The presence of significant inventories of work in progress complicates the cost and output definitions necessary for calculating unit costs. Work-in-process inventories affect the calculation of unit costs by affecting the way the period's output is measured.
Beginning Work-in-Process Inventories
Unit costs are then calculated for each input category, and the total unit cost is the sum of the individual category unit costs.
FIFO Costing Method
- Physical Flow Analysis
- Calculation of Equivalent Units
- Computation of Unit Cost
- Valuation of Inventories
- Cost Reconciliation
First, units begun and completed in this period are obtained by subtracting the units in beginning work in process from the total number of completed units. But the cost of the 10,000 beginning work-in-process units transferred out is another matter.
Journal Entries
Weighted Average Costing Method
Similarly, the 7,000 equivalent units of conversion cost found in beginning work in process are also included in the 60,000 units completed for the conversion category.2 Beginning inventory units are therefore treated as if they were started and completed during the current period . The weighted average method combines current manufacturing costs and the manufacturing costs associated with the units in beginning work in process. You should note that if we subtract the 10,000 equivalent units of direct materials from the 80,000 units calculated by the weighted average method, we arrive at the 70,000 units calculated by the FIFO method;.
Calculating completion of work in progress is done by obtaining the costs of each production input and then adding these individual input costs. For our example, this requires adding the cost of the direct materials at the end of work in process to the conversion cost at the end of work in process. The direct materials cost is the direct material unit cost multiplied by the direct material equivalent units at the end of work in process.
Similarly, the total conversion costs in ending work in process are the unit conversion costs multiplied by the equivalent units of conversion costs.
Production Report
Valuation of transferred goods (step 4) is done by multiplying the unit cost by the finished goods.
FIFO Compared with Weighted Average
The FIFO method is the more theoretically attractive because it divides the costs over the period. However, the weighted average method adds costs in beginning work in process to current period costs and adds the output found in beginning work in process to current period output. This creates the possibility for error - especially if the weighted average method is used for settings where input costs change significantly from one period to the next.
In the mixing department example, the FIFO method unit cost and the weighted average method unit cost for conversion costs are the same; the cost of this input apparently remained the same in the two periods considered. Apparently, direct materials costs have increased, and combining the lower direct materials costs from the previous period with the costs in the current period creates a weighted average direct materials cost that understates the current period's direct materials costs. The weighted average method also combines the performance of the current period with the results of a previous period.
The weighted average method makes this comparison suspect because the performance of the current period is not independent of the previous period.
Treatment of Transferred-In Goods
Physical Flow Schedule
The calculation of equivalent units of production using the weighted average method is shown in Exhibit 6-14. Note that transferred goods from mixing are treated as materials added at the beginning of the process. Downloaded materials are always 100% complete as they are added at the beginning of the process.
Computation of Unit Costs
The cost of production report for Estrella Company for the month of October, including Step 5 (which was skipped), is shown in Exhibit 6-15. Estrella Company Tableting Division Production Report for October. The only additional complication introduced in the analysis for a subsequent section is the presence of the category transferred. However, remember that the current cost of this special type of material is the cost of the units carried over from the previous process and that the units carried over are the units started (adjusted for any differences in output measurement).
Operation Costing
Basics of Operation Costing
Now consider two batches of shoes going through the sewing process: one batch consists of 50 pairs of men's leather boots, and the second batch consists of 50 pairs of women's leather sandals. First, it should be clear that the batches have different direct material requirements, so the cost of direct materials should be tracked separately (job cost feature). Second, it must also be clear that the sewing activity is the same for everyone in the sense that one hour of sewing time must consume the same resources regardless of whether the product is boots or sandals (the process cost characteristic).
Even though the products consume the same resources per machine hour, the batches may differ in the total amount of resources consumed during an operation. Thus, the direct material costs would be assigned to the work-in-process account for the beginning process for each batch. The letters immediately following the process represent the application of conversion charges to the respective batches.
Operation Costing Example
Panel A: Physical Flows
Furthermore, we have shown that process costing can be used in service organizations and JIT manufacturing firms. These two settings often do not have significant work-in-process inventories and, therefore, represent the simplest and most straightforward applications of the approach. The use of process costing is complicated by the presence of work-in-process inventories.
