4-1
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Management Accounting Lecture 10 (Chapter 4)
Systems Design: Process Costing
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Todays’ Lecture
n System Design – Process Costing
n Review of Process Costing versus Job-Order Costing
n When should Process Costing be Used?
n How is it Used?
n Journal entries
n Calculating balances by the Weighted Average Cost method
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Product Costing
n Product Costing is the mapping and allocating of costs to a specific product
n Its purpose is to provide executives with critical information including: n How to minimize costs n How to price a product competitively and profitably
n There are two main methodologies of Product Costing 1. Job-Order Costing – each job is different 2. Process Costing – many of the same products
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Job Order Costing
n Job-Order Costing is the costing methodology applied in companies in the following circumstances: n Produce many different products or packages n Manufacture to order so each job is different
n Examples would be: n SNC (engineering and construction) n Airbus (aircraft) n Other?
n In these cases, a company needs to know, often on an order by order basis, what are the costs associated with fulfilling the order
n Cost records for each job will be required to support decision making and billing of the customer
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Process Costing
n Process Costing is the costing methodology applied in companies in the following circumstances: n Produce many units of a single product n Each unit is substantially similar to other units
n Examples would be: n Lenovo (PC manufacturing) n Frito lay (Snacks and beverages) n Others?
n That each of these products are substantially the same, managers are able to apply the same average cost to each unit
n Cost records for each job will be required to support decision making and billing of the customer
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Similarities & Differences Between Job-Order and Process Costing
n Similarities n Both are Product Costing systems assigning material, labour
and overhead to products n Both systems use the same manufacturing accounts n The flow of costs are very similar in both systems
n Differences n Process Costing is used for single products which run
continuously (versus differing products/packages) n Process Costing tracks cost by department (versus by job) n Tracks unit cost by department (versus by job sheet)
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Processing Departments
Any location in an organization where materials, labor or overhead are added to the product.
The activities performed in a processing department are performed uniformly on all
units of production. Furthermore, the output of a processing department must be
homogeneous.
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Finished Goods
Cost of Goods Sold
Work in Process
Direct Materials
Direct Labor
ManufacturingOverhead
Flow of Materials, Labor and Overhead Costs
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Finished Goods
Cost of Goods Sold
Direct Labor
ManufacturingOverhead
Jobs
Costs are traced and applied to individual jobs in a job-order
cost system. Direct
Materials
Flow of Materials, Labor and Overhead Costs
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Finished Goods
Cost of Goods Sold
Direct Labor
ManufacturingOverhead
Processing Department
Costs are traced and applied to departments
in a process cost system.
Direct Materials
Flow of Materials, Labor and Overhead Costs
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For purposes of this example, assume there are two
processing departments – Departments A and B.
We will use T-accounts and journal entries.
T-Account and Journal Entry Views of Process Cost Flows
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Raw Materials
Work in Process Department B
Work in Process Department A
• Direct Materials
• Direct Materials
• Direct Materials
Process Cost Flows (in T-Account form)
4-3
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GENERAL JOURNAL Page 4
Date DescriptionPost. Ref. Debit Credit
Work in Process - Department A XXXXXWork in Process - Department B XXXXX
Raw Materials XXXXXTo record the use of direct material.
Process Cost Flows (in journal entry form)
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Work in Process Department B
Work in Process Department A Salaries and
Wages Payable
• Direct Materials
• Direct Materials
• Direct Labor
• Direct Labor • Direct
Labor
Process Cost Flows (in T-Account form)
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GENERAL JOURNAL Page 4
Date DescriptionPost. Ref. Debit Credit
Work in Process - Department A XXXXXWork in Process - Department B XXXXX
Salaries and Wages Payable XXXXXTo record direct labor costs.
Process Cost Flows (in journal entry form)
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Work in Process Department B
Work in Process Department A
Manufacturing Overhead
• Overhead Applied to
Work in Process
• Applied Overhead
• Applied Overhead
• Direct Labor
• Direct Materials
• Direct Labor
• Direct Materials
• Actual Overhead
Process Cost Flows (in T-Account form)
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GENERAL JOURNAL Page 4
Date DescriptionPost. Ref. Debit Credit
Work in Process - Department A XXXXXWork in Process - Department B XXXXX
Manufacturing Overhead XXXXXTo apply overhead to departments.
