Process costing

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  • 1. Process Costing System:Cost accumulation procedures used by manufacturing concerns are classified as either job ordercosting or process costing. The Job Order Costing System deals with the procedures applicable to joborder costing. It is important to understand that, except for some modifications, the accumulation ofmaterials costs, labor costs, and factory overhead also applies to process costing system.Process costing – a system applicable to a continuous process of production of the same or similargoods. It is used for industries producing chemicals, petroleum, textiles, steel, rubber, cement, flour,pharmaceuticals, shoes, plastics, sugar, and coal. Process costing system is also used by firmsmanufacturing items such as rivets, screws, bolts, and small electrical parts. A third type of industryusing process costing system is the assembly type industry which manufactures such things astypewriters, automobiles, airplanes, and household electric appliances (washing machines,refrigerators, toasters, irons, radios, television sets, etc.). Finally certain service industries, such asgas, water, and heat, cost their products by using process costing system. Thus, process costing isused when products are manufactured under conditions of continuous processing or under massproduction methods. In fact, process costing procedures are often termed "continuous or massproduction cost accounting procedures".The type of manufacturing operations performed determines the cost procedures that must be used.For example, company manufactures custom machinery will use job order costing, whereas a chemicalcompany will use process costing. In the case of machinery manufacturer, a job order cost sheet isprepared for each order, accumulating the costs of materials, labor, and factory overhead. In contrastthe chemical company cannot identify materials, labor, and factory overhead with each order, sinceeach order is part of a batch or a continuous process. The individual order identity is lost, and the costof a completed unit must be computed by dividing total cost incurred during a period by total unitscompleted. The summarization of the costs takes place via the cost of production report, which is anextremely efficient, economical, and timesaving device for the collection of large amounts of data. Thismatter considers the (1) cost of production report, (2) calculation of departmental unit costs, (3)costing of work in process, (4) computations of costs transferred to other departments or to thefinished goods storeroom, and (5) effect of lost units on unit costs. Process Costing System - Additionof Materials, Average and FIFO Costing deals with (1) special problems involved in adding materials indepartments other than the first, (2) problems connected with the beginning work in process, and (3)the possibility of using costing methods.Characteristics and Procedure of Process Costing System:The characteristics of process costing system: 1. A cost of production report is used to collect, summarize and compute total and unit costs. 2. Production is accumulated and reported by departments. 3. Costs are posted to departmental work in process accounts. 4. Production in process at the end of a period is restated in terms of completed units. 5. Total cost charged to a department is divided by total computed production of the department in order to determine a unit cost for a specific period. 6. Costs of completed units of a department are transferred to the next processing department in order to arrive at the total costs of the finished products during a period. At the same time, costs are assigned to units still in process.The procedures of process costing are designed to: 1. Accumulate materials, labor, and factory overhead costs by departments. 2. Determine a unit cost for each department. 3. Transfer costs from one department to the next and to finished goods. 4. Assign costs to the inventory of work in process (WIP)If accurate units and inventory costs are to be established by process costing procedures, costs of aperiod must be identified with units produced in the same period.