If work-in-process inventories are present, equivalent units should be used to measure output. When starting work-in-progress inventories, we also have to decide what to do with the work from the previous period and the costs from the previous period. Two methods have been described for dealing with incipient work-in-progress inventories: the FIFO method and the weighted average method.
The FIFO approach is theoretically attractive because it follows the process costing principle: a period's unit costs are calculated by dividing the period's costs by the period's output.
Appendix: Spoiled Units
The first entry assumes that all materials needed for the batch are requested at the beginning. In the mixing section, all direct materials are added at the beginning of the process. Beginning work in process (BWIP), February pounds, 40 percent complete with respect to conversion costs.
Termination of Work in Process (EWIP), February pounds, 60 percent complete with respect to conversion costs. Now we need to calculate the cost of the goods transferred and the cost of finishing work in progress. Therefore, none of the damaged units are from finishing work in progress (since these units are only 60 percent complete and have not yet been inspected).
When spoilage is assumed to be normal, it is not tracked separately but is included in the total cost of good units.
R e quir e d
L UTIO N
What journal entry will be made as goods are transferred from one department to another department. How is the equivalent unit calculation affected when direct materials are added at the beginning or end of the process rather than uniformly throughout the process. Describe the five steps in accounting for the manufacturing activity of a processing department, and indicate how they are interrelated.
Under what circumstances will the weighted average and FIFO methods have essentially the same results. How do the weighted average and FIFO methods differ in allocating costs to goods transferred out.
Includes only the direct materials, direct labor, and overhead used to process the partially finished goods received from the previous department. Prepare journal entries showing the transfer of costs from one department to the next (including the entry to transfer the costs to the final department).
Determine the costs for finishing work in progress and the costs for transferring goods.
W EIGHTED A VERAGE M ETHOD , P HYSICAL F LOW ,
A N ALYSIS , U N IFOR M C OSTS
Required
S ERVICE O RGANIZATION WITH W ORK - IN -P ROCESS
I NVENTORIES , M ULTIPLE D EPARTMENTS , FIFO M ETHOD , U NIT C OST
W EIGHTED A VERAGE M ETHOD , J OURNAL E NTRIES
Prepare journal entries showing the flow of production costs for the molding department.
O PERATION C OSTING : U NIT C OSTS
AND J OURNAL E NTRIES
For batch with regular strength of 12,000, direct materials are required for blending and bottling departments.
C ASE ON P ROCESS C OSTING , O PERATION C OSTING , I MPACT ON R ESOURCE A LLOCATION D ECISION
Calculate the unit cost of the handles produced by the pattern department, assuming that process costing is completely appropriate. Calculate the unit cost of each handle using the separate cost information found on materials. In the past, the marketing manager has requested more money to advertise the Econo line.
A PPENDIX : N ORMAL AND A BNORMAL S POILAGE
A PPENDIX : N ORMAL AND A BNORMAL S POILAGE IN P ROCESS C OSTING
A PPENDIX : N ORMAL AND A BNORMAL S POILAGE IN P ROCESS C OSTING , C HANGES IN O UTPUT M EASURES ,
Beginning work in process for this department was 25,000 pounds, 40 percent complete with the following costs: transferred cost,.
C OLLABORATIVE L EARNING E XERCISE : S TRUCTURED
P ROBLEM S OLVING (C ASE ON E QUIVALENT U NITS , V ALUATION OF W ORK - IN -P ROCESS I NVENTORIES , FIFO
VERSUS W EIGHTED A VERAGE )
The Arizona facilities had been in operation for more than a decade and were full of work in progress. The New Mexico plant had only been in operation for two years and had much smaller work-in-process inventories. The New Mexico partner argued that it would be grossly unfair to disregard the unequal value of the ongoing settlements.
Unfortunately, throughout AKL Foundry's business history, work-in-process inventory has never been assigned a value. AKL partners want a reasonable estimate of the cost of work-in-process inventory. Using the inventory of the receiving department as an example, prepare an estimate of the cost of finished work in process.
Assume that the shell creation process has 8,000 units in beginning work in process, 20 percent complete.
C OLLABORATIVE L EARNING E XERCISE : J IGSAW M ETHOD
Suppose that Stoney is 63 years old and that his prospects for employment elsewhere are poor. Stoney also knows that Keri's superior, the owner of the company, is her father-in-law.
C YBER R ESEARCH C ASE
