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’’

CHAPTER THREE

PROCESS COSTING SYSTEM

Chapter Learning Objectives:

Dear students, after the studying this chapter you should be able to:

1. Define process costing system as one of the alternative systems of product costing.

2. List down types of industries that need the application of process costing system.

3. List and explain the similarities and differences between job and process costing systems.

4. Prepare journal entries to record the flow of costs in a process costing system with a
sequential product flow pattern.

5. Distinguish between average costing method and FIFO costing method when they are
used in process costing system.

6. Prepare a schedule of production report for the first department in a process costing
system using weighted average and FIFO methods.

7. Describe the advantages and disadvantages of Average and FIFO costing method.

8. Describe the difficulties or Limitations in a process costing procedure.

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Introduction

Cost accumulation procedures used by manufacturing concerns are classified as either job order
costing or process costing. The previous chapter, Chapter Two, dealt with the procedures
applicable to job order costing system. It is important to understand that, except for some
modifications the concepts discussed in the previous chapter like the accumulation of materials
costs, labor costs, and factory overhead also apply to process costing system.

Process costing method is used for industries producing multiple units of similar products such
as chemicals, petroleum, textiles, steel, rubber, cement, flour, pharmaceuticals, shoes, plastics,
sugar, beverages, brewery and coal. It is also used by firms manufacturing items such as nails,
screws, bolts, and small electrical parts. A third type of industry using process costing is the
assembly type industry which manufactures such things as typewriters, automobiles, and
household electric appliances such as: washing machines, refrigerators, toasters, irons, radios,
television sets, etc.

Finally certain service industries, such as gas, water, and heat, cost their products by using
process costing system. Thus, process costing is used when products are manufactured under
conditions of continuous processing or under mass production methods. In fact, process
costing procedures are often termed "continuous or mass production cost accounting
procedures".

The type of manufacturing operations performed determines the cost procedures that must be
used. For example, a company that manufactures custom machinery will use job order costing,
whereas a chemical company will use process costing. In the case of machinery manufacturer, a
job order cost sheet is prepared for each order, accumulating the costs of materials, labor, and
factory overhead. In contrast the chemical company cannot identify materials, labor, and factory
overhead with each order, since each order is part of a batch or a continuous process. The
individual order identity is lost, and the cost of a completed unit must be computed by dividing
total cost incurred during a period by total units completed. The summarization of the costs
takes place via the cost of production report, which is an extremely efficient, economical, and
timesaving device for the collection of large amounts of data.

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 The characteristics of process costing system:

1. A cost of production report is used to collect, summarize and compute total and unit
costs.
2. Production is accumulated and reported by departments.
3. Costs are posted to departmental work in process accounts
4. Production in process at the end of a period is restated in terms of completed units (using
equivalent units).
5. Total cost charged to a department is divided by total computed production of the
department in order to determine a unit cost for a specific period.
6. Costs of completed units of a department are transferred to the next processing
department in order to arrive at the total costs of the finished products during a period. At
the same time, costs are assigned to units that are still in process.
 The procedures of process costing are designed to:

1. Accumulate materials, labor, and factory overhead costs by departments.

2. Determine a unit cost for each department.
3. Transfer costs from one department to the next and to finished goods.
4. Assign costs to the inventory of work in process (WIP)

If accurate units and inventory costs are to be established by process costing procedures, costs of
a period must be identified with units produced in the same period.

 Similarities and differences between Job and Process Costing Systems

o Similarities:
1. Both systems have the same basic purposes-assigning manufacturing costs and providing
a mechanism for determining unit product costs.
2. They use the same basic manufacturing accounts: MOH, Raw Materials, Work-in-
Process, and Finished goods.
3. The flow of costs through the manufacturing accounts is basically the same i.e.,

Raw material +
Labor + MOH
Work-in-process Finished Goods Cost of Goods Sold

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 Differences:

Job-Order Costing System Process Costing System

 Many different jobs are worked  A single and identical product is produced
each having different production either on continuous basis or for long
requirements. period of time.

 The Job Cost Sheet is the key  The Department Production Report
document controlling the controls accumulation and disposition of
accumulation of costs by a job. costs by departments.

 Unit costs are computed on job  Unit costs are computed on department
basis by dividing total cost of a job basis by dividing total costs in a
to total units in the job at the department to total units produced in
completion of a job. the department during a particular
 Only one Work-in-Process account  Each department will have its own
is used. Work-in-Process account, i.e. Multiple
WIP accounts are used.

