Process Costing

Meaning

Used in an assembly line of structure. Within each department, the company must allocate the costs of that department
to the units produced.

Types of Costs

Direct materials

Conversion Costs

Where Costs come from

1. Already in BWIP
2. Incurred by the department during the period
3. Transferred in from previous department

Where Costs Go

1. EWIP
2. Finished goods – transferred out

Steps in Process costing

1. Determine the physical flow of goods

2. Calculate units “started and completed” during the period
3. Identify when materials are added to the process
4. Calculate the equivalent units produced for materials and conversion costs
5. Calculate the costs incurred during the period for materials and conversion costs
6. Calculate the cost per equivalent unit for materials and conversion costs
7. Allocate the costs to EWIP and transferred out

1. Physical Flow of goods

Number of beginning WIP inventory + Number of Units transferred in

= Number of Units in Ending WIP Inventory + Number of Units Completed

Example: Ben Company had 4000 units in its work-in-progress (WIP) on January 1. Each unit was 50% complete in respect
to conversion costs. During the first quarter 15000 units were completed. On March 31, there were 5000 units in ending
WIP that were 70% complete in respect to conversion cost. For this product, all of the direct materials are added when
the unit enters the facility.

How many units did Ben start during the first quarter?

Units in the beginning WIP + Units transferred in

= Units in ending WIP + Units to FG

4000 + X = 5000 + 15000

X = 16000

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Notes By: Prof. Ravi Gupta Created By: Drashti Gosalia
2. No of Units Started and Completed

This is the number of units for which 100% of the work was done during the period.

Number of units completed - Number of units in BWIP

3. When Materials are Added

You need to identify if the materials are added at the start of the process, the end of the process, or at a specific point
during the process.

4. Calculate Equivalent Units Produced

This calculation determines how many units would have been completed if the company had started and completed each
unit before starting the next.

Basic EUP situation

In a basic EUP situation there will be number of units that are some percent complete.

Example: There are 100 units in the beginning WIP and each 2unit is 25% complete. There are no other units added to
the system this period, and at the end of the period there are 100 complete units.

How many equivalent units were produced?

75% of the work need to be done to complete 100 units

= 100 * 0.75

= 75 equivalent units

Developed EUP Situation

To calculate EUP, we need to recognize that there are 3 “classes” of units during the period based on how much work was
done during the period to them.

1. Completed BWIP
2. Started and Completed
3. Started EWIP

Example: Let us assume that in addition to the 100 units in beginning WIP (still 25%), there were also 100 units transferred
in the during the period, and at the period there are 10 units in ending WIP that are 10 units in ending WIP that are 40%
complete. Calculate

1. The number of units completed

2. The number of units started and completed
3. The number of EUP during the period

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Notes By: Prof. Ravi Gupta Created By: Drashti Gosalia
Solution:

A. The number of units completed is 190

Units in BWIP + transferred in = Units in EWIP + Units Completed

100 + 100 = 10 + Units Completed

100 100 = 10 + 190

B. Having calculated the number of units completed, we can determine that there were 90 units started and
completed. (190 units completed – 100 units in BWIP)

C. The Calculation of equivalent units of production is:

To Complete BWIP(100*0.75) = 75
Started and Completed(90*1) = 90
To Start EWIP(10* 0.4) = 4

Total EUP = 169

EUP for Materials and CC

There are also two calculations that will be made for EUPs:

• EUP for materials

• EUP for conversion costs

EUP :FIFO vs. WAVG

Under FIFO, it is assumed that all of the units in beginning inventory were completed during the period and transferred to
the next process.

Under weighted average, we do not assume that the units in beginning inventory were finished.

EUP Calculation : FIFO

EUP needed to complete beginning WIP

+ Number of units started and completed

+ EUP needed to start ending WIP

= EUP under the FIFO method

Remember that this needs to be done for both materials and conversion costs.

EUP Calculation: FIFO Materials

If the materials are added at the beginning of the process, the EUPs for materials will be equal to the number of units
started during the period.