  • 2. Costing By Departments:The nature of manufacturing operations in firms using process or job order cost procedures is usuallysuch that work on product takes place in several departments.With either procedure, departmentalization of materials, labor, and factory overhead costs facilitatesapplication of responsibility accounting. Each department performs a specific operation or processtowards the completion of the product. For example, after the blending department has completed thestarting phase of the work on product, units are transferred to the testing department, after which theymay go to the terminal department for completion and transferred to the finished goods storeroom.Both units and costs are transferred from one manufacturing department to another manufacturingdepartment. Separate departmental work in process (WIP) accounts are used to charge eachdepartment for the materials, labor, and factory overhead used to complete its share of manufacturingprocess.Process costing involves averaging costs for a particular period in order to obtain departmental andcumulative unit costs. The cost of a completed unit is determined by dividing the total cost of a periodby the total units produced during the period. Determining departmental production for a periodincludes evaluating units still in process. The breakdown of costs for the computation of total unit costsand for costing units transferred and departmental work in process (WIP) inventories is also desirablefor cost control purposes.Departmental total and unit costs are determined by the use of the cost of production report, which isdescribed and illustrated in detail on the Cost Of Production Report page. Most of the activity in processcosting system involves the accumulation of data needed for the preparation of these reports.Product Flow in Process Costing System:A product can flow through a factory in numerous ways. Three product flow formats associatedwith process costing - sequential, parallel, and selective - are illustrated here to indicate that basicallythe same costing procedures can be applied to all types of product flow situations.Sequential Product Flow:In a sequential product flow, each item manufactured goes through the same set of operation, asillustrated below. Work in Process Work in Process Work in Process Finished Goods Blending Department Testing Department Terminal DepartmentMaterialsLabor Labor LaborFOH* FOH* FOH* → → →*Factory OverheadMaterials are placed into production in the Blending Department, and labor and factory overhead areadded. When the work is finished in the Blending Department, it moves to the Testing Department.The second process, and any succeeding processes, may add more materials or simply work on thepartially completed input from the preceding departments, adding only labor and factory overhead, asin this example. After the product has been processed by the Terminal Department, it is a completedproduct and becomes a part of finished goods inventory.Parallel Flow:In a parallel product flow, certain portion of the work are done simultaneously and then broughttogether in a final process or processes for completion and transfer to finished goods inventory. As inthe previous illustration, materials may be added in subsequent processes.
  • 3. Selective Product Flow:In a selective product flow, the product moves to different departments within the plant, dependingupon the desired final product. For example, in meet processing, after the initial butchering process,some of the product goes directly to the Packaging Department and then to finished goods inventory;some goes to the Smoking Department and then to the Packaging Department and finallyto finished goods inventory; Some goes to the grinding department, then to thepackaging department and lastly to finished goods inventory. Transfer of costs from theButchering Department involves joint cost allocation, discussed on By-Products and Joint ProductsCosting page.Procedures for Materials, Labor, and Factory Overhead Costs Accumulations:In process costing, materials, labor, and factory overhead costs are accumulated in the usual accounts,using normal cost accounting procedures. Costs are then analyzed by departments or processes andcharged to departments by appropriate journal entries. The details involved in process costing areusually fewer than those in the job order costing, where accumulation of costs for many orders canbecome unwieldy.Materials Costs:In job order costing system, materials requisitions are used to charge jobs for direct materials used. Ifrequisitions are used in process costing, details are considerably reduced because materials are chargedto departments rather than to jobs, and the number of departments using materials is usually less thanthe number of jobs a firm might handle at a given time. Frequently materials are issued only to theprocess-originating department; subsequent department other than the first, they are charged to thatdepartment performing the specific operation.For materials control purposes, materials need not always be priced individually on requisition forms.The cost of materials used can be determined at the end of the production period through inventorydifference procedures, i.e., adding purchases to beginning inventory and then deducting endinginventory. Or consumption reports which state the cost of materials or quantity of materials put intoprocess by various departments can be used. Costs or quantities charged to departments byconsumption reports may be based on formulas or proration. Formulas specify the type and quantity ofmaterials required in the various products and are applied to finished production in order to calculatethe materials consumed. Chemical and pharmaceutical industries use such procedures, particularlywhen more than one product is manufactured by a department. Frequently the cost of materialsused by a department must by prorated to different products on various estimated bases. This topic willbe discussed By-Products and Joint Products Costing.For any of the materials cost computation methods discussed, a typical journal entry charging directmanufacturing materials used during a period is:Work in Process - Blending department 24,500 Materials 24,500The source of the cost figures for the above entry as well as the entries for labor and factory overheadis the cost of production report which is discussed on cost of production report page.Direct Labor:Labor costs are identified by and charged to departments in process costing, thus eliminating thedetailed clerical work of accumulating labor costs by jobs. Daily time tickets or weekly time clockcards are used instead of job time tickets. Summary labor charges are made to departments throughan entry which distributes the direct manufacturing payroll:Work in Process - Blending department 29,140Work in Process - Testing Departments 37,310Work in Process - Terminal Department 32,400 Payroll 98,850