The main difference between process costing and job costing is the extent of averaging used to
compute unit costs of products. In a job costing system, individual jobs use different quantities of
production resources; so it will be incorrect to cost each job t the same average production cost.
In contrary to this, in process costing we use same average production cost per unit for all units
produced.

 Product Flow in Process Costing System:

A product can flow through a factory in numerous ways. Three product flow formats associated
with process costing - sequential, parallel, and selective - are illustrated here to indicate that
basically the same costing procedures can be applied to all types of product flow situations.

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 Sequential Product Flow:

In a sequential product flow, each item manufactured goes through the same set of operation, as
illustrated below.

Work in Process Work in Process Finished Goods

Mixing Department Bottling
 Materials Department
 Labor →  Labor →
 FOH*  FOH*

Materials are placed into production in the Mixing Department, and labor and factory overhead
are added. When the work is finished in the Mixing Department, it moves to the Bottling
Department. The second process, and any succeeding processes, may add more materials or
simply work on the partially completed input from the preceding departments, adding only labor
and factory overhead. After the product has been processed by the Bottling Department, it is a
completed product and becomes a part of finished goods inventory.

 Parallel Flow:

In a parallel product flow, certain portion of the work are done simultaneously and
independently, and then brought together in a final process or processes for completion and
transfer to finished goods inventory. As in the previous illustration, materials may be added in
subsequent processes.

 Selective Product Flow:

In a selective product flow, the product moves to different departments within the plant,
depending upon the desired final product. For example, in meat processing, after the initial
butchering process, some of the product goes directly to the Packaging Department and then to
finished goods inventory; some goes to the Smoking Department and then to the Packaging
Department and finally to finished goods inventory; Some goes to the grinding department, then
to the packaging department and lastly to finished goods inventory. Transfer of costs from the

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Butchering Department involves joint cost allocation, discussed on later chapter of the course-
Accounting for By-Products and Joint Products.

 Procedures for Materials, Labor, and Factory Overhead Costs:

In process costing, materials, labor, and factory overhead costs are accumulated in the usual
accounts, using normal cost accounting procedures. Costs are then analyzed by departments or
processes and charged to departments by appropriate journal entries. The details involved in
process costing are usually fewer than those in the job order costing, where accumulation of
costs for many orders can become unwieldy.

o Materials Costs:

In job order costing system, materials requisitions are used to charge jobs for direct materials
used. If requisitions are used in process costing, details are considerably reduced because
materials are charged to departments rather than to jobs, and the number of departments using
materials is usually less than the number of jobs a firm might handle at a given time. Frequently
materials are issued only to the process-originating department; subsequent department other
than the first, they are charged to that department performing the specific operation.

For materials control purposes, materials need not always be priced individually on requisition
forms. The cost of materials used can be determined at the end of the production period through
inventory difference procedures, i.e., adding purchases to beginning inventory and then
deducting ending inventory. Or consumption reports which state the cost of materials or quantity
of materials put into process by various departments can be used. Costs or quantities charged to
departments by consumption reports may be based on formulas or proration. Formulas specify
the type and quantities of materials required in the various products and are applied to finished
production in order to calculate the materials consumed. Chemical and pharmaceutical industries
use such procedures, particularly when more than one product is manufactured by a department.
Frequently the cost of materials used by a department must be prorated to different products on
various estimated bases. This portion is described in chapter that deals with accounting for By-
Products and Joint Products Costing.

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For any of the materials cost computation methods discussed, a typical journal entry charging
direct manufacturing materials used during a period is:

Work in Process – Department A xxxxx   Dr.

xxxxx   Cr.
Materials

o Direct Labor:

Labor costs are identified by and charged to departments in process costing, thus eliminating the
detailed clerical work of accumulating labor costs by jobs. Daily time tickets or weekly time
clock cards are used instead of job time tickets. Summary labor charges are made to departments
through an entry which distributes the direct manufacturing payroll:

Work in Process – Department A xxxxx       Dr.

Work in Process – Department B xxxxx       Dr.
Work in Process – Department C xxxxx       Dr.
Payroll xxxxx     Cr.

