1,000*11
cost
Total W/P ending 29,000
Total cost accounted for 186,600

Journal entries:
To record normal and abnormal spoilage
 Finished goods--------------------------151,600
Work in process-----------------------------------------151,600
 Loss from abnormal spoilage-----------------6,000
Work in process----------------------------------------6,000
Inspection and Spoilage at Intermediate Stage of Completion in process Costing
In some cases inspection may take place not on finished goods but at various stage of
production. In this case, spoilage is computed on only those units passing the inspection
point.

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 Example: The following data relate to ZAK Company for a given month
W/P-Beginning-----------------11,000(25% complete as to conversion costs)
Started this period--------------74,000
Good units completed----------61,000
W/P-Ending----------------------16,000
Total spoilage---------------------8,000
Additional information
 Normal spoilage is 10% of good units passing inspection
 Direct material is added at the beginning of the process and conversion cost is
added evenly through out the process
 Inspection occurs at 20%, 50% and 100%
See the following:
Flow of production 20% 50& 100%
Beginning work in 11,000 11,000 11,000
process
Started during the month 74,000 74,000 74,000
Total units to Account for 85,000 85,000 85,000
Good units completed 61,000 61,000 61,000
Normal spoilage 6,600 7,700 6,100
Abnormal spoilage 1,400 300 1,900
Work in process ending 16,000 16,000 16,000
Note: 6,600=10 %( 74,000-8,000); because W/P-beginning is already inspected
7,700=10 %( 85,000-8,000); because all units passed inspection this period
6,100=10 %( 61,000)
Physical units and equivalent units for the company can be computed as follows if
inspection takes place at 50% of completion
Step-1 Step-2 Equivalent units
Flow of production Physical units Direct Material Conversion costs
Beginning work in 11,000
process

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Started during the month 74,000
Total units to Account for 85,000
Good units Completed 61,000 61,000 61,000
Normal spoilage 7,700 7,700 3,850(.5*7,700)
Abnormal spoilage 300 300 150
Work in process ending 16,000 16,000 12,000
Total units accounted for 85,000
Work done to date 85,000 77,000

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