  • 4. Factory Overhead Costs:Factory overhead incurred in process costing as well as in job order costing should be accumulated inthe factory overhead subsidiary ledger for producing and service departments. This procedure isconsistent with requirements for responsibility accounting and responsibility reporting.Normally it is emphasized to use the predetermined overhead rates for charging overhead to jobs andproducts. However, in various process and job order costing procedures, actual rather than appliedoverhead is sometimes used for product costing. This practice is feasible when production remainscomparatively stable from period to period, since factory overhead will then remain about the samefrom one month to the next. The use of actual overhead can also be justified when factory overhead isnot an important part of total cost. However, predetermined overhead rates for producing departmentsshould be used if: 1. Production is not stable. 2. Factory overhead, especially fixed overhead, is a significant cost.Fluctuations in production can lead to the unequal incurrence of actual factory overhead from month tomonth. In such cases, factory overhead should be applied to production using predetermined rates, sothat units produced receive proper charges for factory overhead. Similarly, if factory overhead -especially fixed factory overhead - is significant, it is desirable to allocate factory overhead on the basisof normal or uniform production using predetermined overhead rates. Indeed, the use of predeterminedrates is highly recommended for improving cost control and facilitating cost analysis.Prior to charging factory overhead to departments via their respective work in processaccounts, expenses must be accumulated in a factory overhead control account. As expenses areincurred the entry is:Factory overhead control xxxxx Accounts Payable xxxxx Accumulated Depreciation - Machinery xxxxx Prepaid Insurance xxxxx Materials xxxxx Payroll xxxxxThe use of factory overhead control account requires a subsidiary ledger for factory overhead, withdepartmental expense analysis sheet to which all expenses are posted. Servicedepartment expenses are kept in like manner and distributed later to producing departments. At theend of each period, departmental expense analysis sheets are totaled. These totals, which also includedistributed service department costs, represent factory overhead for each department.By debiting the actual cost incurred or by using the predetermined overhead rates multiplied by therespective actual activity base (e.g., direct labor hours) for each producing department, the entrycharging these expenses to work in process is as follows:Work in Process - Blending department 28,200Work in Process - Testing Departments 32,800Work in Process - Terminal Department 19,800 Factory Overhead Control 80,800
  • 5. Cost of Production Report (CPR):Definition and Explanation of Cost of Production Report (CPR):A departmental cost of production report (CPR) shows all costs chargeable to a department. It isnot only the source for summary journal entries at the end of the month but also a most convenientvehicle for presenting and disposing of costs accumulated during the month. A cost of production reportshows: 1. Total unit costs transferred to it from a preceding department. 2. Materials, labor, and factory overhead added by the department. 3. Unit cost added by the department. 4. Total and unit costs accumulated to the end of operations in the department. 5. The cost of the beginning and ending work in process inventories. 6. Cost transferred to a succeeding department or to a finished goods storeroom.It is customary to divide the cost section of the report into two parts: one was showing costs forwhich the department is accountable, including departmental and cumulative total and unit costs, theother showing the disposition of these costs. A quantity schedule showing the total number of units forwhich a department is accountable and the disposition made of these units is also part of eachdepartments cost of production report. Information in this schedule, adjusted for equivalent productionis used to determine the unit costs added by a department, the costing of the ending work in processinventory, and the cost to be transferred out of the department.A cost of production report determines periodic total and unit costs. However, a report that wouldmerely summarize the total costs of materials, labor, and factory overhead and shows only the unit costfor the period would not be satisfactory for controlling costs. Total figures mean very little; cost controlrequires detailed data. Therefore, in most instances, the total cost is broken down by cost elements foreach department head responsible for the costs incurred. Furthermore, detailed departmental figuresare needed because of the various completion stages of the work in process inventories.Either in the cost of production report itself or in the supporting schedules, each item of material usedby a department is listed; every labor operation is shown separately; factory overhead components arenoted individually; and a unit cost is derived for each item. To condense the illustrated cost ofproduction reports, only total materials, labor, and factory overhead charged to departments areconsidered; and unit costs are computed only for each cost element rather than for each item.Example:The reports of The Starex Corporation, which manufactures one product in three producingdepartments (Blending, Testing, and Terminal), are used to illustrate the details involved in thepreparation of cost of production reports.Cost of Production Report - Blending Department (1st Department):Learning Objective: 1. Prepare a cost of production report of first department in a process costing system. 2. How equivalent units are calculated in a process costing system? 3. How the lost units are treated in the cost of production report of first department?The cost of production report of the Blending Department, the originating department of The StarexCorporation, is shown on the following page. It illustrates the detailed computations needed tocomplete a cost of production report.
