The cost flows in a process costing systemare similar to the cost flows in a job costing system. The primarydifference between the two costing methods is that a processcosting system assigns product costs—direct materials, directlabor, and manufacturing overhead—to each production department (orprocess) rather than to each job. Each production department hasits own work-in-process inventory account when using processcosting. Recall the three components of product costs—direct materials, direct labor, and manufacturing overhead. Assigning these product costs to individual products remains an important goal for process costing, just as with job costing. However, instead of assigning product costs to individual jobs (shown on a job cost sheet), process costing assigns these costs to departments (shown on a departmental production cost report).
Accounting for Managers
The assumption is that the cost of each unit is the same as that of any other unit, so there is no need to track information at an individual unit level. Figure 3.8 “Flow of Costs through the Work-in-Process Inventory T-Account of Desk Products’ Assembly Department” shows the flow of costs through the work-in-process inventory T-account for the Assembly department. Note that four key steps were performed for the Assembly department to determine the costs assigned to (1) completed units transferred out to the Finishing department ($248,000) and (2) units in Assembly’s WIP inventory ($138,000). Work in process begins with the first stage of production (mixing and blending), continues with the second stage (bottling), and ends with the third stage (inspecting, labeling, and packaging). When products have gone through all three stages of production, they are shipped to a warehouse, and the costs are entered into finished goods inventory. Once products are delivered to retail stores, product costs are transferred from finished goods inventory to cost of goods sold.
Materials Cost
- Once the individual items have been identified and analyzed, one must convert them into equivalent units to calculate the applicable costs per unit.
- A process costing system accumulates costs and assigns them at the end of an accounting period.
- We also assign the full standard labor cost to all units that were begun and completed in the period.
The product’s final cost is determined by adding the costs incurred in each process and dividing it by the total number of units produced. It involves breaking down the entire inventory into individual elements, such as labor and materials costs, to identify discrepancies or overlaps. Process costing and job order costing are both acceptable methods for tracking costs and production levels. Some companies use a single method, while some companies use both, which creates a hybrid costing system. The system a company uses depends on the nature of the product the company manufactures. Period costs are expensed during the period in which they are incurred; this allows a company to apply the administrative and other expenses shown on the income statement to the same period in which the company earns income.
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Process costing is used when a company produces large quantities of homogeneous products, such as chemicals, beverages, and plastics. Examples of companies that typically use a what is residual income and why do you want it include oil refiners, food processors, and paint manufacturers. In contrast, job costing systems are used when products are produced in small quantities, when production varies greatly from one period to the next, or for manufacturers of dissimilar products.
Practice Questions
Cost assigned to units produced or in process are recorded in the inventory asset account, where it appears on the balance sheet. When the goods are eventually sold, the cost is shifted to the cost of goods sold account, where it appears on the income statement. A This column represents actual physical units accounted for before converting to equivalent units. A new competitor recently began producing a similar desk, and Ann is concerned about whether Desk Products’ production costs are reasonable.
Ore is introduced in the melting stage, alloys in the skimming stage, etc. (this is equally true for labor and overhead). This necessitates the employment of a separate Work in Process account for each major manufacturing activity. Examine the graphic below that compares job and process costing, noting in particular the difference in how costs are shifted out of work in process. Process costing entails handing off accumulated costs from one department to the next. The cutting process involves the costs related to direct material, direct labor, and the overheads related to the cutting department.
Accounting for Process Costs
The next step is to calculate the total expenses that are applicable to the production of the product. In this example, the total expenses are $350,000 ($100,000 + $200,000 + $50,000). Process costing also has difficulty detecting cost fluctuations due to changes in production volume and product mix.
If a process costing system does not mesh well with a company’s cost accounting systems, there are two other systems available that may be a better fit. The job costing system is designed to accumulate costs for either individual units or for small production batches. Direct labor is accumulated by units throughout the production process, so it is more difficult to account for than direct materials.
The widgets then move to the trimming department for further work, and these per-unit costs will be carried along with the widgets into that department, where additional costs will be added. Most companies use either the weighted average https://www.business-accounting.net/ or first-in-first-out (FIFO) method to assign costs to inventory in a process costing environment. The weighted average method includes costs in beginning inventory and current period costs to establish an average cost per unit.
Table 3.1 “A Comparison of Process Costing and Job Costing” outlines the similarities and differences between these two costing systems. In an exam, use the first in first out (FIFO) method if the percentage completion of each element of opening WIP is given. Use the weighted average (WA) method if the value of each element of opening WIP is given. [Note that the two methods give different valuations for the closing WIP.]In the weighted average method, no distinction is made between units of opening inventory and new units introduced to the process during the accounting period. The cost flows are tracked using a cost of production report, which tracks the costs incurred in each process and the number of units produced. The prices are then accumulated and allocated to the units produced based on a predetermined allocation method.
While still in production, the work in process units are moved from one department to the next until they are completed, so the work in process inventory includes all of the units in the shaping and packaging departments. When the units are completed, they are transferred to finished goods inventory and become costs of goods sold when the product is sold. When the units are completed, they are transferred to finished goods inventory and become costs of goods sold when the product is sold. Because Wrigley produces identical units ofproduct in batches employing a consistent process, it likely uses aprocess costing system. With such a system,Wrigley would need a separate work-in-processinventory account to track costs for each stage of the productionprocess.
Direct costs accumulate and indirect costs are applied to the batches as they move through the production processes. Eventually, costs are averaged over the units produced during the period to determine the cost of one item. A batch is defined as each time a quantity of materials is added to the first point of production to keep the work flow going. The board of directors at Computer Tech established a compensation incentive plan that includes a substantial bonus for the president of the company if annual net income before taxes exceeds $2,000,000. Preliminary figures show current year net income before taxes totaling $1,970,000, which is short of the target by $30,000.
It assumes that equal cost is incurred in each unit of production in the batch. By dividing the total cost of a process by the total number of units produced, the cost per unit can be obtained. A process costing system accumulates the costs of a production process and assigns them to the products that the business outputs. Financial results for the first 11 months of the current fiscal year (through February 28) are well below expectations of management, owners, and creditors. Figure 4.7 “Assigning Costs to Products in Desk Products’ Assembly Department” shows that total costs of $248,000 are assigned to units completed and transferred out and that $138,000 in costs are assigned to ending WIP inventory.
In this example, the total cost for the completed products is $280,000 ($28 x 10,000) and the total cost for the incomplete products is $70,000 ($28 x 2,500). The above steps are important because they ensure that the correct information is used in the calculation of the cost per unit of output. The cost per unit of output can be used to monitor the profitability of a product. If the cost per unit is too high, it may not be possible to sell the product at a price that will generate a profit. Therefore, it is important to keep track of the cost per unit in order to make sure that the product is profitable.