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Chapter 15

Chapter 15. Process Costing. Many production environments have a “continuous” flow Paper, cereal manufacturing, bottling soft drinks, pharmaceuticals, garment manufacturing, electronics assembly Two main features

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Chapter 15

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  1. Chapter 15 Process Costing

  2. Many production environments have a “continuous” flow Paper, cereal manufacturing, bottling soft drinks, pharmaceuticals, garment manufacturing, electronics assembly Two main features Units in the same batch might be at different levels of completion (in different inventory accounts) Not possible to track costs of individual units in a batch We can only track costs at the level of the batch / department What is Process Costing? LO1: Explain the mechanics of process costing

  3. How to determine inventory values? Some units might have been finished and sold Some units might be finished but not sold Some might still be in process Some might not have started into production We allocate costs (for each batch) among COGM and WIP Divide by number of units in COGM to value the layer of inventory Can then calculate COGS Using “average values” OK because the items are similar Process costing focuses on the allocation Problem LO1: Explain the mechanics of process costing

  4. Begin with basic setting Will keep adding detail as we progress Data Began with 0 inventory Started 180,000 units Completed 155,000 units Incurred $6,880,000 of cost What is the value of Cost of Goods Manufactured (COGM) and ending WIP inventory? Example LO1: Explain the mechanics of process costing

  5. We can allocate based on number of units $6,880,000 * (25,000/180,000) = $955,555 to WIP $6,880,000 * (155,000/180.000) = $5,924,444 to COGM This allocation is probably wrong! Each unit (whether in WIP or completed) is valued at $6,880,000/180,000 = $15.22 per unit But, we will work some more (and incur more costs) to finish the units in WIP The value of the units cannot both be $15.22 currently. Easy Solution LO1: Explain the mechanics of process costing

  6. Test Your Knowledge! Which of the following companies would be most likely to use process costing: • A catering company • A custom yacht maker • A tire manufacturer • An attorney’s office

  7. Process Costing Systems solve the problem by computing equivalent units Physical units * % completion = Equivalent units 100 physical units * 20% complete = 20 Eq. units 500 physical units * 40% complete = 200 Eq. units We use equivalent units (rather than physical units) as the allocation basis Convenient to use a 5-step template to organize the allocation process. Equivalent Units LO1: Explain the mechanics of process costing

  8. Five-step Template Applied Five-step Template

  9. We might want to split out the costs into smaller pools Different costs might have different completion rates Materials might be added as a lump amount at the start of process Labor might be incurred uniformly The same unit in WIP could therefore be 100% complete for materials, 20% complete for labor In our example, suppose: We added all materials at start and ending WIP was 20% complete for labor and other costs Let $6,880,000 = $4,320,000 for materials and $2,560,000 for labor Refining the Allocation LO2: Apply process costing to settings with many pools and beginning inventory

  10. Do the allocations separately! Create a separate column (in Steps 2-5) for each kind of input Number of columns = number of cost pools Thus, we will have: One column for materials One column for labor We can do allocation separately and then add up Refining the Allocation: Solution LO2: Apply process costing to settings with many pools and beginning inventory

  11. LO2: Apply process costing to settings with many pools and beginning inventory

  12. Real world systems might have many columns for many cost pools Raw materials for a belt (e.g., leather strips) can be added in the beginning Some components (e.g., studs) can be added in the middle Yet more pieces (e.g., buckles) might be added at the end We might also separate out different types of overhead The underlying mechanics remain unaltered We also can refine the allocation for the product going through many processes Not covered in this text Additional Refinements LO2: Apply process costing to settings with many pools and beginning inventory

  13. We often have to deal with inventory left over from the prior period Need inventory cost flow assumption Weighted Average Method is most sensible and common Other methods possible but are rare in practice Weighted average method Do not distinguish between units in opening inventory and those started this period Do not distinguish (i.e., add together) the costs from opening inventory and the current period Dealing with Opening Inventory LO2: Apply process costing to settings with many pools and beginning inventory

  14. Chen began June with 25,000 units The ending inventory for May Valued at $561,250 for materials and $80,000 for labor Added more 175,000 units Incurred $4,038,750 for materials, $2,830,000 for labor and $323,750 for packing Ended with 15,000 units 90% complete for labor Materials added at beginning, labor incurred uniformly and packing added at end of process What is the value of COGM and Ending WIP? Example LO2: Apply process costing to settings with many pools and beginning inventory

  15. Many firms take advantage of large production volumes to use the same rate each accounting period Product cost does not change across periods Permits variance analysis (see Chapter 8) for exercising operational control Method Same template as before Use standard rates instead of calculating actual rates as we did before Standard Process Costing LO3: Perform process costing using standard costs

  16. LO3: Perform process costing using standard costs

  17. Standard process costing lets us calculate the variance We know that Chen spent $4,041,000 on materials in May The standard cost of the work done is $4,005,000 Thus, we can calculate the variance as $36,000 U = $4,041,000 - $4,005,000. We can extend the idea to settings with opening inventory Be careful in considering cost of work done during the period Compare with actual expenditure for the period Can Integrate with Variances LO3: Perform process costing using standard costs

  18. Test Your Knowledge! Which of the following only applies to process costing? • Separate and distinct jobs • The use of equivalent units • The use of predetermined overhead rates • Averaging

  19. Exercise 15.31 Mechanics of process costing, steps 1 and 2 (LO1). Orange Computers began June with zero units of its portable music player in work-in-process inventory. During June, Orange started 250,000 units into production, completing 175,000 units by month’s end. Production personnel estimate that the 75,000 units still in process on June 30 are 100% complete with respect to materials and 40% complete with respect to conversion costs. Required: Complete steps 1 and 2 of Orange’s process-costing report for June.

  20. Exercise 15.31 (Continued) Complete steps 1 and 2 of Orange’s process-costing report for June. Using the information provided, we have:

  21. Exercise 15.31 (Concluded) Complete steps 1 and 2 of Orange’s process-costing report for June. Notice that the percentage of completion varies between materials and conversion costs. Thus, the number of equivalent units also varies. For materials, each unit in WIP is equivalent to a finished unit as it has consumed all of the requisite materials. In contrast, each unit is only 0.40 of a finished unit in terms of conversion costs, because the unit in WIP is only 40% complete with respect to conversion costs.

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