  • 6. The Starex Corporation Blending Department (1st Dept.) Cost of Production Report For the Month of January, 2011Quantity Schedule:Units started in process 50,000 ======Units transferred to next department 45,000Units still in process (all materials - 1/2 labor and FOH) 4,000Units lost in process 1,000 50,000 ------- ======Cost Charged To the Department: Total unit Cost CostCost added by the department:Materials P24,500 P0.50Labor 29,140 0.62Factory Overhead (FOH) 28,200 0.60 ------- -----Total cost to be accounted for P81,840 P1.72 ====== ====Cost Accounted for as Follows:Transferred to next department (45,000 × P1.72) P77,400Work in process - ending inventory:Materials (4,000 × P0.50) P2,000Labor (4,000 × 1/2 × P0.60) 1,240Factory Overhead (4,000 × 1/2 × P0.60) 1,200 4,440 ------ ------Total cost accounted for P81,840 ===== Additional Computations Equivalent Production: Materials = 45,000 + 4,000 = 49,000 units Labor and factory overhead = 45,000 + 4,000 / 2 = 47,000 units Unit Costs: Materials = P24,500 / 49,000 = P0.50 per unit Labor = P29,140 / 47,000 = P0.62 per unit Factory overhead = P28,200 / 47,000 = 0.60 per unit
  • 7. Explanation:The quantity schedule of the cost report shows that Blending Department put 50,000 units inprocess, with units reported in terms of finished product. Finished units could be stated in pounds, feet,gallons, barrels, etc. If materials issued to a department are stated in pounds and finished product isreported in gallons, units in the quantity schedule will be in terms of the finished product, gallons. Aproduct conversion table would be used to determine the number of units for which the department isaccountable. The quantity schedule of the Blending Departments report shows that of the 50,000 unitsfor which the department was responsible, 45,000 units were transferred to thenext department (Testing Department - second department), 4,000 units are still in process, and 1,000units were lost in processing.Equivalent Production:Costs charged to a department come from an analysis of materials used, payroll distribution sheets,and department expense analysis sheets. The Blending Departments unit cost amounts to P1.72 (P0.50for materials, P0.62 for labor, and P0.60 for factory overhead).Calculations of individual unit costs require an analysis of the ending work in process to determine itsstage of completion. This analysis is usually made by a supervisor or is the result of usingpredetermined formula. Materials, labor, and factory overhead have been used on the 4,000 units inthe process but not in an amount sufficient for completion. To assign costs equitably to inprocess inventory and transferred units, units still in process must be restated in terms of completedunits, which is 4,000 units for materials cost but less than 4,000 for labor and overhead costs. Thefigure for partially completed units in process is added to units actually completed in order to arrive atthe equivalent production figure for the period. This equivalent production figure represents the numberof units for which sufficient materials, labor, and overhead were issued or used during aperiod. Materials, labor and overhead costs are divided by the appropriate equivalent production figureto compute unit costs by elements. Should a cost element be at a different stage of completion withrespect to units in process, then a separate equivalent production figure must be computed.In many manufacturing processes, all materials are issued at the start of production. Unless statedotherwise, the illustrations in this discussion assume such a procedure. Therefore, the 4,000 unitsstill in process have all the materials needed for their completion but not all labor and factory overhead(FOH). Only 50% of the labor and factory overhead needed to complete the units has been used. Interms of equivalent production, labor and factory overhead in process are sufficient to complete 2,000units.Units Costs:Departmental cost of production reports indicates the cost of units as they leave department. Theseindividual departmental units’ costs are accumulated into a completed unit cost for the period. Thereport for the Blending Department shows a materials cost of P24,500, labor cost of P29,140, andfactory overhead of P28,200. The materials cost of P24,500 is sufficient to complete 49,000 units (the45,000 units transferred out of the department as well as the work in process for