Process Cost Flows (in journal entry form)
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Work in Process Department B
Work in Process Department A
• Direct Materials
• Direct Labor
• Applied Overhead
• Direct Materials
• Direct Labor
• Applied Overhead
Transferred to Dept. B
• Transferred from Dept. A
Process Cost Flows (in T-Account form)
4-4
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GENERAL JOURNAL Page 4
Date DescriptionPost. Ref. Debit Credit
Work in Process - Department B XXXXXWork in Process - Department A XXXXX
To record the transfer of goods fromDepartment A to Department B.
Process Cost Flows (in journal entry form)
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Finished Goods Work in Process Department B
• Cost of Goods
Manufactured
• Direct Materials
• Direct Labor
• Applied Overhead
• Transferred from Dept. A
• Cost of Goods
Manufactured
Process Cost Flows (in T-Account form)
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GENERAL JOURNAL Page 4
Date DescriptionPost. Ref. Debit Credit
Finished Goods XXXXXWork in Process - Department B XXXXX
To record the completion of goodsand their transfer from Department Bto finished goods inventory.
Process Cost Flows (in journal entry form)
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Finished Goods
Cost of Goods Sold
Work in Process Department B
• Cost of Goods
Manufactured
• Direct Materials
• Direct Labor
• Applied Overhead
• Transferred from Dept. A
• Cost of Goods
Sold
• Cost of Goods
Sold
• Cost of Goods
Manufactured
Process Cost Flows (in T-Account form)
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GENERAL JOURNAL Page 4
Date DescriptionPost. Ref. Debit Credit
Cost of Goods Sold XXXXXFinished Goods XXXXX
To record cost of goods sold.
Process Cost Flows (in journal entry form)
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Equivalent Units of Production
Equivalent units are the product of the number of partially completed units and the percentage
of completion of those units.
We need to calculate equivalent units because a department usually has some partially completed
units in its beginning and ending inventory.
4-5
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Two half completed products are equivalent to one completed product.
So, 10,000 units 70% complete are equivalent to 7,000 complete units.
+ = 1
Equivalent Units – The Basic Idea
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Calculating Equivalent Units
Equivalent units can be calculated two ways:
�The First-In, First-Out Method – FIFO is covered in the appendix to this chapter.
�The Weighted-Average Method – This method will be covered in the main portion of the chapter.
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The weighted-average method . . . • Makes no distinction between work done in prior or current periods. • Blends together units and costs from prior and current periods.
Characteristics of the Weighted Average Method
The equivalent units of production for a department are the number of units transferred to the next department (or finished goods) plus the equivalent units in the department’s ending
work in process inventory. McGraw-Hill /Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Direct labor costs may be small
in comparison to other product
costs in process costing systems.
Direct Materials
Type of Product Cost
Dol
lar A
mou
nt
Direct Labor
Conversion
Treatment of Direct Labor
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Type of Product Cost
Dol
lar A
mou
nt Conversion
Direct labor and manufacturing overhead may be combined into one product cost called conversion.
Direct Materials
Treatment of Direct Labor
Direct labor costs may be small
in comparison to other product
costs in process costing systems.
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Weighted-Average Example
Percent CompletedShaping and Milling Department Units Materials ConversionBeginning work in process 200 55% 30%
Units started into production in May 5,000
Units completed during May and 4,800 100% 100% transferred to the next department
Ending working process 400 40% 25%
Double Diamond Skis reported the following activity in Shaping and Milling Department
for the month of May:
4-6
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Weighted-Average Example
The first step in calculating the equivalent units is to identify the units completed and transferred
out of the Department in May (4,800 units).
Materials Conversion
Units completed and transferred to the next department 4,800 4,800
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Weighted-Average Example
Materials Conversion
Units completed and transferred to the next department 4,800 4,800 Work in process, June 30:
400 units × 40% 160
Equivalent units of Production in during the month of May 4,960
The second step is to identify the equivalent units of production in ending work in process with respect to
materials for the month (160 units) and add this to the 4,800 units from step one.