Factory Overhead Costs:

Factory overhead incurred in process costing as well as in job order costing should be
accumulated in the factory overhead subsidiary ledger for producing and service departments.
This procedure is consistent with requirements for responsibility accounting and responsibility
reporting.

Normally it is emphasized to use the predetermined overhead rates for charging overhead to jobs
and products. However, in various process and job order costing procedures, actual rather than
applied overhead is sometimes used for product costing. This practice is feasible when
production remains comparatively stable from period to period, since factory overhead will then
remain about the same from one month to the next. The use of actual overhead can also be
justified when factory overhead is not an important part of total cost. However, predetermined
overhead rates for producing departments should be used if:

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1. Production is not stable.

2. Factory overhead, especially fixed overhead, is a significant cost.
Fluctuations in production can lead to the unequal incurrence of actual factory overhead from
month to month. In such cases, factory overhead should be applied to production using
predetermined rates, so that units produced receive proper charges for factory overhead.

Similarly, if factory overhead - especially fixed factory overhead - is significant, it is desirable to

allocate factory overhead on the basis of normal or uniform production using predetermined
overhead rates. Indeed, the use of predetermined rates is highly recommended for improving cost
control and facilitating cost analysis.

Prior to charging factory overhead to departments via their respective work in process accounts,
expenses must be accumulated in a factory overhead control account. As expenses are incurred
the entry is:

Factory overhead control xxxxx       Dr.

Accounts Payable xxxxx      Cr.
Accumulated Depreciation - Machinery xxxxx      Cr.
Prepaid Insurance xxxxx      Cr.
Materials xxxxx      Cr.
Payroll xxxxx      Cr.

The use of factory overhead control account requires a subsidiary ledger for factory overhead,
with departmental expense analysis sheet to which all expenses are posted. Service department
expenses are kept in like manner and distributed later to producing departments. At the end of
each period, departmental expense analysis sheets are totaled. These totals, which also include
distributed service department costs, represent factory overhead for each department. By debiting
the actual cost incurred or by using the predetermined overhead rates multiplied by the respective
actual activity base (e.g., direct labor hours) for each producing department, the entry charging
these expenses to work in process is as follows:
Work in Process – Department A xxxxx       Dr.
Work in Process – Department B xxxxx       Dr.
Work in Process – Department C xxxxx       Dr.
Factory Overhead Control xxxxx    Cr.

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There are three cases in Process costing:

 Case I: Process costing with no beginning or ending WIP inventory.

 Case II: Process costing with no beginning but with an ending WIP inventory
 Case III: Process Costing with both beginning & ending WIP inventory

 Cost of Production Report (CPR):

A departmental cost of production report (CPR) shows all costs chargeable to a department. It is
not only the source for summary journal entries at the end of the month but also a most
convenient vehicle for presenting and disposing of costs accumulated during the month. A cost
of production report shows:

1. Total unit costs transferred to it from a preceding department.

2. Materials, labor, and factory overhead added by the department.
3. Unit cost added by the department.
4. Total and unit costs accumulated to the end of operations in the department.
5. The cost of the beginning and ending work in process inventories.
6. Cost transferred to a succeeding department or to a finished goods storeroom.
It is customary to divide the cost section of the report into two parts: one showing costs for
which the department is accountable, including departmental and cumulative total and unit costs,
the other showing the disposition of these costs. A quantity schedule showing the total number of
units for which a department is accountable and the disposition made of these units is also part of
each department's cost of production report. Information in this schedule, adjusted for equivalent
production is used to determine the unit costs added by a department, the costing of the ending
work in process inventory, and the cost to be transferred out of the department.

A cost of production report determines periodic total and unit costs. However, a report that
would merely summarize the total costs of materials, labor, and factory overhead and shows only
the unit cost for the period would not be satisfactory for controlling costs. Therefore, in most
instances, the total cost is broken down by cost elements for each department head responsible
for the costs incurred. Furthermore, detailed departmental figures are needed because of the
various completion stages of the work in process inventories.

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Either in the cost of production report itself or in the supporting schedules, each item of material
used by a department is listed; every labor operation is shown separately; factory overhead
components are noted individually; and a unit cost is derived for each item. To condense the
illustrated cost of production reports, only total materials, labor, and factory overhead charged to
departments are considered; and unit costs are computed only for each cost element rather than
for each item.

