The production processes described above often are referred to as batch manufacturing processes. Such processes are characterized by high-volume production of several prod- uct lines that differ in some important ways but are nearly identical in others. Since batch manufacturing operations have characteristics of both job-order costing and process- costing environments, a hybrid product-costing system is required. One common approach is called operation costing. This product-costing system is used when conver- sion activities are very similar across product lines, but the direct materials differ signifi- cantly. Conversion costs are accumulated by department, and process-costing methods are used to assign these costs to products. In contrast, direct-material costs are accumulated by job order or batch, and job-order costing is used to assign material costs to products.
The main features of operation costing are illustrated in Exhibit 4–10. Notice in the exhibit that products pass sequentially through production Departments A and B. Direct- material costs are traced directly to each batch of goods, but conversion costs are applied on a departmental basis. Direct labor and manufacturing overhead are combined in a single cost category called conversion costs, rather than separately identifying direct labor. Moreover, under operation costing, conversion costs are applied to products using a predetermined application rate. This predetermined rate is based on budgeted conver- sion costs, as follows:4
Predetermined application rate for conversion costs =
Budgeted conversion costs (direct labor and manufacturing overhead)
____________________________________________________________
Budgeted cost driver (or activity base)
As an illustration of operation costing, we will focus on the Minnesota Division of MVP Sports Equipment Company. This division manufactures two different grades of basketballs: professional balls, which have genuine leather exteriors, and scholastic balls, which use imitation leather. The cutting and stitching operations for the two different products are identical. Scholastic balls are sold without special packaging, but profes- sional balls are packaged in an attractive cardboard box.
3Sequential production operations are also covered in a supplement to this textbook titled Process Costing in Sequential Production Departments. This supplement is available to students and instructors in the Connect Library.
Hybrid Product-Costing Systems
4The budgeted amount for the cost driver is based on the company’s practical capacity for production.
Learning Objective 4-7 Describe how an operation costing system accumulates and assigns the costs of direct-material and conversion activity in a batch manufacturing process.
During October two batches were entered into production and finished. There was no beginning or ending inventory of work in process for October. Cost and production data are given in Exhibit 4–11. Notice in Exhibit 4–11 that the direct-material costs are identified by batch. The conversion costs, however, are associated with the two produc- tion departments and the Packaging Department.
The product cost for each of the basketballs is computed as follows:
Exhibit 4–10 Operation Costing
Accumulated by department
Accumulated by batch
Work-in-Process Inventory:
Production Department A Batch 1 Batch 2
Work-in-Process Inventory:
Production Department B
Batch 3 Batch 4
Conversion costs Direct labor Manufacturing overhead
Direct-material costs
Finished-Goods Inventory
Notice in the preceding display that each ball receives the same conversion costs in the Preparation Department and the Finishing Department, since these operations are identical for the two products. Direct-material costs and packaging costs, though, differ for the products. The total costs of $104,500 (Exhibit 4–11) are accounted for in the prod- uct costs, as shown below.
Professional Scholastic Direct material:
Batch P19 ($20,000 ÷ 1,000) ... $20.00
Batch S28 ($30,000 ÷ 3,000) ... $10.00 Conversion: Preparation Department
(conversion costs of $30,000 ÷ 4,000 units produced)* ... 7.50 7.50 Conversion: Finishing Department
(conversion costs of $24,000 ÷ 4,000 units produced)* ... 6.00 6.00 Conversion: Packaging Department
(conversion costs of $500 ÷ 1,000 units packaged)* ... .50 –0–
Total product cost ... $34.00 $23.50
*The two production departments each worked on a total of 4,000 balls, but the Packaging Department handled only the 1,000 professional balls.
Professional balls: 1,000 × $34.00 ... $ 34,000 Scholastic balls: 3,000 × $23.50 ... 70,500 Total ... $104,500
The following journal entries are made to record the Minnesota Division’s flow of costs. The first entry is made to record the requisition of raw material by the Prepara- tion Department, when batch P19 is entered into production. (This amount excludes the
$1,000 in packaging costs to be incurred subsequently for batch P19.)
Work-in-Process Inventory: Preparation Department ... 19,000
Raw-Material Inventory ... 19,000
Work-in-Process Inventory: Preparation Department ... 30,000
Raw-Material Inventory ... 30,000
Work-in-Process Inventory: Preparation Department ... 30,000
Applied Conversion Costs ... 30,000
The following entry is made to record the requisition of raw material by the Prepara- tion Department, when batch S28 is entered into production.