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Weighted-Average Example
Materials Conversion
Units completed and transferred to the next department 4,800 4,800 Work in process, June 30:
400 units × 40% 160 400 units × 25% 100
Equivalent units of Production in during the month of May 4,960 4,900
The third step is to identify the equivalent units of production in ending work in process with respect to conversion for the month (100 units) and add this to
the 4,800 units from step one.
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Weighted-Average Example
Equivalent units of production always equals: Units completed and transferred + Equivalent units remaining in work in process
Materials Conversion
Units completed and transferred to the next department 4,800 4,800 Work in process, June 30:
400 units × 40% 160 400 units × 25% 100
Equivalent units of Production in during the month of May 4,960 4,900
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Weighted-Average Example
Beginning Work in Process
200 Units 55% Complete
Ending Work in Process
400 Units 40% Complete
5,000 Units Started
4,800 Units Started and Completed
Materials
4,800 Units Completed 160 Equivalent Units 400 × 40%
4,960 Equivalent units of production
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5,000 Units Started
4,800 Units Completed
4,800 Units Started and Completed
100 Equivalent Units 400 × 25%
4,900 Equivalent units of production
Beginning Work in Process
200 Units 30% Complete
Ending Work in Process
400 Units 25% Complete
Conversion
Weighted-Average Example
4-7
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The following table includes some additional facts for Double Diamond Skis’ Shaping and Milling Department for May.
Computing Cost Per Equivalent Unit
Beginning work in process: 200 units
Materials: 55% complete $ 9,600 Conversion: 30% complete 5,575
Production started during May 5,000 units Production completed during May 4,800 units Costs added to production in May
Materials cost $ 368,600 Conversion cost 350,900
Ending work in process 400 units Materials: 40% complete Conversion: 25% complete
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Compute and Apply Costs
The formula for computing the cost per equivalent unit is :
Cost per equivalent
unit =
Cost of beginning work in process
inventory Cost added during
the period
Equivalent units of production
+
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Compute and Apply Costs
TotalCost Materials Conversion
Cost to be accounted for: Work in process, May 1 15,175$ 9,600$ 5,575$ Costs added in the Shipping and Milling Department 719,500 368,600 350,900 Total cost 734,675$ 378,200$ 356,475$
Equivalent units 4,960 4,900 Cost per equivalent unit
Here is a schedule with the cost and equivalent unit information.
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TotalCost Materials Conversion
Cost to be accounted for: Work in process, May 1 15,175$ 9,600$ 5,575$ Costs added in the Shipping and Milling Department 719,500 368,600 350,900 Total cost 734,675$ 378,200$ 356,475$
Equivalent units 4,960 4,900 Cost per equivalent unit 76.25$ 72.75$ Total cost per equivalent unit = $76.25 + $72.75 = $149.00
Compute and Apply Costs
$378,200 ÷ 4,960 units = $76.25
Here is a schedule with the cost and equivalent unit information.
$356,475 ÷ 4,900 units = $72.75
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Computing the Cost of Ending Work in Process Inventory
Materials Conversion TotalEnding work in process inventory: Equivalent units of production 160 100
Cost of ending work in process inventory -$ -$ -$
Units completed and transferred out: Units transferred to the next department 4,800 4,800 Cost per equivalent unit 76.25$ 72.75$ Cost of units transferred out 366,000$ 349,200$ 715,200$
Shaping and Milling DepartmentCost of Ending Work in Process Inventory and the Units Transferred Out
Step 1: Record the equivalent units of production in ending work in process inventory.
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Materials Conversion TotalEnding work in process inventory: Equivalent units of production 160 100 Cost per equivalent unit 76.25$ 72.75$ Cost of ending work in process inventory 12,200$ 7,275$ 19,475$
Units completed and transferred out: Units transferred to the next department 4,800 4,800 Cost per equivalent unit 76.25$ 72.75$ Cost of units transferred out 366,000$ 349,200$ 715,200$
Shaping and Milling DepartmentCost of Ending Work in Process Inventory and the Units Transferred Out
Computing the Cost of Ending Work in Process Inventory
Step 2: Record the cost per equivalent unit.