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Notes By: Prof. Ravi Gupta Created By: Drashti Gosalia
If the material are added at the end of the process, the EUPs for materials will be equal to the number of units that were
completed during the period.

EUP Calculation: WAVG

Number of units completed during the period

+ EUPs needed to start ending WIP

= EUPs under the WAVG

EUP Calculation Comments

Over a long period of time,

FIFO EUP = Actual units completed

However, in any one period of time,

WAVG EUP > FIFO EUP

5. Calculate the costs Incurred

Under FIFO, the costs that are included are only the costs that were actually incurred during the period.

Under weighted average, there are two costs to be included:

• The costs actually incurred during the period, and

• The costs that were associated with the units in beginning inventory.

6. Costs per EUP

To calculate the cost per equivalent unit, divide the costs for the period by the number of equivalent units for the period.

Cost for the period (step #5)

Number of Equivalent units (step #4)

7.Allocation of costs to the Products

Once the cost per EUP is known, it is simply a process of multiplying the number of equivalent units in ending WIP by the
cost per EUP.

Example: Beginning WIP inventory is 150 units (60% complete). Beginning WIP inventory material costs are $250 and
conversion costs are $500

All material for the product is added at the beginning of the production process. Conversion takes place continuously
throughout the process. During the period 550 units were started. Material costs for the period are $800 and the
conversion costs for the period are $6000

Ending WIP is 80 units at 20% completion.

Calculate the amounts to be in EWIP and FG using the FIFO method.

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Notes By: Prof. Ravi Gupta Created By: Drashti Gosalia
 1) Determine the physical flow.

BWIP + started = EWIP + Units completed

150 + 550 = 80 + 620

2) Calculate the units Started and completed.

S&C = Units Completed - BWIP

470 = 620 - 150

3) Materials are added at the beginning of the process.

4) Calculate equivalent units of production.

Under FIFO, the costs in BWIP are allocated 100% to units completed and transferred out. Therefore, only costs
incurred during the current period are allocated between completed units and units in EWIP on the basis of equivalent
units.

Materials Conv.Cost

Complete BWIP 0 60 (=150*40%)

Started &Completed 470 470

Start EWIP 80 16 (=80*20%)

TOTAL EUP 550 546

5) Calculate costs incurred.

Under FIFO, only costs actually incurred during the period are allocated between units completed and units inEWIP.

Materials $800

Conversion Costs $6,000

6) Costs per equivalent unit.

Materials $800 + 550 = $1.46

Conversion Costs $6000 + 546= $10.99

7) Allocate costs to EWIP

Materials $1.46 * 80= $116.80

Conversion Costs $10.99 * 16 = 175.84

Total $292.64

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Notes By: Prof. Ravi Gupta Created By: Drashti Gosalia
 Allocate costs to finished goods.

Costs of BWIP $250 + $500 = $750.00

Materials $1.46* 470 = $ 686.20

Conversion Costs $10.99*530 = $5824.70

Total $7260.90

Example: Beginning WIP inventory is 150units (60% complete). Beginning WIP inventory material costs are $250 and
conversion costs are $500.

All the material for that product is added at the beginning of the production process. During the period 550 units were
started. Material costs for the period are $800 and conversion costs for the period are $6000.

Ending WIP is 80 units at 20% completion.

Calculate the amounts to be in EWIP and FG using the WAVG method.

1) Determine the physical flow.

BWIP + Started = EWIP + Units completed

150 + 550 = 80 + 620

2) Calculate the units started and completed

S&C = units completed – BWIP

470 = 620 - 150

3) Materials are added at the beginning of the process.

4) Calculate equivalent units of production.

Materials Conversion costs

Units Completed 620 620

EWIP 80 16(80*20%)

Total 700 636

5) Calculate costs to allocate using EUP

Under WAVG the costs that are associated with BWIP are added to the costs incurred during the period.