Illustration for process costing using weighted average method:

Case-I : process costing with both beginning and ending work in process

The key document in a typical process costing system is the departmental production report,
prepared for each production department at the end every accounting period. This report, as
stated in the previous section discussions, replaces the job cost record, which is used to
accumulate costs by job in a job order costing system. The departmental production report
summarizes the flow of production quantities through the department and, and it shows the
amount of production cost transferred out of the department’s Work-in-Process Inventory
account during the period. The following four the steps followed in preparing the departmental
production report are summarized as follows:

1. Summarize the flow of physical units of output.

2. Compute equivalent unit costs.
3. Compute unit costs.
4. Assign total costs to units completed and to units in ending work-in-process.

Illustrative Example

Suppose that Peace Corporation, chemical manufacturing Company, has two production
departments using sequential production flow: the Mixing Department and the Bottling
Department. In the Mixing Department direct material consisting ingredient chemicals is added
at the beginning of the production process. Direct labor and manufacturing overhead costs are
incurred evenly throughout the production process. Predetermined overhead rate is used in the
mixing department using direct labor cost as a cost allocation base and at 125% overheads per $1

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direct labor cost. The following table presents the summary activity performed in Mixing
Department during March. The direct material and conversion costs listed under beginning work
in process section represent the work done during February.

Work in process, March 1: 20,000 Units

Direct material, 100% Complete, cost of* $50,000
Conversion costs, 10% Complete, cost of* 7,200
Balance in work in process, March 1* $57,200

Units started in March 30,000 Units

Units completed during March and transferred out of the Mixing

40,000 Units
department

Work in process, March 31: 10,000 Units

Direct material, 100% Complete
Conversion costs, 50% Complete

Costs incurred During March:

Direct material $90,000

Conversion costs:
Direct labor $86,000
Applied Manufacturing Overhead** 107,500
Total Conversion Costs $193,500

*These costs were incurred during the month of February

**Overhead is allocated at 125% of Direct Labor cost

Solution:

The four steps used to prepare a departmental production report using weighted average process
costing method are shown to solve the above comprehensive problem.

Step 1 Summarize the flow of physical units of output: the first step is to prepare a table
summarizing the flow of physical units during the month of March. This step can be shown by
the following formula.

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( )(
Physical Units
¿ Beginning +
Inventory
Physical Units =
Started )( Physical Units
Completed ∧¿ Transferred out
+¿
)
The following calculations in the table are based on the above formula.
Step-1: Analysis of Physical Flow of Units
Work in process, March 1 20,000
Units started in March 30,000
Total Units to account for 50,000
Units completed during March and transferred out 40,000
Work in process, March 31 10,000
Total Units accounted for 50,000
Step 2 Compute equivalent unit costs: the second step in process costing is computation of
equivalent unit costs for direct material and conversion cost activities. The following table
calculations are based on the above table computations for flow of physical units.
A formula that aid this computations is:
¿
Step-2: Calculation of Equivalent Units
%age of
Completio
n with DM CC
Physical respect to Equivalen Equivalen
Units conversion t Units t Units
Work in process, March 1 20,000 10%
Units started in March 30,000
Total Units to account for 50,000
Units completed during March and
transferred out 40,000 100% 40,000 40,000
work in process, March 31 10,000 50% 10,000 5,000
Total Units accounted for 50,000
Total Equivalent Units 50,000 45,000

Step 3 Compute unit costs: The third step in the process costing procedure is calculating the cost
per equivalent unit for both direct material and conversion activity. The cost per equivalent unit
for direct material is computed by dividing the total direct material cost, including the cost in the
beginning work in process and the cost incurred during March, by the total equivalent units
drawn from Step-2 above. An analogous procedure is used for conversion costs.

Step-3: Computation of Unit Costs

Direct Conversion
Material Cost Total
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work in process, March 1 50,000 7,200 57,200

Cost Incurred During March 90,000 193,500 283,500
total costs to account for 140,000 200,700 340,700
Equivalent Units 50,000 45,000
Cost per Equivalent Units $2.80 $4.46 $7.26
(140,000÷ (200,700
(2.8+4.46)
50,000) ÷45,000)
Step 4 Assign total costs to units completed and to units in ending work-in-process: the final
step in the preparation of departmental production report is determining the total cost to be
transferred out of the Mixing Department’s Work-in-Process Inventory account and into the
Bottling Department’s Work-in-Process Inventory account. A check is made to be sure that the
total costs of $340,700 have been fully accounted for in the cost of goods completed and
transferred out and the balance remaining in work in process inventory.

