Chapter-Four

Process Costing
Overview of process Costing Systems
Process costing is used by companies that produce large numbers of identical units. Firms that produce
chemicals, microchips, gasoline, beer, fertilizer, textiles, processed food, and so on are among those using
process costing. In these kinds of firms, there is no need to trace costs to specific product or batches of
products, because the products in the different batches are identical. A process costing system
accumulates all the production costs for a large number of units of outputs, and then costs are averaged
over all of the units.
Costs are divided in to two based on when the costs are introduced in to the production process.
 Direct Cost: this cost is usually added at one time either at the beginning at the middle or the end of
the production process.
 Conversion Cost (DL+MOH cost): these costs are usually added evenly or uniformly throughout the
production process
For example, assume that Harer-Brewery S.co has Produced 20,000 bottles beer during September. The
following manufacturing costs were incurred in September.
Direct material ---------------------------------------------- Br 10,000
Direct labor----------------------------------------------------- 12,000
Manufacturing Overhead------------------------------------- 18,000
Total manufacturing ---------------------------------------Br 40,000
The cost per bottle of beer would be 2-birr (total manufacturing cost of Br 40,000 ÷ 20,000 units
produced).
In process costing system, the unit cost of a product or service is obtained by assigning total costs to many
identical or similar units as been introduced in the preceding paragraph. In process-costing setting, each
unit is assumed to receive the same amount of direct materials costs, direct manufacturing labor costs,
and indirect manufacturing costs. Unit costs are then computed by dividing total costs by the number of
units produced. This method is used by companies that produce identical products or services.
Comparison of Job-Order and Process Costing
In some ways process costing is very similar to job-order costing, and in some other ways it is very
different. Similarities between Job-order and Process Costing
1. Both systems have the same basic purpose-to assign material, labor, and overhead costs to a
product and to provide a mechanism for computing unit product costs.
2. Both systems use the same basic accounts, including manufacturing overheads, Raw Materials,
Work-in-process, and Finished Goods accounts.
3. The flow of costs through the manufacturing accounts is basically the same.
Difference between Job-order and Process Costing
Job-Order Costing Process Costing
1. Many different jobs are worked on during each 1. A single product is produced either on a
period, with each job having different continuous basis or for long periods of time. All
production requirements. units of products are identical
2. Costs are accumulated by individual job 2. Costs are accumulated by department
3. The job cost sheet is the key document 3. The department production report is the key
controlling the accumulation of cost by the job document showing the accumulation of costs in
the department and how those costs were
assigned to product
4. Unit costs are computed by the job on the cost 4. Unit costs are computed by the department on
job sheet the department production report

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Example 1:
Global Defense Inc., manufacturing thousands of components for missiles and military equipment. These
components are assembled in the Assembly Department. Upon completion, the units are immediately
transferred to the Testing Department. We will focus on the Assembly Department Process for one of
these components, DG-19. Every effort is made to ensure that all DG-19 units are identical and meet a set
of demanding performance specifications. The process-costing system for DG-19 in the assembly
Department has a single direct cost category (direct material) and a single indirect-cost category
(conversion costs). Conversion costs are all manufacturing labor, indirect material, energy, plant
depreciation, and so on. Direct material is added at the beginning of the process in Assembly. Conversion
costs are added evenly during assembly. Required summarize diagrammatically the above facts

Transferred Testing Department Transferred Finished Good

Assembly Department
DM added at the Conversion cost DM added at the Conversion cost
beginning added evenly during end of processing added evenly
processing during processing
To illustrate, we will use the production of the DG-19 component in the Assembly Department to
illustrate process costing in three cases:
 Case-1: Process costing with zero beginning and zero ending work-in-process inventory of DG-19,
that is, all units are started and fully completed by the end of the accounting period. This case
presents the most basic concepts of process costing and illustrates the key feature of averaging of costs.
Example 2: Process costing with zero beginning and zero ending work-in-process inventories
On January 1, 2001, there was no beginning inventory of DG-19 units in the Assembly Departments.
During January 2001, Global Defense started, complete assembly, and transferred out to the Testing
Department, 400 DG-19 units
Data for Assembly department for January are:
Physical units for January 2001
Work-in-process beginning inventory (January-1) 0 units
Started during January 400 units
Completed and transferred out during January 400 units
Work in process, ending inventory January-31 0 units
Total costs for January 2001
Direct material costs added during January Br.32,000
Conversion costs added during January 24,000
Total Assembly Department costs added during January Br.56,000
Required: Calculate the average cost unit cost in the assembly department