Conversion costs are applied in the Preparation Department with the following jour- nal entry.
The following entry records the transfer of the partially completed professional and scholastic basketballs to the Finishing Department.
Work-in-Process Inventory: Finishing Department ... 79,000
Work-in-Process Inventory: Preparation Department ... 79,000 Operation Costing Data
Direct-material costs:
Batch P19 (1,000 professional balls) ... $20,000 (includes $1,000 for packaging material) Batch S28 (3,000 scholastic balls) ... 30,000
Total direct-material costs $50,000
Conversion costs (budgeted):
Preparation Department ... $ 30,000 Finishing Department ... 24,000 Packaging Department ... 500 Total ... $ 54,500 Total costs:
Direct material ... 50,000 Conversion: Preparation ... $30,000
Finishing ... 24,000 Packaging ... 500
Total conversion costs ... 54,500 Total ... $104,500 Predetermined application rates for conversion costs:*
Preparation Department:
Budgeted conversion costs ______________________
Budgeted production = _________$30,000
4,000 units = $7.50 per unit Finishing Department:
Budgeted conversion costs ______________________
Budgeted production = _________$24,000
4,000 units = $6.00 per unit Packaging Department:
Budgeted conversion costs ______________________
Budgeted units packaged = _________$500
1,000 units = $.50 per unit
*The cost driver (or activity base) is the number of units processed.
Exhibit 4–11
Basic Data for Illustration of Operation Costing
The conversion costs applied in the Finishing Department are recorded as follows:
Next, the professional balls are transferred to the Packaging Department, and the scholastic balls are transferred to finished goods.
Raw-material (packaging) costs and conversion costs are recorded in the Packaging Department as follows:
Finally, the professional basketballs are transferred to finished goods.
Suppose that at the end of an accounting period, applied conversion costs differ from the actual conversion costs incurred. Then the difference, called overapplied or underap- plied conversion costs, would be closed into Cost of Goods Sold. This accounting treat- ment is similar to that described in Chapter 3 for overapplied or underapplied overhead.
Work-in-Process Inventory: Finishing Department ... 24,000
Applied Conversion Costs ... 24,000
Work-in-Process Inventory: Packaging Department ... 32,500 Finished-Goods Inventory ... 70,500
Work-in-Process Inventory: Finishing Department ... 103,000
Work-in-Process Inventory: Packaging Department ... 1,500
Raw-Material Inventory ... 1,000 Applied Conversion Costs ... 500
Finished-Goods Inventory ... 34,000
Work-in-Process Inventory: Packaging Department ... 34,000
Chapter Summary
LO4-1 List and explain the similarities and important differences between job-order and process costing. Process costing is used in production processes where relatively large numbers of nearly iden- tical products are manufactured. The purpose of a process-costing system is the same as that of a job- order costing system—to accumulate costs and assign these costs to units of product. Job-order costing is used by firms that produce relatively small numbers of dissimilar products.
LO4-2 Prepare journal entries to record the flow of costs in a process-costing system with sequen- tial production departments. Costs of direct material, direct labor, and manufacturing overhead are added to a Work-in-Process Inventory account. Direct labor and manufacturing overhead often are combined into a single cost category termed conversion costs. When products are completed, the costs assigned to them are transferred either to Finished-Goods Inventory or to the next production depart- ment’s Work-in-Process Inventory account. Finally, when goods are sold, their costs are transferred to the expense account called Cost of Goods Sold.
LO4-3 Prepare a table of equivalent units under weighted-average process costing. The table of equivalent units, illustrated in the chapter, computes the equivalent units of activity for the period for both direct material and conversion costs.
LO4-4 Compute the cost per equivalent unit under the weighted-average method of process cost- ing. The cost per equivalent unit, for both direct material and conversion, is calculated as shown in the chapter. For each factor input, direct material and conversion, the cost of that input is divided by the number of equivalent units for that input.
LO4-5 Analyze the total production costs for a department under the weighted-average method of process costing. The total production costs incurred during the period, for both direct material and conversion, are assigned to either ending work-in-process inventory or to the cost of goods completed and transferred out.