Step-4: Analysis of total cost. Cost Assignment to units in work in process and Completed and
transferred Goods
Cost assignment to units completed and transferred
(No of Units transferred out)X(total cost per equivalent
units) 40,000 X$7.26 $290,400
costs remaining in March 31 work in process inventory
(No of Equivalent Units of DM) X (cost per
equivalent unit of DM) 10,000X$2.8 28,000
(No of Equivalent Units of CC) X (cost per
equivalent unit of CC) 5000X$4.46 22,300
$50,300
Check: Cost of Goods Completed and Transferred $290,400
Cost of March 31 work in process
Inventory 50,300
  Total Costs Accounted for:  340,700

Journal Entries

To record the usage of materials mixing department

Work in Process - Mixing Department 90,000   Dr.
Materials 90,000   Cr.
To record the incurrence of various conversion costs:

Work in Process - Mixing Department 193,500   Dr.

Various Accounts 193,500   Cr.
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To record the completion and transfer of partially completed goods from Mixing to Bottling
Department.

Work in Process - Mixing Department 290,400   Dr.

Work in Process - Mixing Department 290,400   Cr.

 First-In, First-Out Method of Process Costing

The first-in, First-Out (FIFO) process costing method assigns the cost of the previous period’s
equivalent units in the beginning work-in-process inventory to the first units completed and
transferred out of the process; and assigns the cost of equivalent units worked on during the
current period first to complete the units in the beginning work in process inventory, next to start
and complete new units and finally to units in ending work-in-process inventory. The FIFO
method assumes that the earliest equivalent units in the work-in-process are completed first.

A distinct 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 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 cost-per-equivalent-unit
calculations under weighted average method merge the units and costs in the beginning
inventory with units and costs of work done in the current period.

The following tables describe the FIFO method based on data derived from the Peace
Corporation for the first processing department- the Mixing Department.

work in process, March 1-20,000 Units:

Direct material, 100% Complete, cost of* $50,000
Conversion costs, 10% Complete, cost of* 7,200
Balance in work in process, March 1* $57,200
30,000
Units started in March Units
Units completed during March and transferred out of the Mixing 40,000
department Units

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10,000
work in process, March 31: Units
Direct material, 100% Complete
Conversion costs, 50% Complete
Costs incurred During March:
Direct material $90,000
Conversion costs:
Direct labor $86,000
Applied Manufacturing Overhead** 107,500
Total Conversion Costs $193,500
*These costs were incurred during the month of February
**Overhead is allocated at 125% of Direct Labor cost

Step 2 Compute equivalent unit costs.

%age of
Completio
n with DM CC
Physical respect to Equivalen Equivalen
Units conversion t Units t Units
Work in process, March 1 20,000 10%
Units started in March 30,000
Total Units to account for 50,000
Units completed during March and
transferred out (40,000 units)
Beginning Work in Process 20,000 0 18,000
Started and Completed 20,000 20,000 20,000
work in process, March 31 10,000 50% 10,000 5,000
Total Units accounted for 50,000
Total Equivalent Units 30,000 43,000

Step 3 Compute unit costs.

Step-3: Computation of Unit
Costs
Conversion
Direct Material Cost Total
Cost Incurred During March 90,000 193,500 283,500
Equivalent Units 30,000 43,000
Cost per Equivalent Units $3 $4.5 $7.5
(90,000÷ (193,500
(3+4.5)
30,000) ÷43,000)

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Step 4 Assign total costs to units completed and to units in ending work-in-process.
Step-4: Analysis of total cost. Cost Assignment to units in work in process and Completed and
transferred Goods
Cost assignment to units completed
and transferred (40,000 units)
Brought From Beginning Work
in Process 50,000  7,200 57,200
Direct materials added to
Beginning WIP 0 - 0
Conversion Costs added to 18,000X4.5=81,0
Beginning WIP - 00 81,000
Costs to units Started and 20,000X3=60,00 20,000X4.5=90,0
Completed 0 00 150,000
Total costs assigned to units
completed and transferred 288,200
costs remaining in March 31 work in
process inventory
(No of Equivalent Units of DM)
X (cost per 10,000X$3=30,0
equivalent unit of DM) 00 30,000
(No of Equivalent Units of CC) X
(cost per 5000X$4.5=22,50
equivalent unit of CC) 0 22,500
 Ending work-in-process Inventory $52,500
Totals 140,000 200,700  340,700
Check: Cost of Goods Completed
and Transferred $288,200
Cost of March 31 work in
process
inventory 52,500
  Total Costs Accounted for:  340,700

Journal Entries

To record the usage of materials mixing department

Work in Process - Mixing department 90,000   Dr.
Materials 90,000   Cr.
To record the incurrence of various conversion costs:

Work in Process - Mixing department 193,500   Dr.