Materials $250 in BWIP + $800 incurred = $1050

Conv.Costs $500 in BWIP + $6000 incurred = $6500

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Notes By: Prof. Ravi Gupta Created By: Drashti Gosalia
 6) Costs per equivalent unit ( including costs in BWIP)

Materials ($250 + $800)/700 = $1.50

Conv.Costs ($500 + $6000)/636= $10.22

7) Allocate costs to EWIP.

Materials $1.50*80 = $120.00

Conversion costs $ 10.22*16 =163.52

Total $283.52

Allocate costs to finished goods.

Materials $1.50*620 = $930.00

Conversion costs $10.22*620 = $6336.40

Total $7266.40

Spoilage in Process Costing

Spoiled units are units that are in some way defective and not able to be transferred to the next department.

Spoiled units are included in the calculation of EUPs, and the cost per EUP.

Costs are then assigned to the spoiled units based on the number of EUPs that were in the spoiled units.

Spoilage Issues

1. How many units were spoiled?

2. How are the spoiled units classified?
3. What costs are allocated to each spoiled unit?
4. What is done with the costs allocated to each spoiled unit?

Expanded Units Formula

In a situation in which there in spoilage, the formula to calculate the physical flow of units of goods needs to be expanded
to the following:

Units in BWIP + Started units

Units in EWIP + Completed + Spoiled Units

1) How many units were spoiled?

These are the units that do not pass inspection.

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Notes By: Prof. Ravi Gupta Created By: Drashti Gosalia
 2) How are the spoiled units classified?

Normal is the amount of spoilage that is expected.

• % of units started
• % of units completed
• % of units that pass inspection

Spoiled units in excess of normal spoilage are classified as abnormal spoilage.

3) What costs are allocated to each spoiled unit?

Need to add a line to the EUP calculation that we had for FIFO and WAVG if the units are spoiled after they started.

The cost per unit will be calculated the same as before, but there will now need to be an allocation to the spoiled
units, based on the EUP in spoiled units.

EUP with Spoilage : FIFO

1. Completion of BWIP Units in BWIP* % work done this period

2. + Started and Completed # of S&C units *1
3. + Starting of EWIP Units in EWIP* % work this period
4. +Starting Spoiled Units Units Spoiled* % work before spoilage
= EUP this period TOTAL

After the cost per EUP of materials and conversion costs are calculated, the company will allocate costs to each unit,
including the spoiled units.

4) Where do spoiled Units go?

Normal spoilage- transferred out to finished goods. Normal cost of production.

Abnormal spoilage – expensed in period incurred.

Additional classification of spoilage

Shrinkage occurs when a product evaporates or losses some quantity over time.

Rework occurs when spoiled goods are fixed and prepared for sale.

Waste is the material that is left over after production is complete.

Job-order Costing

Job – order costing is used when each item the company produces is unique and identifiable from all others.

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Notes By: Prof. Ravi Gupta Created By: Drashti Gosalia
 Operating Costing

Operation costing is a hybrid or combination, of job-order costing and process costing.

A company applies the basic operation of process costing to a production process that produces batches of items.

Direct materials are charged to the specific batch where they are used.

Conversion costs are accumulated and disturbed using a predetermined conversion cost per unit.

Life- Cycle costing

Useful for internal decision making.

Company does not determine the production cost in the short-term sense of the production of one unit.

This longer-term view is of particular importance when the product has significant R&D costs.

All of the costs in the life cycle of the company can be broken down into these categories:

• Upstream costs
• Manufacturing costs
• Downstream costs

Customer Life Cycle costing

Looks at the cost of the product from the customer’s standpoint.

It focuses on the total costs that will be paid by the customer during the whole time the customer owns the product:
the customer’s purchase costs plus costs to use, maintain, and dispose of the product or service.

Customer Life-cycle costing is important to a company because it is part of the pricing decision.

9|CMA US – Level I Cost Management

Notes By: Prof. Ravi Gupta Created By: Drashti Gosalia