Managerial Accounting

Seventh Edition
James Jiambalvo

Chapter 3

Process Costing

Copyright ©2020 John Wiley & Sons, Inc.

Chapter Outline

Learning Objectives

LO 1 Describe how products flow through departments and how costs flow
through accounts.

LO 2 Discuss the concept of an equivalent unit and calculate the cost of goods
completed and the ending Work in Process balance in a processing
department.

LO 3 Describe a production cost report.

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 2

Learning Objective 1

Describe how products flow through departments and how

costs flow through accounts.

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 3

Difference Between Job-Order and Process
Costing Systems (1 of 2)
• Job-Order Costing
o Each unique product or batch is considered a job for which
cost information is needed
o Necessary to trace manufacturing costs to specific jobs
o When completed, cost of job is removed from Work in
Process and included in Finished Goods

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 4

Difference Between Job-Order and Process
Costing Systems (2 of 2)
• Process Costing
o Large quantities produced of homogeneous products
o Average cost = total costs divided by total number of items
produced
o When completed, number of units completed times
average cost determines cost to be moved from WIP to
Finished Goods

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 5

Test Your Knowledge 1

Which of the following characteristics are associated with a

process costing system?
a. Heterogeneous products
b. Homogeneous products←
Answer: b
o Heterogeneous products are unique
o Homogeneous products are identical
• Process costing is associated with identical products

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 6

Test Your Knowledge 2

Which of the following characteristics are associated with a

process costing system?
a. Continuous production←
b. Discontinuous production
Answer: a
o Job order costing is associated with discontinuous
production
o Process costing is associated with continuous production

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 7

Test Your Knowledge 3

Which of the following characteristics are associated with a

process costing system?
a. Costs are traced to jobs
b. Costs are traced to processing departments←
Answer: b
o Job order costing requires tracing costs to jobs
o Process costing is associated with tracing costs to
departments

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 8

Test Your Knowledge 4

An example of a business requiring a process costing system

would be a(n):
a. Custom cabinet shop
b. Antique furniture restorer
c. Soap manufacturer←
d. Automobile repair shop
Answer: c
A soap manufacturer produces many identical units

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 9

Job-Order Costing System

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 10

Process Costing System

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 11

Product Flows through Departments

• Manufacturing operations typically pass through two or

more departments
o Costs are accumulated in each department
o Easy to identify when materials are added
o Harder to identify when labor and overhead are added
• Often grouped together as conversion costs
• Assumed to be added evenly throughout the process

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 12

Test Your Knowledge 5

The costs in a process costing system are traced to:

a. Specific jobs
b. Specific customers
c. Specific company administrators
d. Specific production departments←
Answer: d
Specific production departments

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 13

Cost Flows through Accounts (1 of 6)

• The product costs accumulated in process costing are the

same as in job-order costing
o Direct materials
o Direct labor
o Manufacturing overhead
• A processing department might have transferred in costs from
another department
• Each processing department accumulates product cost in a
separate Work in Process account

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 14

Cost Flows through Accounts (2 of 6)

• Direct Material
o Suppose that $142,000 of direct materials are used
o Journal entry:

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 15

Cost Flows through Accounts (3 of 6)

• Direct Labor
o Suppose that $62,200 of direct labor costs are incurred
o Journal entry:

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 16

Cost Flows through Accounts (4 of 6)

• Manufacturing Overhead
o A company may use either actual overhead costs or a
predetermined overhead rate to assign overhead to
products
• Unless production and overhead costs are constant from
month to month, use of actual overhead may result in
substantial fluctuations in the unit cost
• For that reason most companies use a predetermined
overhead rate

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 17

Cost Flows through Accounts (5 of 6)

• Manufacturing Overhead
o Suppose manufacturing overhead is applied at a rate of $3
per direct labor dollar
o Journal entry:

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 18

Cost Flows through Accounts (6 of 6)

• Transferred-in Cost
o When a department completes its work, the items are
transferred to the next department
o Related costs are transferred as well
o Suppose the Mixing Department completed units with a
cost of $360,000

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 19

Flow of Costs Between Processing Departments

LO 1 Copyright ©2020 John Wiley & Sons, Inc. 20

Learning Objective 2

Discuss the concept of an equivalent unit and calculate the

cost of goods completed and the ending Work in Process
balance in a processing department.