This case shows that, in a process-costing system, unit costs can be averaged by dividing total costs in a
given accounting period by total units produced in that period. Because, each unit is identical, we assume
all units receive the same amount of direct material and conversion costs. This approach can be used by
any company that produces a homogeneous product or service but has no incomplete units when each
accounting period ends. This situation frequently occurs in service-sector organizations.
Caes-2: Process costing with zero beginning work-in-process inventories but some ending work-in-
process inventory of DG-19, that is, some units of DG-19 started during the accounting period are
incomplete at the end of the period. This case builds on the basics and introduces the concepts of
equivalent units.

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The key points to note in case-2 are that a partially assembled unit is not the same as a fully assembled
unit. Whenever there are some fully assembled and some partially assembled units, as to how should
Global Defense calculate (1) the cost of fully assembled units in February 2001, and (2) the cost of the
partially assembled units still in process at the end of February 2001 is a very important points to be
noticed here.
Global Defense calculates these costs by using the following five steps:
 Step-1: Summarize the flow of physical units of outputs
Physical unit express the physical flow of production. It is a measure of the unit the unit of production
that have been started and that may or may not be completed. It does not consider the degree of
completion. Physical flow:
 WIP beginning ………………………….xx
 Units started …………………………….xx
 Total account ……………………………xx
 Units completed ………………………..xx
 Ending WIP …………………………….xx
 Account for ……………………………...xx
 Step-2: Compute output in terms of equivalent units (EU)
Equivalent units measures output in terms of the physical quantity of each of the input (factors of
production) that has been consumed when producing the units. Equivalent unit of each major category of
production inputs is calculated: Equivalent unit = Physical Unit x Percentage of Completion
 Step-3: Compute equivalent unit costs
Cost per EU = Production Cost/ Equivalent Unit
 Step-4: Summarize total costs to account for
 Step-5: Assign total costs to units completed and to units in ending work in process.
Example 3: zero beginning WIP inventories but some ending WIP inventory
In February 2001, Global Defense placed another 400-unit of DG-19 into the assembly process. Because
all units placed into production in January 2001 were completely assembled here is no beginning WIP
inventory unit in the Assembly Department on February 1, 2001. Customer delays in placing orders for
DG-19 prevent the complete assembly of all units started in February. Only 175-units are completed and
transferred out to the Testing Department. Data for the Assembly Department for February 2001 are:
Physical Units for February 2001
Work –in-process, beginning inventory (February-1) 0 units
Started during February 400 units
Completed and transferred out 175 units
Work in process, ending inventory (February 28) 225 units
DM (100% complete)
CC (60% complete)
The 225 units partially assembled units as of February 28, 2001, are fully processed with respect to direct
materials. This is because all direct materials in the Assembly Department are added at the beginning of
the assembly process. Conversion costs are added evenly during the assembly process. Based on the work
completed relative to the total work required to complete the DG-19 units still in the process, an
Assembly supervisor estimates that the partially assembled units, are on average, 60% complete as to
conversion costs.
Total costs for February 2001
Direct materials costs added during February Br.32,000
Conversion costs added during February Br.18,600
Total Assembly Department costs added during February Br.50,600

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Required:
a) Summarize the flow of physical unit.
b) Compute output in terms of equivalent unit
c) Compute equivalent unit cost
d) Summarize total cost to account for
e) Assign total cost to units complete and to ending WIP
f) Record the required journal entry.

Note: The accuracy of the completion percentages depends on the care and skill of the estimator and the
nature of the process. Estimating the degree of completion is usually easier for direct materials than it is
for conversion costs. This is because; the materials for partially completed units can be measured more
easily. In contrast, the conversion sequence usually consists of a number of basic operations for a specified
number of hours, days or weeks, for various steps in assembly, testing, and so forth. Thus, the degree of
completion for conversion costs depends on what proportion of the total effort needed to complete one
unit or both of production has been devoted to units still in process. This estimate is more difficult to
make because of the difficulties in estimating conversion cost completion percentages, department
supervisors and line managers –individual most familiar with the process often make these estimates.