4-8
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Materials Conversion TotalEnding work in process inventory: Equivalent units of production 160 100 Cost per equivalent unit 76.25$ 72.75$ Cost of ending work in process inventory 12,200$ 7,275$ 19,475$
Units completed and transferred out: Units transferred to the next department 4,800 4,800 Cost per equivalent unit 76.25$ 72.75$ Cost of units transferred out 366,000$ 349,200$ 715,200$
Shaping and Milling DepartmentCost of Ending Work in Process Inventory and the Units Transferred Out
Computing the Cost of Ending Work in Process Inventory
Step 3: Compute the cost of ending work in process inventory.
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Computing the Cost of Units Transferred Out
Materials Conversion TotalEnding work in process inventory: Equivalent units of production 160 100 Cost per equivalent unit 76.25$ 72.75$ Cost of ending work in process inventory 12,200$ 7,275$ 19,475$
Units completed and transferred out: Units transferred to the next department 4,800 4,800 Cost per equivalent unit 76.25$ 72.75$ Cost of units transferred out 366,000$ 349,200$ 715,200$
Shaping and Milling DepartmentCost of Ending Work in Porcess Inventory and the Units Transferred Out
Step 1: Record the units transferred out to the next department.
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Materials Conversion TotalEnding work in process inventory: Equivalent units of production 160 100 Cost per equivalent unit 76.25$ 72.75$ Cost of ending work in process inventory 12,200$ 7,275$ 19,475$
Units completed and transferred out: Units transferred to the next department 4,800 4,800 Cost per equivalent unit 76.25$ 72.75$ Cost of units transferred out 366,000$ 349,200$ 715,200$
Shaping and Milling DepartmentCost of Ending Work in Porcess Inventory and the Units Transferred Out
Computing the Cost of Units Transferred Out
Step 2: Record the cost per equivalent unit.
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Materials Conversion TotalEnding work in process inventory: Equivalent units of production 160 100 Cost per equivalent unit 76.25$ 72.75$ Cost of ending work in process inventory 12,200$ 7,275$ 19,475$
Units completed and transferred out: Units transferred to the next department 4,800 4,800 Cost per equivalent unit 76.25$ 72.75$ Cost of units transferred out 366,000$ 349,200$ 715,200$
Shaping and Milling DepartmentCost of Ending Work in Process Inventory and the Units Transferred Out
Computing the Cost of Units Transferred Out
Step 3: Compute the cost of units transferred out.
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Reconciling Costs
Step 1: Compute the costs to be accounted for by adding the cost of beginning work in process and the production costs added in May.
Costs to be accounted for: Cost of beginning work in process inventory 15,175$ Costs added to production during the period 719,500 Total cost to be accounted for 734,675$
Shaping and Milling DepartmentCost Reconciliation
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Costs to be accounted for: Cost of beginning work in process inventory 15,175$ Costs added to production during the period 719,500 Total cost to be accounted for 734,675$
Cost accounted for as follows: Cost of ending work in process inventory 19,475$ Cost of units transferred out 715,200 Total cost accounted for 734,675$
Shaping and Milling DepartmentCost Reconciliation
Reconciling Costs
Step 2: Compute the costs to accounted for by adding the cost of ending work in process and the cost of units transferred out in May.
4-9
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FIFO vs. Weighted-Average Method
The FIFO method (generally considered more accurate than the weighted-average method) differs
from the weighted-average method in two ways:
1. The computation of equivalent units.
2. The way in which the costs of beginning inventory are treated.
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Equivalent Units – FIFO Method
Let’s revisit the Smith Company example. Here is information concerning the Assembly Department
for the month of June.
Percent CompletedUnits Materials Conversion
Work in process, June 1 300 40% 20%
Units started into production in June 6,000
Units completed and transferred out 5,400 of Department A during June
Work in process, June 30 900 60% 30%
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Equivalent Units – FIFO Method
Step 1: Determine equivalent units needed to complete beginning Work in Process Inventory.