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 21

Calculating Unit Cost (1 of 2)

• Equivalent Units
o Partially completed units are converted to a comparable
number of completed units, called equivalent units
• Multiply the number of units by the percent complete to
calculate the equivalent units
• 100 units that are 50% complete are equivalent to 50 complete
units (100 x 50%)
o Equivalent units may be different for material and
conversion costs if materials and conversion costs enter
production at different times.

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 22

Equivalent Units – Material and Conversion
Costs

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 23

Calculating Equivalent Units

• Equivalent units are normally calculated for materials and

conversion costs
o The equivalent units produced is the sum of the units
finished and the units in ending work in process
• Units finished are always 100% complete in terms of materials
and conversion costs
• Multiply the number of units in ending work in process by the
corresponding percent complete to calculate the equivalent
units

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 24

Test Your Knowledge 6

At Rainier Chemical, conversion costs (labor and overhead) enter

evenly throughout the production process. At the end of the year,
200 units in work in process are 80 percent complete. With respect
to conversion costs, how many equivalent units are in work in
process?
a. 200
b. 160
c. 360←
d. 280
Answer: b
200 units * 80% complete = 160 equivalent units
LO 2 Copyright ©2020 John Wiley & Sons, Inc. 25
Test Your Knowledge 7

• Beginning Work in Process 500 units

% complete = 65% materials, 45% conversion
• Units started: 2,300
• Units finished: 2,500
• Ending Work in Process 300 units
% complete = 85% materials, 50% conversion
1. Calculate equivalent units for materials
Units finished 2,500 X 100% 2,500
Ending Work in Process 300 X 85% 255
Equivalent Units - Materials   2,755

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 26

Test Your Knowledge 8

• Beginning Work in Process 500 units

o % complete: 65% materials, 45% conversion
• Units started: 2,300
• Units finished: 2,500
• Ending Work in Process 300 units
o % complete: 85% materials, 50% conversion
2. Calculate equivalent units for conversion
Units finished 2,500 X 100% 2,500
Ending Work in Process 300 X 50% 150
Equivalent Units - Conversion Costs 2,650

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 27

Calculating Unit Cost (2 of 2)

• Cost Per Equivalent Unit

o The average unit cost in a process costing system is referred
to as cost per equivalent unit
o The numerator represents the total cost for which a
processing department must account in each period
o Divide by the units completed plus the equivalent units in
ending Work in Process

Cos t in beginning WIP + Cost incurred in current period

Cost per equivalent unit =
Units completed + Equivalent units in ending WIP

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 28

Calculating Cost per Equivalent Unit

• Consider cost per equivalent unit calculations for the

mixing department
o Beginning Work in Process inventory: 10,000 gallons that
are 80% complete
• Direct material costs = $18,000
• Direct labor =$7,800
• Overhead = $23,400
o 70,000 gallons started, 60,000 gallons completed
• Direct material costs = $142,000
• Direct labor cost = $62,200
• Overhead cost = $186,600
LO 2 Copyright ©2020 John Wiley & Sons, Inc. 29
Cost per EU – Mixing Department

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 30

Test Your Knowledge 9

At Rainier Chemical, labor cost in Work in Process at the start of April was
$50,000 and $450,000 of labor was incurred during the month. 200 units are in
WIP at the end of April and they are 80% complete with respect to labor. 840
units were completed during the month. What is the cost per equivalent unit for
labor?
a. $225
b. $481
c. $536
d. $500←
Answer: d
Total labor cost = $50,000 + $450,000 = $500,000
Equivalent units = 840 units + 200 units * 80% = 1,000 units
Cost per equivalent unit = $500,000 / 1,000 = $500
LO 2 Copyright ©2020 John Wiley & Sons, Inc. 31
Costs Transferred Out

• 60,000 gallons completed by the Mixing Department

• Unit cost is $6 per gallon
• $360,000 (60,000 X $6) of cost transferred to the Packaging
Department

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 32

Ending Work in Process

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 33

Summary of Cost Activity – Mixing
Department

LO 2 Copyright ©2020 John Wiley & Sons, Inc. 34

Learning Objective 3

Describe a production cost report.