whichenough materials are in process to complete 4,000 units). The unit materials cost is, therefore, P0.50(P24,500 / 49,000). A similar computation determines the number of units actually and potentiallycompleted with the labor cost of P29,140 and the factory overhead of P28,200. The2,000 equivalent units in process are added to the 45,000 units completed and transferred to obtain atotal equivalent production figure of 47,000 units for both labor and factory overhead (FOH). Whenthe equivalent production figure of 47,000 units is divided into the monthly labor cost of P29,140, aunit cost for labor of P0.62 (P29,140 / 47,000) is computed. The unit cost for factory overhead is P0.60(P28,200 / 47,000). The unit cost added by the department is P1.72, which is the sum of the materials,labor, and overhead unit costs - P0.50, P0.62, and P0.60. This departmental unit cost figure cannot bedetermined by dividing the total departmental cost of P81,840 by a single equivalent production figure,because no such figure exists; units in process are at different stages of completion as to materials,labor and factory overhead.Disposition of Departmental Costs:In the departmental cost report, the section titled "Cost Charged to the Department" shows a totaldepartmental cost of P81,840. The section titled "Cost Accounted for as Follows" show the disposition ofthis cost. The 45,000 units transferred to the next department have a cost of P77,000 (45,000 ×P1.72). The balance of the cost to be accounted for, P4,440 (P81,840 - P77,400), is the cost of work inprocess.
  • 8. The inventory figure must be broken down into its component parts: materials, labor, and factoryoverhead. These individual costs are easily determined. The cost of materials in process is obtained bymultiplying total units in process by the materials unit cost (4,000 × P0.50 = P2,000). The costs oflabor and overhead in process is sufficient to complete only 50 percent or 2,000 of the units in process.Therefore, the cost of labor in process is P1,240 (2,000 × P0.62) and factory overhead in process isP1,200 (2,000 × P0.60).Lost Units:Continuous processing leads to the possibility of waste, seepage, shrinkage, and other factors whichcause loss or spoilage of production units. Management is interested not only in the quantities reportedas completed production, units in process, and lost units but also in a comparison of planned and actualresults. In verifying reported figures, the accountant must reconcile quantities put into process withquantities reported as completed and lost. One method of making such reconciliation is to establish theprocess yield, i.e., the finished production that should result from processing various materials. Thisyield is computed as follows: Percent Yield = (Weight of finished product / weight of materials charged) × 100The yield figure is useful to management for controlling materials consumption and ties in closely with afirms quality control procedures. Various yields are established as normal. Yields below normal aremeasures of inefficiencies and are some times used to compute lost units. Frequently quality controldata are used to compute production costs, since the use of incorrect quantities would result inincorrect unit costs.Units Lost in the First Department:Lost units reduce the number of units over which total cost can be spread, causing an increase in unitcosts. The 1,000 units lost in the Blending Department increase the units costs of materials, labor, andfactory overhead. Had these units not been lost, the equivalent production figure would be 50,000 unitsfor materials and 48,000 for labor and factory overhead. The unit cost for materials would be P0.49instead of P0.50; labor, P0.607 instead of 0.62; and factory overhead, P0.588 instead of P0.60. In thefirst department, the only effect of losing units is an increase in the unit cost of the remaining goodunits. In this situation, the loss is assumed to apply to all good units and to be within normal tolerancelimits.Cost of Production Report - Testing Department (2nd Department):Learning Objective: 1. Prepare a cost of production report of second department in a process costing system. 2. How lost units are treated in process costing system when a cost of production report of subsequent to the first department is prepared? The Starex Corporation Testing Department (2nd Dept.) Cost of Production Report For the Month of January, 2011Quantity Schedule:Units received from the preceding department 45,000 ======Units transferred to next department 40,000Units still in process (1/2 labor and FOH) 3,000Units lost in process 2,000 45,000 ======
