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Chapter 4

 System Design—Process Costing Learning Objectives 1. Record the flow of materials, labor, and overhead through a process costing system. 2. Compute the equivalent units of production using the weighted-average method. 3. Prepare a quantity schedule using the weighted-average method. 4. Compute the costs per equivalent unit using the weighted-average method. 5. Prepare a cost reconciliation using the weighted-average method. Chapter Overview A. Job-Order Costing vs. Process Costing. Process costing is used in industries that produce homogenous products such as bricks, flour, and cement on a continuous basis. 1. Similarities between job-order and process costing. Job-order and process costing systems share some characteristics: a. Both systems have the same basic purpose—to assign material, labor, and overhead cost to products. b. Both systems use the same basic manufacturing accounts: Manufacturing Overhead, Raw Materials, Work In Process, and Finished Goods. c. The flow of costs through the manufacturing accounts is basically the same. 2. Differences between job-order and process 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 the units are essentially indistinguishable from one another. Under process costing: a. A single homogenous product is 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. b. Costs in process costing are accumulated by department, rather than by individual job. c. The department production report is the key document in process costing, showing the accumulation and disposition of cost. In job-order costing, the job-cost sheet is the key document. B. Overview of Process Costing. Manufacturing costs are accumulated in processing departments in a process costing system. A processing department is any location in the organization where work is performed on a product and where materials, labor, and overhead costs are added to the product. Processing departments should also have two other features. First, the activity performed in the processing department should be essentially the same for all units that pass through the department. Second, the output of the department should be homogeneous. In process costing, the average cost of processing units for a period is assigned to each unit passing through the department. Two process costing methods are illustrated in the text—the weighted-average method and the FIFO method. While the FIFO method provides more current cost data for decision-making and performance evaluation purposes, it is more difficult for students to grasp. For that reason, the FIFO method is covered in an appendix. C. Equivalent Units of Product. In order to calculate the average cost per unit, the total number of units must be determined. Partially completed units pose a difficulty that is overcome using the concept of equivalent units. Equivalent units are the equivalent, in terms of completed units, of partially completed units. The formula for computing equivalent units is: Equivalent units are the number of complete, whole units one could obtain from the materials and effort contained in partially completed units. Under the weighted-average method, the equivalent units for a particular cost category (e.g., materials or conversion cost) is computed by adding together the number of units completed and transferred out to the next department during the period and the equivalent units in the ending work in process inventory in the department. D. Production Report. The purpose of a production report is to summarize all of the activity that takes place in a department's work in process account for a period. A production report consists of three parts: • A quantity schedule and a computation of equivalent units. • A computation of costs per equivalent unit. • A reconciliation of all cost flows into and out of the department during the period. E. Production Report: Weighted-Average Method. Emphasize that the weighted-average method does not attempt to separate units in the beginning inventory from units started during the current period. Costs and units from beginning inventory are blended together with costs and units from the current period. 1. Quantity Schedule and Equivalent Units. The first step in preparing a production report is to prepare a quantity schedule, which shows the physical flow of units through the department. This schedule allows managers to see at glance how many units moved through the department during the period. Using the quantity schedule, the equivalent units can be easily computed. 2. Costs per Equivalent Unit.The second step in preparing a production report is to calculate the costs per equivalent unit. The cost per equivalent unit is computed for a particular cost category (i.e., materials, labor, overhead, or conversion) 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. 3. Cost Reconciliation. The third step in preparing a production report is to prepare a 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. a. 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 prior department. b. 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.  F. Operation Costing. The costing systems discussed in Chapters 3 and 4 represent the two ends of a continuum. On one end is job-order costing and on the other is process costing. Between the two extremes, there are many “hybrid” systems. Operation costing is an example of such a hybrid system. It is used in situations where products have some common as well as individual characteristics. TVs, for example, have some common characteristics in that all models must be assembled and tested following the same basic steps. However, each model has different components with different costs. The costs of the components (materials) would be charged to a batch of a particular model individually, as in job-order costing, but the conversion costs may be assigned using process costing.