The job costing method does not work well when the production cycle involves
· A continuous flow of raw materials through various processing departments,
· The finished output is characterized as homogenous units, each displaying the same basic characteristics.
Examples, Wood pulp is "processed" into giant rolls of paper, refineries "process" crude oil to gasoline, iron ore is "processed" into steel, sand is "processed" into glass, and on and on.
It is hard to identify and associate specific units of direct labor and direct material with the final output. For example, do you suppose anyone really knows which barrel of oil was used to produce the last tank of gasoline you purchased for your vehicle? Obviously, the gasoline was not produced as a specific job; it was the result of a "process."
2. PROCESS COSTING
Process costing is methodology used to allocate the total costs of production to homogenous units produced via a continuous process that usually involves multiple steps or departments.
Material, labor, and factory overhead will still occur and still be assigned to work in process. And, amounts assigned to work in process will in turn make their way to finished goods.
3. COMPARING JOB AND PROCESS COSTING
The first thing is familiar inventory categories relating to
· Raw materials,
· Work in process,
· Finished goods.
However, process is made up of many individual/discrete jobs, material can be introduced into each process. This necessitates the employment of a separate Work in Process account for each major manufacturing activity.
4 THE COST OF PRODUCTION REPORT
The cost report that is prepared for each department is termed a cost of production report.
The cost of production report provides comprehensive information on the material, labor, and overhead incurred within each department during a period. It is the primary source document for determining how those costs are allocated to actual production.
EQUIVALENT UNITS
1. CONTINUOUS PRODUCTION FLOW
Goods will be in various stages of production within each department at the end of each accounting period.
2. EQUIVALENT UNITS
An equivalent unit is a physical unit expressed in terms of a finished unit. As a simple example, ten units in process that are 30% complete equates to three equivalent units of output.
3. FACTORS OF PRODUCTION
80% of necessary direct material may be in process, but only 60% of the direct labor and factory overhead (i.e., conversion cost) has been incurred. Therefore, proper costing methodology for 100 units in process would require us to state that 80 equivalent units have been produced based on material, while 60 equivalent units based on conversion have been produced.
To assess the equivalent units of production requires careful reasoning about the amount of direct material injected into production for each department, relative to the total amount of direct material that will ultimately be needed to complete the process within that department.
The first stage in Navarro's production process is the Melting Department. Navarro started the month of June with 300,000 tons of iron ore in process in the Melting Department. During June, an additional 600,000 tons were introduced into the melting vats. This means 900,000 total units must be "reconciled." The reconciliation shows that 650,000 units were transferred on to the Skim/Alloy Department, leaving 250,000 tons still in process.
Weighted-average costing method
This simplifies the process because the beginning inventory and current period production can be combined; thus, the 650,000 units that were completed are counted as 650,000 equivalent units of output, 250,000 tons in ending work in process are 50% complete with respect to material.
EQUIVALENT UNIT
The equivalent units are carried forward into the tan schedule below. This "cost per equivalent unit" schedule shows how the combined costs from beginning work in process (assumed at $2,104,500 for Navarro, broken down between materials, labor, and overhead as shown) and current period production (assumed at $7,365,000, again broken down as shown) are divided by the equivalent units. The result is the weighted-average cost per equivalent unit for each factor of production: direct material, direct labor, and factory overhead. The individual cost factors can be combined to identify conversion cost per equivalent unit, and overall cost per equivalent unit. It can be very important to extend the decimals beyond the "cent" level (avoid rounding) because the per unit cost may ultimately be multiplied times millions of units!
COST ALLOCATION TO COMPLETED UNITS AND UNITS IN PROCESS
ALLOCATING TOTAL COST
Navarro's Melting Department incurred total cost of $9,469,500 in producing output that entailed 775,000 equivalent units of material and 750,000 units of conversion. Of course, the end objective is to allocate the total costs between work in process at the end of the month and units that were completed and transferred out during the month.
The cost assigned to completed units totals $8,012,403. This amount is the per unit cost of $12.3268 multiplied times the 650,000 units that were completed and transferred on. The ending work in process is $1,457,097, determined as 125,000 equivalent units of material at $8.9768 each, plus 100,000 equivalent units of conversion at $3.35 each. A check mark is placed beside the total cost allocation ($9,469,500 = $8,012,403 + $1,457,097) as a reminder that this schedule must allocate the entire cost incurred within the Melting Department. If the total cost allocation does not equal the total cost incurred, an error has been made.
COST OF PRODUCTION REPORT
The above schedules are combined into a single report called a cost of production report. This report summarizes the activity within Navarro's Melting Department for the month of June:
RNAL ENTRIES
These journal entries that are needed to record the June activity within the Melting Department:
l entries, along with the beginning work in process of $2,104,500, result in an ending work in process of $1,457,097. The following T-account portrays the cost flow through the Work in Process account of the Melting Department:
SUBSEQUENT DEPARTMENTS
It is very important for you to notice that the journal entry to transfer $8,012,403 out of the Melting Department (credit) is offset with an increase in the Work in Process of the Skim/Alloy Department (debit). The Skim/Alloy Department's T-account for June might look something like this (amounts are assumed):
The corresponding journal entries for the Skim Alloy Department for June are as follows:
And, the Mold/Extrude Department has this T-account and related entries:
Notice that the costs transferred from the Mold/Extrude unit go to the finished goods inventory, since this is the final process.
PROCESS COSTINGCOST OF PRODUCTION REPORTFIRST-IN, FIRST-OUT
BEGINNING WORK IN PROCESS/CURRENT PRODUCTION
The key difference between the weighted-average approach and the FIFO approach is that separate equivalent unit quantity and cost information must be maintained for beginning inventory and current period production under FIFO. Thus, FIFO is computationally more cumbersome.
CHANGES IN THE UNIT RECONCILIATION SECTION
In the FIFO cost of production report, the "Quantity Schedule" includes 300,000 units that were in process at the beginning of the period and 350,000 units that were started and completed during the period; together this represents the 650,000 units that were completed and transferred to the Skim/Alloy Department. Unlike weighted average, FIFO requires to keep these layers separated. At the start of the month, the 300,000 units in beginning inventory were 60% complete as to materials and 50% complete as to conversion. Therefore, an additional 120,000 equivalent units of material and 150,000 equivalent units of conversion were incurred to complete these units during June.
CHANGES IN THE COST PER EQUIVALENT UNIT SECTION
With FIFO, only the current period production cost is considered in determining the cost per equivalent unit for the month. The total cost assigned to the department for the month is divided by the current period equivalent units. The cost from beginning inventory will not impact this per unit calculation since the FIFO method does not "average" costs together.
CHANGES IN THE COST ALLOCATION
The final cost allocation brings forward the cost of the beginning inventory ($2,104,500) and assigns it to units transferred out (remember, first-in, first-out). Of course, added to this is the additional cost relating to the current period equivalent units of production. The ending work in process is entirely based upon current period equivalent unit costs.