Journal Entries
Journal entries in process- costing systems are basically like those made in job-costing systems with
respect to direct materials and conversion costs. The main difference is that, in process costing, there is
often more than one Work-in-Process accounts, one for each process-in our example, Work in Process-
Assembly and Work in Process-Testing. Global Defense purchases direct materials as needed. These
materials are delivered directly to the Assembly Department. Using dollar amounts we record the
required journal entries.
Case-3: Process costing with both some beginning and ending work-in-process inventory of DG-19 units.
In addition to the five steps used in process costing, we use the two inventory costing method. These are:
1. Weighted-Average (WA) Method
- The weighted average process costing method calculate-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 the Work in process account (regardless of
whether it is from beginning work in process or form work started during the period) divided by total
equivalent units of work done to date.
2. First -In-First-Out (FIFO) Method
In contrast to the weighed-average method, the first-in, first-out (FIFO) process costing method assigns
the costs of the previous period’s equivalent units in beginning work in process inventory to the first units
completed ad transferred out of the process, and assign the costs of equivalent units worked on during the
current period first to complete beginning inventory, then to start and complete new units, and finally to
units in ending work-in-process inventory. This method assumes that the earliest equivalent units in the
work in process-Assembly accounts are completed.
A distinctive feature of the FIFO process-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 costs per equivalent unit calculation in

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the weighted average method merge the units and costs in beginning inventory with units and costs of
work done in the current period.
The difference and similarities between WA & FIFO in five steps to assign costs:
Step-1: Summarize the flow of physical units of outputs
Physical unit express the physical flow of production. It is a measure of the unit the unit of production
that have been started and that may or may not be completed. It does not consider the degree of
completion. Physical flow:
 WIP beginning ………………………….xx
 Units started …………………………….xx
 Total account ……………………………xx
 Units completed …………………………xx
 Ending WIP ……………………………..xx
 Account for …………………………….....xx
Step-2: Compute equivalent units (EU) of production
WA: EU produced = Units Transferred Out + EU in Ending WIP inventory
FIFO: EU Produced = EU to Complete beginning WIP + Units Started and Finished during the
Period + EU in Ending WIP
Step-3: Identify the Total Costs to be Accounted for
Total Costs to be Accounted for = Cost in beginning + Costs Incurred this Period
Step-4: Compute Costs per Equivalent Unit
WA: Units Cost = Costs in beginning WIP + Current period Cost
Unit Transferred Out + EU in Ending WIP
FIFO: Units Cost = Current period Cost
EU of Current Work Done
Step-5: Assign costs to batches of work (transferred out equals the total units transferred out and WIP
ending.
WA: using WA the cost of goods transferred out equals the total units transferred out times the WA unit
cost computed in step 4. Using WA, the cost of goods in ending WIP equals the equivalent units in
ending WIP times the WA unit cost computed in step 4.
FIFO: using FIFO, the cost of goods transferred out equals the sum of the following three items
1. The costs already in beginning WIP inventory at the beginning of the period
2. The current period cost to complete beginning WIP inventory which equals the equivalent units
to complete beginning WIP inventory from step 2 times the current period unit cost computed
for FIFO in step 4.
3. The costs to start and complete units, calculated by multiplying the number of units started and
finished from step 2 times the cost per equivalent unit computed from FIFO in step 4.
Using FIFO, the cost of goods in ending WIP inventory equals the equivalent units in ending WIP
inventory from step 2 times the cost per equivalent unit computed for FIFO in step 4.

Example 4: some beginning WIP and some ending WIP inventory

At the beginning of March 2001, Global Defense had 225 partially assembled DG-19 units in the
Assembly Department. During March 2001, Global Defense placed another 275 units into production.
Data for the Assembly Department for March 2001 are:

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 Physical units for March 2001
 Work in process, beginning inventory (march-1) ……………………………225 units
Direct materials (100% complete)
Conversion costs (60% complete)
 Started during March …………………………………………………………275 units
 Completed and transferred out during March ………………………………..400 units
 Work in process, ending inventory (March 31) ……………………………….100 units
Direct materials (100% complete)
Conversion costs (50% complete)
Total costs for March 2001
 Work in process, beginning inventory
Direct material (225 equivalent units×Br.80 per units) ……Br.18,000
Conversion costs (135 equivalent units×Br.60 per units) ….....8,100 ……..Br.26,100
Direct material costs added during March ……………………………………… 19,800
Conversion costs added during March ……………………………………………16,380
Total costs to accounts for …………………………………………………………Br.62,280
Required: using WA and FIFO
A) Summarize the flow of physical unit.
B) Compute output in terms of equivalent unit
C) Compute equivalent unit cost
D) Summarize total cost account for
E) Assign total cost to units complete and to unit in ending WIP
F) Record the required journal entry
G) Compare the result under WA and FIFO
Note: We now have incomplete units in both beginning and ending work-in-process inventory to
account for. Our goal is to use the five steps we describes earlier to calculate
1) The costs of units completed and transferred out, and
2) The cost of ending work in process.
To assign costs to each of these categories, however, we need to choose an inventory cost-flow method.
We next describe the five-step approach to process costing using two alternative inventory cost-flow
methods-the weighted average method and the first-in-first-out method. The different assumption will
assign different amounts of costs to units completed and to units in ending work in process.

From the above summary it can be seen that the weighted –average ending inventory is higher than the
FIFO ending inventory by Br.480, or 4.9% (Br.480÷Br.9,800). This is a significant difference when
aggregated over the many thousands of products that Global Defense makes. The weighted-average
method in our example also results in lower cost of goods sold and hence higher operating income and
higher income taxes than does the FIFO method. Differences in equivalent-unit costs of beginning
inventory and work done during the current period, account for the difference in weighted-average and
FIFO costs. Recall from the data on page-14 that direct materials costs per equivalent units in beginning
work-in –process inventory is Br.80, and conversion cost per equivalent unit in beginning work-in-
process inventory is Br.60.. These costs are greater than the Br.72 direct materials and Br.52 conversion
costs per equivalent unit of work done during the current period. This reduction could be due to a

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decline in the prices of direct materials and conversion cost inputs or could be a result of Global Defense
becoming more efficient.
For Assembly department, FIFO assumes that all the higher-cost units from the previous period in
beginning work in process are the first to be completed and transferred out of the process, and ending
work-in-process consist of only the lower-cost current-period units. The weighted-average method,
however, smoothes out cost per equivalent unit by assuming that more of the lower-cost units are
completed and transferred out, and some of the higher-cost units are placed in ending work in process.
Hence, in this example, the weighted-average method results in a lower cost of units completed and
transferred out and a higher ending work-in-process inventory relative to FIFO.
Cost of units completed and hence operating income can differ materially between the weighted-average
and FIFO methods when (1) the direct materials or conversion costs per unit vary significantly from
period to period, and (2) the physical inventory levels of work in process are large in relation to the total
number of units transferred out of the process. Thus, as companies move towards long-term procurement
contract that reduce difference in unit costs from period to period, and reduce inventory levels, the
difference in cost of units completed under the weighted-average and FIFO method will decrease.
Managers need information from process-costing systems to aid them in the pricing and product mix
decisions and to provide them with feedback about their performance. The major advantage of FIFO is
that it provides managers with information about changes in the costs per unit from one period to the
next. Managers can use this information to evaluate their performance in the current period compared to
a benchmark or compared to their performance in the previous period. By focusing on work done and the
costs of work done during the current period, the FIFO method provide useful information for these
planning and control purposes. The weighed-average method merges unit costs from different periods
and so obscures period-to-period comparisons. The major advantages of the weighted –average method
however are its computational simplicity and its reporting of a more representative average unit cost
when input prices fluctuate markedly from month to month.

Finally, note that unlike in job-costing systems, activity-based costing has less application in process
costing environment. This is because; products are homogeneous and hence use resources in a similar
way. Furthermore, each process-assembly, testing, and so on-corresponds to the different (production)
activities. Managers reduce the costs of activities by controlling the costs of individual processes.
Assignment and Work sheet Questions
Problem 1: National Cement Factory manufactures cement for construction industry. Data relating to
the kilograms of cement processed through the Mixing Department, the first department in the
production process, are provided below for May:
Kilograms of Percentage Completed
Cement Materials Conversion
Work in Process, May 1 80,000 80% 20%
Started into processing during May 480,000 - -
Work in Process, May 31 50,000 40% 10%
Required: (Assignment)
1. Compute the number of kilograms of cement completed and transferred out of the Mixing
Department during May.
2. Compute the equivalent units for the Mixing department for May, assuming the company uses the
weighted average method of process costing.
3. Compute the equivalent units for the Mixing department for May, assuming the company uses the
FIFO method of process costing.
4. Prepare the necessary journal entries