Materials Conversion
To complete beginning Work in Process: Materials: 300 units × (100% - 40%) 180 Conversion: 300 units × (100% - 20%) 240
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Equivalent Units – FIFO Method
Step 2: Determine units started and completed during the period.
Materials Conversion
To complete beginning Work in Process: Materials: 300 units × (100% - 40%) 180 Conversion: 300 units × (100% - 20%) 240
Units started and completed during June 5,100 5,100
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Equivalent Units – FIFO Method
Step 3: Add the equivalent units in ending Work in Process Inventory.
Materials Conversion
To complete beginning Work in Process: Materials: 300 units × (100% - 40%) 180 Conversion: 300 units × (100% - 20%) 240
Units started and completed during June 5,100 5,100 Ending Work in Process Materials: 900 units × 60% complete 540 Conversion: 900 units × 30% complete 270
Equivalent units of production 5,820 5,610
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Beginning Work in Process
300 Units 40% Complete
Ending Work in Process
900 Units 60% Complete
6,000 Units Started
5,100 Units Started and Completed
FIFO Example
Materials
900 × 60% 5,100 Units Completed 540 Equivalent Units 5,820 Equivalent units of production
180 Equivalent Units 300 × 60%
4-10
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Beginning Work in Process
300 Units 20% Complete
Ending Work in Process
900 Units 30% Complete
6,000 Units Started
5,100 Units Started and Completed
FIFO Example
Conversion
5,100 Units Completed 270 Equivalent Units 900 × 30%
5,610 Equivalent units of production
240 Equivalent Units 300 × 80%
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Equivalent Units: Weighted-Average vs. FIFO
Materials ConversionEquivalent units - weighted-average method 5,940 5,670Less equivalent units in beginning inventory: 300 units × 40% 120 300 units × 20% 60 Equivalent units - FIFO method 5,820 5,610
As shown below, the equivalent units in beginning inventory are subtracted from the equivalent units of production per the weighted-average method to obtain the equivalent units of
production under the FIFO method.
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Beginning work in process: 400 units Materials: 40% complete $ 6,119 Conversion: 20% complete $ 3,920
Production started during June 6,000 units Production completed during June 5,400 units Costs added to production in June
Materials cost $ 118,621 Conversion cost $ 81,130
Ending work in process 900 units Materials: 60% complete Conversion: 30% complete
Cost per Equivalent Unit - FIFO
Let’s revisit the Smith Company Assembly Department for the month of June to prepare our production report.
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Cost per Equivalent Unit - FIFO
The formula for computing the cost per equivalent unit under FIFO method is:
Cost per equivalent
unit = Cost added during the period
Equivalent units of production
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Cost per Equivalent Unit - FIFO
TotalCost Materials Conversion
Cost added in June 199,751$ 118,621$ 81,130$ Equivalent units 5,820 5,610 Cost per equivalent unit 20.3816$ 14.4617$
Total cost per equivalent unit = $20.3816 + $14.4617 = $34.8433
$118,621 ÷ 5,820 $81,130 ÷ 5,610
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Materials Conversion TotalEnding WIP inventory:Equivalent units 540 270
Assembly DepartmentCost of Ending WIP Inventory
Applying Costs - FIFO
Step 1: Record the equivalent units of production in ending Work in Process Inventory.
900 units × 60% 900 units × 30%
4-11
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Applying Costs - FIFO
Step 2: Record the cost per equivalent unit.
Materials Conversion TotalEnding WIP inventory:Equivalent units 540 270 Cost per equivalent unit 20.3816$ 14.4617$
Assembly DepartmentCost of Ending WIP Inventory
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Materials Conversion TotalEnding WIP inventory:Equivalent units 540 270 Cost per equivalent unit 20.3816$ 14.4617$ Cost of Ending WIP inventory 11,006$ 3,905$ 14,911$
Assembly DepartmentCost of Ending WIP Inventory
Applying Costs - FIFO
Step 3: Compute the cost of ending Work in Process Inventory.
540 × $20.3816 270 × $14.4617
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Cost of Units Transferred Out
Step 1: Record the cost in beginning Work in Process Inventory.