LO4-6 Prepare a departmental production report under weighted-average process costing. As illustrated in the chapter, there are four steps in preparing a departmental production report: (1) analyze the physical flow of units, (2) calculate the equivalent units, (3) compute the cost per equivalent unit,
Required: Prepare the Cutting Department’s June production report using weighted-average pro- cess costing. (Hint: Follow the format of Exhibit 4–9.)
Solution to Review Problem
The Cutting Department’s June production report is displayed in Exhibit 4–12.
Review Problem on Process Costing
The following data have been compiled for MVP’s Cutting Department for the month of June. Conver- sion activity occurs uniformly throughout the production process.
Work in process, June 1—25,000 units:
Direct material: 100% complete, cost of ... $ 73,750 Conversion: 40% complete, cost of ... 46,000 Balance in work in process, June 1 ... $119,750 Units started during June ... 40,000 Units completed during June and transferred out ... 60,000 Work in process, June 30:
Direct material: 100% complete Conversion: 60% complete Costs incurred during June:
Direct material ... $121,250 Conversion costs: direct labor and applied manufacturing overhead ... 237,500 and (4) analyze the total costs of the department. In the weighted-average method of process costing, the cost per equivalent unit, for each cost category, is a weighted average of (1) the costs assigned to the beginning work-in-process inventory and (2) the costs incurred during the current period.
LO4-7 Describe how an operation costing system accumulates and assigns the costs of direct- material and conversion activity in a batch manufacturing process. Operation costing is a hybrid of job-order and process costing. It is designed for production processes in which the direct material differs significantly among product lines, but the conversion activities are essentially the same. Direct-material costs are accumulated by batches of products using job-order costing methods. Conversion costs are accumulated by production departments and are assigned to product units using process-costing methods.
Exhibit 4–12 June Production Report:
Cutting Department (weighted-average method)
MVP SPORTS EQUIPMENT COMPANY June Production Report: Cutting Department
Physical Units
Percentage of Completion with Respect to Conversion
Equivalent Units Direct
Material Conversion Work in process, June 1 ... 25,000 40%
Units started during June ... 40,000 Total units to account for ... 65,000
Units completed and transferred out during June ... 60,000 100% 60,000 60,000
Work in process, June 30 ... 5,000 60% 5,000 3,000
Total units accounted for ... 65,000
Total equivalent units ... 65,000 63,000
Direct Material Conversion Total Work in process, June 1 ... $ 73,750 $ 46,000 $119,750 Costs incurred during June ... 121,250 237,500 358,750 Total costs to account for ... $ 195,000 $283,500 $478,500 Equivalent units ... 65,000 63,000
Costs per equivalent unit ... $3.00 $4.50 $7.50
$195,000 ________
65,000 $283,500________
63,000 $3.00 + $4.50 (continued)
Key Terms
For each term’s definition refer to the indicated page, or turn to the glossary at the end of the text.
batch manufacturing, 150 departmental production
report, 142
equivalent unit, 141 hybrid product-costing
system, 150
operation costing, 150 process-costing
system, 138
transferred-in costs, 139 weighted-average
method, 142 Cost of goods completed and transferred out of the Cutting Department during June:
(Number of units
transferred out ) × ( Total cost per
equlvalent unit ) ... 60,000 × $7.50 ... $450,000 Cost remaining in June 30 work-in-process inventory in the Cutting Department:
Direct material:
( Number of equivalent
units of direct material ) × ( Cost per equivalent
unit of direct material ) ... 5,000 × $3.00 ... $ 15,000 Conversion:
(Number of equivalent
units of conversion ) × (Cost per equivalent
unit of conversion ) ... 3,000 × $4.50 ... 13,500
Total cost of June 30 work in process $ 28,500
Check: Cost of goods completed and transferred out ... $450,000 Cost of June 30 work-in-process inventory ... 28,500 Total costs accounted for ... $478,500
Review Questions
4–1. Explain the primary differences between job-order and process costing.
4–2. List five types of manufacturing in which process cost- ing would be an appropriate product-costing system.
What is the key characteristic of these products that makes process costing a good choice?
4–3. List three nonmanufacturing businesses in which process costing could be used. For example, a public accounting firm could use process costing to accumu- late the costs of processing clients’ tax returns.
4–4. What are the purposes of a product-costing system?
4–5. Define the term equivalent unit and explain how the concept is used in process costing.