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Various Accounts 193,500   Cr.

To record the completion and transfer of partially completed goods from Mixing to Bottling
Department.

Work in Process - Mixing department 288,200   Dr.

Work in Process - Mixing department 288,200 Cr.

 Process costing for the second processing department under sequential product flow

In a manufacturing operation with sequential production departments, the costs assigned to the
units transferred out of one processing department remain assigned to those units as they enter
the next processing department. That is as the units move from one processing department to
another processing department, the related costs are also transferred by periodic journal entries.

Transferred-in costs, also called as previous department costs, are the costs incurred in previous
processing departments that are carried forward as the product’s cost when it moves to a
subsequent processing department in the production cycle.

Transferred-in costs are treated as if they are a separate type of direct material added at the
beginning of the process. When successive producing departments are involved, transferred units
from one department become all or part of the direct materials of the receiving processing
department; however, they are called transferred-in costs rather than direct material costs.

In our illustration for Peace Corporation, partially completed units, mixed chemicals with the
appropriate dosage, transferred out of the Mixing Department go next to the Bottling Department
where chemicals are carefully filled and packaged, and became ready for sale to customers. The
department treats the cost of bottles as indirect material as it comprise the smallest cost
proportion and accumulates it under manufacturing overhead cost category. However, the
finished goods packaging material, a specially designed chemical carriage box that is useful to
keep the chemicals safe and increase the durability of them, is treated as a direct material and is
added at the end of the production process in Bottling Department.

The cost of goods completed and transferred out of the Mixing department is shown
diagrammatically as follows.

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Work in Process Mixing Work in Process Bottling Finished Goods

Department Department
-Materials Cost of -Transferred-in Cost of Cost of Cost of
-Conversion Cost: goods completed costs goods goods goods
→ →
Labor and transferred -Direct material ManufacturedManufacture Sold
FOH* -Conversion cost: d
Labor
FOH*
As the T-accounts show, the Mixing Department has to cost elements: direct material and
conversion costs. However, the Bottling department has three cost elements: direct material,
conversion and transferred-in costs. Transferred-in costs are the costs assigned to the units
transferred from the Mixing Department to the Bottling department. They are conceptually
similar to that of direct material costs added at the beginning of production process. The only
difference is that direct material relate to the raw material, where as transferred in costs relate to
partially completed goods. The following table presents the basic data for our illustration of
process costing in Bottling Department.

work in process, March 1-10,000 Units:

Transferred-in: 100% Complete, cost of 61000*
Direct material, 0% Complete, cost of* $0
Conversion costs, 20% Complete, cost of* 7,600
Balance in work in process, March 1* 68,600
units transferred in from Mixing Department 40,000 Units
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Units completed during March and transferred out to finished Goods

30,000 Units
Warehouse
work in process, March 31: 20,000 Units
Transferred-in: 100% Complete
Direct material, 0% Complete
Conversion costs, 90% Complete
Costs incurred During March:
Transferred-in form Mixing Department (weighted average value) $290,400
Transferred-in form Mixing Department (FIFO value) $288,200
Direct material $7,500
Conversion costs:
Direct labor $115,000
Applied Manufacturing Overhead** $115,000
Total Conversion Costs $230,000
*These costs were incurred during the month of February
**Overhead is allocated at 100% of Direct Labor cost

 Transferred-in Costs and the Weighted Average Method

To examine the weighted average process costing method with transferred-in costs, we will
follow the four-step procedure described when illustrating process costing in the first processing
department, as shown in the following table using the data for Peace Corporation.