Materials Conversion TotalCost of Units Transferred Out: Cost in beginning WIP inventory 6,119$ 3,920$ 10,039$ Cost to complete beginning WIP Equivalent units to complete 180 240 Cost per equivalent unit 20.3816$ 14.4617$ Cost to complete beginning WIP 3,669$ 3,471$ 7,140 Cost of units started and completed: Units started and completed 5,100 5,100 Cost per equivalent unit 20.3816$ 14.4617$ Cost of units started and completed 103,946$ 73,755$ 177,701 Cost of Units Transferred Out 194,880$
Assembly DepartmentCost of Units Transferred Out in June
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Cost of Units Transferred Out
Step 2: Compute the cost to complete the units in beginning Work in Process Inventory.
Materials Conversion TotalCost of Units Transferred Out: Cost in beginning WIP inventory 6,119$ 3,920$ 10,039$ Cost to complete beginning WIP Equivalent units to complete 180 240 Cost per equivalent unit 20.3816$ 14.4617$ Cost to complete beginning WIP 3,669$ 3,471$ 7,140 Cost of units started and completed: Units started and completed 5,100 5,100 Cost per equivalent unit 20.3816$ 14.4617$ Cost of units started and completed 103,946$ 73,755$ 177,701 Cost of Units Transferred Out 194,880$
Assembly DepartmentCost of Units Transferred Out in June
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Cost of Units Transferred Out
Step 3: Compute the cost of units started and completed this period.
Materials Conversion TotalCost of Units Transferred Out: Cost in beginning WIP inventory 6,119$ 3,920$ 10,039$ Cost to complete beginning WIP Equivalent units to complete 180 240 Cost per equivalent unit 20.3816$ 14.4617$ Cost to complete beginning WIP 3,669$ 3,471$ 7,140 Cost of units started and completed: Units started and completed 5,100 5,100 Cost per equivalent unit 20.3816$ 14.4617$ Cost of units started and completed 103,946$ 73,755$ 177,701 Cost of Units Transferred Out 194,880$
Assembly DepartmentCost of Units Transferred Out in June
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Cost of Units Transferred Out
Step 4: Compute the total cost of units transferred out.
Materials Conversion TotalCost of Units Transferred Out: Cost in beginning WIP inventory 6,119$ 3,920$ 10,039$ Cost to complete beginning WIP Equivalent units to complete 180 240 Cost per equivalent unit 20.3816$ 14.4617$ Cost to complete beginning WIP 3,669$ 3,471$ 7,140 Cost of units started and completed: Units started and completed 5,100 5,100 Cost per equivalent unit 20.3816$ 14.4617$ Cost of units started and completed 103,946$ 73,755$ 177,701 Cost of Units Transferred Out 194,880$
Assembly DepartmentCost of Units Transferred Out in June
4-12
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Reconciling Costs
Costs to be accounted for: Cost of beginning Work in Process Inventory 10,039$ Costs added to production during the period 199,751 Total cost to be accounted for 209,790$
Cost accounted for as follows: Cost of ending Work in Process Inventory 14,911$ Cost of units transferred out 194,880 Total cost accounted for* 209,791$
Assembly DepartmentCost Reconciliation for June
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Reconciling Costs
Costs to be accounted for: Cost of beginning Work in Process Inventory 10,039$ Costs added to production during the period 199,751 Total cost to be accounted for 209,790$
Cost accounted for as follows: Cost of ending Work in Process Inventory 14,911$ Cost of units transferred out 194,880 Total cost accounted for* 209,791$
Assembly DepartmentCost Reconciliation for June
* $1 rounding error.
McGraw-Hill /Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
A Comparison of Costing Methods
In a lean production environment, FIFO and weighted-average methods yield similar
unit costs.
When considering cost control, FIFO is superior to weighted-average because it
does not mix costs of the current period with costs of the prior period.
McGraw-Hill /Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Review
n System Design – Process Costing – FIFO Inventory Method
n What is FIFO?
n FIFO versus Average Cost method
n When should FIFO be used?
n Journal entries
n Calculating balances by the FIFO Cost method
McGraw-Hill /Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Tutorial
n Review of today’s lecture n Review Problem
n 4-2 n 4-5