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 35

Production Cost Report (1 of 6)

• An end of the month report for a process costing system

o Provides a reconciliation of units
o Provides a reconciliation of costs
o Provides the details of the cost per equivalent unit
calculations
• The reconciliations help ensure that mistakes are not made
in calculations

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 36

Production Cost Report (2 of 6)

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 37

Production Cost Report (3 of 6)

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 38

Production Cost Report (4 of 6)

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 39

Production Cost Report (5 of 6)

Reconciliation of Units

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 40

Production Cost Report (6 of 6)

Reconciliation of Costs

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 41

Basic Steps in Process Costing (1 of 4)

Step 1: Account for the physical number of units. The

number of units at the start of the period plus the
number of units started during the period should
equal the number of units completed plus the
number of units in ending Work in Process.

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 42

Basic Steps in Process Costing (2 of 4)

Step 2: Calculate the cost per equivalent unit for material,

labor, and overhead. Remember that cost (numerator
in the calculation) includes both beginning cost and
cost incurred during the period. The number of
equivalent units (denominator) includes the number
of units completed and the number of equivalent
units in ending Work in Process.

Cost per equivalent unit =

 cost in beginning WIP + costs added 
units completed + EU of ending WIP 

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 43

Basic Steps in Process Costing (3 of 4)

Step 3: Assign cost to items completed and items in ending

Work in Process. The cost of items completed is
simply the product of the total cost per equivalent
unit and the number of units completed. The cost of
items in Work in Process is the sum of the products of
equivalent units in process and cost per equivalent
unit for material, labor, and overhead.

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 44

Basic Steps in Process Costing (4 of 4)

Step 4: Account for the amount of product cost. The cost of

beginning inventory plus the cost incurred during the
period should equal the amount of cost assigned to
completed items plus the amount of cost assigned to
items in ending Work in Process.

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 45

Dealing with Transferred-In Cost

• Packaging Department summary

o Beginning Work in Process 15,000 gallons 50% through
packaging operation
• Costs in WIP: materials $10,500, labor $4,500, $9,000
overhead, $92,250 transferred in
o Units transferred in 60,000 gallons with $360,000
transferred in cost
• Costs added: Materials $49,500, labor $27,900, $55,800
overhead
o Ending Work in Process 5,000 gallons 40% through
packaging operation
LO 3 Copyright ©2020 John Wiley & Sons, Inc. 46
Production Cost Report – Packaging
Department (1 of 3)

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 47

Production Cost Report – Packaging
Department (2 of 3)

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 48

Production Cost Report – Packaging
Department (3 of 3)

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 49

Test Your Knowledge 10

The packaging department at Rainier Chemical had no beginning Work in

Process at the start of April. During April, the department received
$300,000 of transferred-in cost. During April, the department completed
600 units and 200 were in Work in Process.
With respect to transferred-in cost, the 200 units in Work in Process are:
a. Equivalent to 200 completed units←
b. Equivalent to 0 completed units
c. Equivalent to 100 completed units
d. Identical to the equivalent units for conversion costs
Answer: a
Since processing was completed in another department, units
transferred in are 100% complete for all categories
LO 3 Copyright ©2020 John Wiley & Sons, Inc. 50
Process Costing and Incremental Analysis (1 of 4)

• Whenever we make a decision, we need to perform

incremental analysis
o We need to determine the change in revenue and the
change is cost, assuming a particular alternative is selected
• If the net change is positive, the decision alternative is
“good” since it will have a positive impact on firm profit
• If the net change is negative, the decision alternative is “bad”
in that it will have a negative impact on firm profit

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 51

Process Costing and Incremental Analysis (2 of 4)

• When using process costing information to make a

decision, we have to be careful to recognize that the cost
per unit is the average of fixed and variable costs
o It does not measure the change in cost associated from
producing an additional unit
o Generally, total fixed costs do not change when one
additional unit is produced

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 52

Process Costing and Incremental Analysis (3 of 4)

• A company has no beginning or ending Work in Process

• Variable costs are materials and labor
• Fixed cost is manufacturing overhead
• Cost summary:

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 53

Process Costing and Incremental Analysis (4 of 4)

• Decreasing price to $2.90 will increase demand to 275,000

units
• $2.90 is less than equivalent cost per unit
• Incremental analysis: profit will increase

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 54

You Get What You Measure

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 55

Copyright

Copyright © 2020 John Wiley & Sons, Inc.

All rights reserved. Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Act without the express written permission of the
copyright owner is unlawful. Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies
for his/her own use only and not for distribution or resale. The Publisher assumes no
responsibility for errors, omissions, or damages, caused by the use of these programs or
from the use of the information contained herein.

Copyright ©2020 John Wiley & Sons, Inc. 56