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Peace Corporation
Production Report: Bottling Department
For the Month Ended on March 31, 2003
Step-I Step-II
%age
Physical Completion Conversio
Units (CC) Transferred-in Direct material n
work in process, March 1 10,000 20%
Units transferred-in during March 40,000
Total Units to account for 50,000
Units completed and transferred out during March 30,000
work in process, March 31 20,000 90% 30,000 30,000 30,000
Total Units accounted for 50,000 20,000 0 18,000

Equivalent Units 50,000 30,000 48,000

Step-III
Transferred-in Direct material Conversion Total
work in process, March 1 $61,000 0 $7,600 $68,600
Cost Incurred During March 290,400 $7,500 230,000 $527,900
Total costs to account for $351,400 $7,500 $237,600 $596,500
Equivalent Units 50,000 30,000 48,000
Cost per Equivalent Units $7.028 $0.25 $4.95 $12.228
($7.028+$0.25+
(Supportive Computation) (351,400/50,000) (7,500/30,000) ($237,600/48,000) $4.95)
Step-IV: Analysis of total cost. Cost Assignment to units in work in process and Completed and transferred Goods
Cost assignment to units completed and transferred
(No of Units transferred out)X(total cost per equivalent units) 30,000 UnitsX$12.228 $366,840
Costs remaining in March 31 work in process inventory
Transferred-in Costs:
(No of Equivalent Units of TI)X(cost per equivalent unit of 20,000X$7.02
TI) 8 140,560
Conversion Costs:
(No of Equivalent Units of CC)X(cost per equivalent unit of
CC) 18000X$4.95 89,100
$229,660

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Check: Cost of Goods Completed and Transferred $366,840

Cost of March 31 work in process inventory 229,660
  Total Costs Accounted For 596,500

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Journal Entries

To record the usage of materials mixing department

Work in Process - Bottling department 7,500   Dr.
Materials 7,500   Cr.
To record the incurrence of various conversion costs:

Work in Process - Bottling department 230,000   Dr.

Various Accounts 230,000   Cr.
To record the completion and transfer of partially completed goods from Mixing to Bottling
Department.

Finished Goods 366,840   Dr.

Work in Process - Bottling department 366,840   Cr.

 Transferred-in Costs and the FIFO Method

To examine the FIFO process costing method with transferred-in costs, we again consider the
Peace Corporation illustration by working out for the Bottling Department. Other than
considering transferred-in costs, the computation of equivalent units are the same as under the
FIFO method for the Mixing Department.

The cost per equivalent unit for the current period in step three is only calculated on the basis of
costs transferred-in and work done in the current period. In step 4, the assignment of costs to the
units completed and transferred, and to the units in the ending work-in-process, the total costs to
account for and accounted for of $594,300 under the FIFO differ from the corresponding
amounts under the weighted average method of $596,500. That is because the different costs of
completed units transferred-In from Mixing Department under the two methods-$288,200 under
the FIFO and $290,400 under the weighted average method.

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Peace Corporation
Production Report: Bottling Department
For the Month Ended on March 31, 2003
Step-I: Summarization of Physical
Units Step-II: Computation of Equivalent Units
%age
Completion Transferred-
Physical Units (CC) in Direct material Conversion
work in process, March 1 10,000 Units 20%
Units transferred-in during March 40,000 Units
Total Units to account for 50,000 Units
Units completed and transferred out during March:
work in process, March 1 10,000 Units 0 10,000 8,000
Started and Completed 20,000 Units 20,000 20,000 20,000
work in process, March 31 20,000 Units 90% 20,000 0 18,000
Total Units accounted for 50,000 Units
Equivalent Units 40,000 30,000 46,000
Step-III computation of Cost per equivalent Units
Direct
Transferred-in material Conversion Total
work in process, March 1 $68,600
Cost Incurred During March 288,200 $7,500 230,000 525,700
total costs to account for 288,200 7,500 230,000 $594,300
Equivalent Units 40,000 30,000 46,000
Cost per Equivalent Units $7.205 $0.250 $5.000 $12.455
(7,500/30,000 ($230,000/48,000 ($7.205+$0.25+
(Supportive Computation) (288,200/50,000) ) ) $5)
Step-IV: Analysis of total cost. Cost Assignment to units in work in process and Completed and transferred Goods
Cost assignment to units completed and transferred
From Beginning balance of WIP Inventory $68,600
Direct Material Added to Beginning WIP during
March 10,000X$0.25 $2,500
Conversion Costs Added to Beginning WIP during
March 8,000X$5.00 40,000 $111,100
20,000X$12.45
Started and Completed 5 249,100

