CHAPTER THREE
PROCESS COSTING
Learning Objectives
• Identify the types of firms or operations for which a process costing system is most
suitable
• Explain and calculate equivalent units produced
• Describe the five steps in process costing
• Demonstrate the weighted-average method of process costing
• Demonstrate the FIFO method of process costing
• Apply process costing to a firm with multiple departments
• Prepare journal entries to record the flow of costs in a process cost system
• Explain how process cost systems are implemented and enhanced in practice
• Account for spoilage in process costing
Process Costing
• Process costing: a product costing system that accumulates costs according to processes
or departments
• Accumulated costs are spread over output of the period
• Used when outputs are standardized/ homogeneous
• Examples: chemicals, oil refining, textiles, paints, flour, canneries, rubber, steel, glass,
cement, and sporting goods
Production Cost Report
• Prepared each period (e.g., each month) for each department
• Each department has its own WIP Inventory account
• The production cost report summarizes:
– The number of physical and equivalent units
– Costs incurred during the period
– Cost per equivalent unit for each cost element (e.g., DL, DM, factory
overhead)
– Costs assigned to units completed and to units in ending WIP inventory
Production Cost Report (continued)
• Equivalent units:
– A measure of output for the period
• Example: 2 units 50% complete = 1 unit fully complete
– An expression of partially completed units in terms of fully completed units
• Cost/equivalent unit = costs in each department for the period by the “number of
equivalent units” produced during the period
– Definition of numerator and denominator depends on whether FIFO or weighted-
average method is used
Some Cost Issues
• Because of the relatively small DL content in many process industries, factory overhead
and DL costs are often combined into a separate cost element and called conversion costs
• Many firms incur conversion costs uniformly throughout the production process
• DM costs can be added at discrete points of manufacturing or continuously over
production (in the latter case, DM for equivalent-unit purposes will be calculated using
the same proportion as conversion costs)
Completing the Production Cost Report: 5 Steps
1. Account for the physical units
2. Calculate equivalent units for each manufacturing cost element (FIFO
or weighted-average method)
3. Determine total costs for each manufacturing cost element (FIFO or
weighted-average method)
4. Compute cost per equivalent unit for each manufacturing cost element
5. Assign total manufacturing costs to units completed and ending WIP
Inventory
Weighted-Average vs. FIFO?
• The weighted average method includes all costs (i.e., beginning WIP inventory + current
period manufacturing costs) in calculating cost per equivalent unit for each cost element
the unit cost
– Thus, prior period and current period costs are averaged
– The FIFO method includes in calculating the unit cost only costs incurred and
work effort performed during the current period
– Thus, FIFO costs represent the current period’s cost per equivalent unit for each
manufacturing cost element
Process Costing Example
HSU Toy Company has two production departments, molding and finishing.
Molding places direct materials into production at the beginning of the process.
Direct labor and factory overhead costs are incurred gradually throughout the
process with different proportions. The molding department’s units of production
and costs for the month of June are provided
Process Costing Example (continued)
Step 1: Account for Physical Product Flow
Step 2: Calculate Equivalent Units for Each Cost Element
Step 3: Determine Total Cost for Each Cost Element
“Total Costs for Each Manufacturing Cost Element” = Numerator in cost per equivalent
unit calculation (and is different for FIFO vs. Weighted-Average method)
Step 4: Calculate Cost per Equivalent Unit for Each Cost Element
Step 5: Cost Assignment
FIFO Example: Step 1
Step 2, Alternative 1: Calculate FIFO Equivalent Units
Step 2, Alternative 2: Calculate FIFO Equivalent Units
Step 3: Calculate FIFO (i.e., Current Period) Costs
Step 4: Calculate FIFO Costs per Equivalent Unit
Step 5, Part 1: Assign Costs to Units Completed from Beginning WIP Inventory
Step 5, Part 2: Assign Costs to Units Started & Completed and Account for Total
Costs
Weighted-Average vs. FIFO
Weighted- FIFO
Average
Handling of No separate Separates the units in the beginning WIP (and their
partially completed treatment costs)
beginning WIP from the units started and completed during the period
Ease of calculation Easier; best in More difficult; best in situations where
and situations prices/costs fluctuate; better for “control” purposes
appropriateness where WIP is
small and
prices/costs
are stable
Process Costing with Multiple Departments
• As a product passes from one department to another, the accumulated cost passes from
department to department
• Transferred-in costs, or prior department costs, are costs of work performed in earlier
departments that are transferred into the present department
These costs are treated like an additional cost element
Implementation and Enhancement of Process Costing
• Sometimes process-based manufacturers have very different products going through
different processes, making process costing by itself inadequate
Activity-based costing (ABC) is an important enhancement to process costing when product and
process variety arises