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Problem 2: Gulf Fisheries, Inc ., processes tuna for various distributors. Two departments are involved –
Cleaning and Packing. Data relating to pounds of tuna processed in the Cleaning department during
May are given below:
Pounds Percentage
of Tuna Completed*
Work in Process, May 1 30,000 55%
Started into processing during May 480,000 -
Work in Process, May 31 20,000 90%
*Conversion cost (labor and overhead) only.
All materials are added at the beginning of processing in the Cleaning Department.
Required:
a) Compute equivalent units for May for the cleaning Department, assuming that the company uses the
weighted average method of accounting for units.
b) Compute equivalent units for May for the cleaning Department, assuming that the company uses the
FIFO method of accounting for units.
Problem 3: KK Inc manufactures an antacid product that passes through two departments. Data for May
for the first department follow:
Gallons Materials Conversion
Work in Process, May 1 8,000 Br 68,600 Br 30,000
Gallons started in process 7,600
Gallons transferred out 10,000
Work in Process, May 31 5,600
Costs added during May _ 90,720 37,000
The beginning work in process inventory was 80% complete with respect to materials and 75% complete
with respect to conversion. The ending work in process inventory was 60% complete with respect to
materials and 20% complete with respect to conversion.
Required:
1. Assuming that the company uses the weighted average method of accounting for units and costs:
a) Determine equivalent units for May.
b) Determine the costs per equivalent unit for May.
c) Determine the amount of that should be assigned to gallons transferred out and to ending work in
process inventory.
2. Assuming that the company uses the FIFO method of accounting for units and costs:
a) Determine equivalent units for May.
b) Determine the costs per equivalent unit for May.
c) Determine the amount of that should be assigned to gallons transferred out and to ending work in
process inventory.

Problem 4: The PVC Company manufactures a high quality plastic pipe in two departments, Cooking
and Molding. Materials are introduced at various points during work in the Cooking department. After
the cooking is completed, the materials are transferred in to the Molding Department, in which pipe is
formed.
Selected data relating to the Cooking Department during May are given below:
Production data:
Pounds in Process, May 1: materials 100% complete, conversion 90% complete …… 70,000
Pounds started into production during May ……………………………………… 350,000
Pounds completed and transferred to Molding ………………………………… ?
Pounds in process, May 31: materials 75% complete, conversion 25% complete……. 40,000

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Cost data:
Work in Process inventory, May 1:
Materials cost………………………………………………………………… Br 86,000
Conversion cost ……………………………………………………………… 36,000
Costs added during May:
Materials cost………………………………………………………………… 447,000
Conversion cost …………..…………………………………………………. 198,000
Required: Using WA and FIFO (Assignment)
H) Summarize the flow of physical unit.
I) Compute output in terms of equivalent unit
J) Compute equivalent unit cost
K) Summarize total cost account for
L) Assign total cost to units complete and to unit in ending WIP
M) Record the required journal entry
N) Compare the result under WA and FIFO

Problem 5: Solex Company produces a high quality insulation material that passes through two
processing departments. Information relating to activity in the first process during June is provided
below:
Work in Process, June 1(materials 75% complete; conversion 40% complete) ….. 60,000
Started into production ……………………………….……………………………… 280,000
Completed and transferred to the next process .……………………………………. 300,000
Work in Process, June 30(materials 50% complete; conversion 25% complete)…...40,000
Cost data:
Work in Process inventory, June 1:
Materials cost……………………………………………………………………… Br 56,600
Conversion cost …………………………………………………………………….. 14,900
Costs added during June:
Materials cost ……………………………………………………………………… 385,000
Conversion cost ……………………………………………………….……………. 214,500
Required:
1. Assuming that the company uses the weighted average method of accounting for units and costs:
a) Determine equivalent units for June.
b) Determine the costs per equivalent unit for June.
c) Determine the amount of that should be assigned to units transferred to the next
process and to ending work in process inventory.
2. Assuming that the company uses the FIFO method of accounting for units and costs:
a) Determine equivalent units for June.
b) Determine the costs per equivalent unit for June.
c) Determine the amount of that should be assigned to units transferred to the next
process and to ending work in process inventory.

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