4–6. List and briefly describe the purpose of each of the four process-costing steps.
4–7. Show how to prepare a journal entry to enter direct- material costs into the Work-in-Process Inventory account for the first department in a sequential produc- tion process. Show how to prepare the journal entry recording the transfer of goods from the first to the sec- ond department in the sequence.
4–8. What are transferred-in costs?
4–9. A food processing company has two sequential produc- tion departments: mixing and cooking. The cost of the January 1 work in process in the cooking department is detailed as follows:
During what time period and in what department were the $182,000 of costs listed above incurred? Explain your answer.
4–10. Explain the reasoning underlying the name of the weighted-average method.
4–11. How would the process-costing computations dif- fer from those illustrated in the chapter if overhead were applied on some activity base other than direct labor?
4–12. Explain the concept of operation costing. How does it differ from process or job-order costing? Why is operation costing well suited for batch manufacturing processes?
4–13. What is the purpose of a departmental production report prepared using process costing?
4–14. Question for classroom or small-group discussion.
Now that we have studied different kinds of costs and the systems used to accumulate them, let’s think about how these concepts might apply in the social media industry. Suppose you are the CFO (chief financial officer) of Facebook, Twitter, Instagram, or any other social media company. What kinds of costs do these companies incur? Are there labor, material, and overhead costs? Direct and indirect costs? Fixed and variable costs? What are the types of services produced by social media companies? And how do the costs these companies incur relate to the services they generate?
Direct material ... $ 79,000 Conversion ... 30,000 Transferred-in costs ... 182,000
Use the Internet to access the website for Weyerhaeuser (www.weyerhaeuser.com), International Paper (www.internationalpaper.com), or Boise Cascade (www.boisecascade.com).
Required: Skim over the information presented on the website about the company’s products and operations. Then discuss why process costing is an appropriate product-costing method for this company.
Rainbow Glass Company manufactures decorative glass products. The firm employs a process-costing system for its manufacturing operations. All direct materials are added at the beginning of the process, and conversion costs are incurred uniformly throughout the process. The company’s production sched- ule for October follows.
Exercise 4–17 Equivalent Units;
Weighted-Average (LO 4-1, 4-3)
Exercises
In each case below, fill in the missing amount.
Exercise 4–15 Physical Flow of Units (LO 4-1, 4-3)
All applicable Exercises are available in Connect.
®
Required: Calculate each of the following amounts using weighted-average process costing.
1. Equivalent units of direct material during October.
2. Equivalent units of conversion activity during October.
(CMA, adapted)
Terra Energy Company refines a variety of petrochemical products. The following data are from the firm’s Lodi plant.
Work in process, November 1 ... 2,000,000 gallons Direct material ... 100% complete Conversion ... 25% complete Units started in process during November ... 950,000 gallons Work in process, November 30 ... 240,000 gallons Direct material ... 100% complete Conversion ... 80% complete 1. Work in process, September 1 ... 9,000 tons
Units started during September ... ? Units completed during September ... 19,000 tons Work in process, September 30 ... 2,000 tons 2. Work in process, February 1 ... 13,000 kilograms
Units started during February ... 1,500 kilograms Units completed during February ... 9,200 kilograms Work in process, February 28 ... ? 3. Work in process, January 1 ... 100,000 gallons
Units started during the year ... 850,000 gallons Units completed during the year ... ? Work in process, December 31 ... 200,000 gallons
Units Work in process on October 1 (60% complete as to conversion) ... 1,000 Units started during October ... 5,000 Total units to account for ... 6,000 Units from beginning work in process, which were completed and transferred out during October ... 1,000 Units started and completed during October ... 3,000 Work in process on October 31 (20% complete as to conversion) ... 2,000 Total units accounted for ... 6,000
Required: Compute the equivalent units of direct material and conversion for the month of November.
Use the weighted-average method of process costing.
Exercise 4–18 Equivalent Units;
Weighted-Average (LO 4-1, 4-3) Exercise 4–16 Process Costing; Use of Internet
(LO 4-1)
The Evanston plant of Fit-for-Life Foods Corporation produces low-fat salad dressing. The following data pertain to the year just ended.
Equivalent units of direct material (weighted-average method) ... 60,000 Equivalent units of conversion (weighted-average method) ... 52,000 Units completed and transferred out during September ... 50,000
During the year, the company started 120,000 pounds of material in production.