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Total Costs assigned to units Completed and

Transferred $360,200
Costs remaining in March 31 work in process inventory
(No of Equivalent Units of TIC)X(cost per equivalent
unit of TIC) 20,000X$7.26 144,100
(No of Equivalent Units of DM)X(cost per equivalent
unit of DM) 0X0.25 0
(No of Equivalent Units of CC)X(cost per equivalent unit
of CC) 18000X$5.00 90,000
Total Costs assigned to units March 31 WIP inventory 234,100 $594,300
Check: Cost of Goods from March 1 work in process
inventory $68,600
Cost added in March 525,700
  Total Cost to Accounted for 594,300

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Journal Entries

To record the usage of materials Bottling Department

Work in Process - Bottling department 7,500   Dr.
Materials 7,500   Cr.
To record the incurrence of various conversion costs in Bottling Department:

Work in Process - Bottling department 230,000   Dr.

Various Accounts 230,000   Cr.
To record the completion and transfer of fully completed finished goods from Mixing to Bottling
Department.

Finished Goods 360,200   Dr.

Work in Process - Bottling department 360,200   Cr.

Average Costing Method versus FIFO Costing Method - Process Costing:

Both average costing and FIFO costing have certain advantages. It would be arbitrary to state
that one method is either simpler or more accurate than the other. The selection of either method
depends entirely upon management's opinion regarding the most appropriate and practical hustle
cost determination procedures.

The basic difference between the average costing and FIFO costing method concerns the
treatment of beginning work in process inventory. The averaging method adds beginning work in
process inventory costs to the preceding department's materials, labor and factory overhead costs
incurred during a period. Unit costs are determined by dividing these costs by equivalent
production figures. Units and costs are transferred to next department as one cumulative figure.

The FIFO method retains the beginning work in process inventory cost as a separate figure.
Costs necessary to complete the beginning work in process units are added to this total cost. The
sum of these two costs totals is transferred to the next department. Units started and finished
during the period have their own unit cost which is usually different from the completed unit cost
of the units in process at the beginning of the period. The FIFO method thus separately identifies

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for management the current period unit cost originating in a department. Unfortunately, the costs
are averaged out in the next department, resulting in a loss of much of the value associated with
the use of the FIFO method.

In computing equivalent production figures in FIFO costing, the degree of completion of both
the beginning and ending work in process inventories must be considered.

The principal disadvantage of FIFO costing is that if several unit cost figures are used at the
same time, extensive detail is required within the cost of production report which can lead to
complex procedures and even inaccuracy. Whether the extra detail yields more representative
unit costs than the average costing method is debatable, especially in a firm using process costing
where production is continuous and more or less uniform and appreciable fluctuations in unit
costs are not expected to develop. Under such conditions, the average costing method leads to
more satisfactory cost computations.

Difficulties Encountered in Process Costing Procedures:

Certain difficulties likely to be encountered in actual practice should be mentioned with regard to
process cost accounting procedures:

1. The determination of production quantities and their stage of completion presents problem.
Every computation is influenced by these figures. Since the data generally come to the cost
department from operating personnel often working under circumstances that make a precise
count difficult, a certain amount of double counts and unreliable estimates are bound to exist.
Yet, the data submitted from the basis for the determination of inventory costs.

2. Materials cost computations frequently require careful analysis. In the illustrations materials
are generally considered to the cost of first department. In certain industries, materials costs
are not even entered on production reports. When materials prices are influenced by
fluctuating market quotations, the materials cost may be recorded in a separate report
designed to facilitate management decisions in relation to the materials market.

3. In the case of multiple products, Joint processing cost must be allocated the products
resulting from the processes. Weighted unit averages or other bases are used to prorate the

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joint cost to the several products. If units manufactured are used as a basis for cost allocation,
Additional clerical expenses are necessary if the labor hour or machine hour basis is used for
charging overhead to work in process. Management must decide whether economy and low
operational cost are compatible with increased information based on additional cost
computations and procedures.

It should be noted that some companies use both process costing and job order costing
procedures for various purposes in different departments. This is particularly true when a parallel
or selective cost flow format is required. Each system or method employed by a company must
be based on reliable production and performance data which, when combined with output,
budget, or standard cost data, will provide the foundation for effective cost control and analysis.

Thank you!!!

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