Required: Prepare a schedule analyzing the physical flow of units and computing the equivalent units of both direct material and conversion for the year. Use weighted-average process costing.
Idaho Lumber Company grows, harvests, and processes timber for use in construction. The following data pertain to the firm’s sawmill during November.
The equivalent units of activity for November were as follows: 7,000 equivalent units of direct material and 1,740 equivalent units of conversion activity.
Required: Calculate the cost per equivalent unit, for both direct material and conversion, during November. Use weighted-average process costing.
Otsego Glass Company manufactures window glass for automobiles. The following data pertain to the Plate Glass Department.
The equivalent units of activity for June were as follows: 17,000 equivalent units of direct material and 48,500 equivalent units of conversion activity.
Required: Calculate the cost per equivalent unit, for both direct material and conversion, during June.
Use weighted-average process costing.
Savannah Textiles Company manufactures a variety of natural fabrics for the clothing industry. The fol- lowing data pertain to the Weaving Department for the month of September.
Percentage of Completion Units Direct Material Conversion Work in process, January 1 ... 20,000 lb. 80% 60%
Work in process, December 31 ... 15,000 lb. 70% 30%
Work in process, November 1:
Direct material ... $ 65,000 Conversion ... 180,000 Costs incurred during November:
Direct material ... $425,000 Conversion ... 690,000
Work in process, June 1:
Direct material ... $ 37,000 Conversion ... 36,750 Costs incurred during June:
Direct material ... $150,000 Conversion ... 230,000
Exercise 4–19
Physical Flow and Equivalent Units; Weighted-Average (LO 4-1, 4-3)
Exercise 4–20 Cost per Equivalent Unit;
Weighted-Average (LO 4-1, 4-3, 4-4)
Exercise 4–21 Cost per Equivalent Unit;
Weighted-Average (LO 4-1, 4-3, 4-4)
Exercise 4–22 Analysis of Total Costs;
Weighted-Average (LO 4-5)
The cost data for September are as follows:
Work in process, September 1
Direct material ... $ 94,000 Conversion ... 44,400 Costs incurred during September
Direct material ... $164,000 Conversion ... 272,800
Direct material (weighted-average method) ... 110,000 Conversion (weighted-average method) ... 92,000 Completed and transferred out ... 90,000
There were 20,000 units in process in the Weaving Department on September 1 (100% complete as to direct material and 40% complete as to conversion).
Required: Compute each of the following amounts using weighted-average process costing.
1. Cost of goods completed and transferred out of the Weaving Department.
2. Cost of the September 30 work-in-process inventory in the Weaving Department.
3. Build a spreadsheet: Construct an Excel spreadsheet to solve all of the preceding requirements.
Show how the solution will change if the following data change: the costs incurred in September were $328,000 for direct material and $818,400 for conversion.
The following data pertain to Tulsa Paperboard Company, a manufacturer of cardboard boxes.
The equivalent units of activity for February were as follows:
Work in process, February 1 10,000 units*
Direct material ... $ 5,500 Conversion ... 17,000 Costs incurred during February
Direct material ... $110,000 Conversion ... 171,600
*Complete as to direct material; 40% complete as to conversion.
Required: Compute the following amounts using weighted-average process costing.
1. Cost of goods completed and transferred out during February.
2. Cost of the February 28 work-in-process inventory.
The November production of MVP’s Minnesota Division consisted of batch P25 (2,000 professional basketballs) and batch S33 (4,000 scholastic basketballs). Each batch was started and finished during November, and there was no beginning or ending work in process. Costs incurred were as follows:
Direct Material:
Batch P25, $42,000, including $2,500 for packaging material; batch S33, $45,000.
Conversion Costs:
Preparation Department, predetermined rate of $7.50 per unit; Finishing Department, predetermined rate of $6.00 per unit; Packaging Department, predetermined rate of $.50 per unit. (Only the profes- sional balls are packaged.)
Required:
1. Draw a diagram depicting the division’s batch manufacturing process. Refer to Exhibit 4–10 for guidance.
2. Compute the November product cost for each type of basketball.
3. Prepare journal entries to record the cost flows during November.
Exercise 4–24 Operation Costing (LO 4-7) Exercise 4–23 Analysis of Total Costs;
Weighted-Average (LO 4-5)