  • 9. Cost Charged To the Department: Total unit Cost CostCost from preceding department:Transferred in during the month P77,400 P1.72Cost added by the department:Labor 29,140 0.91Factory Overhead (FOH) 28,200 0.80 ------- -----Total cost added P81,840 P1.71Adjusted for lost units 0.08* ------- ------Total cost to be accounted for P147,510 P3.51 ====== ======Cost Accounted for as Follows:Transferred to next department (40,000 × P3.51) P140,400Work in process - ending inventory:Adjusted cost from preceding department [3,000 ×(P1.72 + P0.08)] P5,400Labor (4,000 × 1/2 × P0.60) 910Factory Overhead (4,000 × 1/2 × P0.60) 800 7,110 ------ ------Total cost accounted for P147,510 ====== Additional Computations Equivalent Production: Labor and factory overhead = 40,000 + 3,000 / 3 = 41,000 units Unit Costs: Labor = P37,310 / 41,000 = P0.91 per unit Factory overhead = P32,800 / 41,000 = 0.80 per unit *Adjustment for lost units: Method No.1: P77,400 / 43,000 = P1.80; P1.80 - P1.72 = P0.08 per unit Method No.2: 2,000 units × P1.72 = P3,440; P3,440 / 43,000 = P0.08 per unitExplanation:The Blending Department (first department) transferred 45,000 units to the Testing Department, wherelabor and factory overhead were added before the units were transferred to the Terminal Department
  • 10. (third or final department). Costs incurred in the testing department resulted inthe additional departmental as well as cumulative unit costs.The cost of production report of the testing department differ from that of the Blending Department(first department) in several respects. Several additional calculations are made, for which space hasbeen provided on the report. The additional information deals with: 1. Cost received from the preceding department. 2. An adjustment of the preceding departments unit cost because of lost units. 3. Cost received from the preceding department to be included in the cost of ending work in process inventory.The quantity schedule of the Testing Department shows that the 45,000 units received fromthe Blending Department (first department) were accounted for as follows: 1. 40,000 units sent to terminal department. 2. 3,000 units still in process. 3. 2,000 units lost.An analysis of the work in process (WIP) indicates that units in process are but one third complete as tolabor and factory overhead. Unit costs, P0.91 for labor and P0.80 for factory overhead, were calculatedas follows:Equivalent production of the testing department is 41,000 units [40,000 + P1/3 × (3,000)], the laborunit cost is P0.91 (P37,310 / 41,000), and the factory overhead unit cost P0.80 (P32,800 / 41,000).There is no materials unit cost, since no materials were added by the department. The department unitcost is P1.71, the sum of the labor unit cost of P0.91 and the factory overhead unit cost of P0.80.The testing department is responsible for the labor and factory overhead used as well as for the cost ofunits received from the Blending Department (first department). This latter cost is inserted as a costcharged to the department under the title "cost from preceding department" which is immediatelyabove the section of the report dealing with cost added bythe department. The cost transferred in wasP77,400, previously shown in the cost report of the Blending Department (first department) as costtransferred out of that department by this journal entry:Work in process - Testing department 77,400 Work in process - Blending department 77,400The work in process account of the testing department is charged with cost received from the precedingdepartment and with P70,110 of departmental labor and factory overhead (FOH), a total cost ofP147,510 to be accounted for by the department.Units Lost in the Department Subsequent to the First:The Blending Department (first department) unit cost was P1.72 when 45,000 units were transferred tothe Testing Department. However, because 2,000 of these 45,000 units were lost during processing inthe Testing Department, the P1.72 unit cost figure no longer applies and must be adjusted. The totalcost of the units transferred remains at P77,400, but 43,000 units must now absorb this total cost,causing an increase of P0.08 in the cost per unit due to the loss of 2,000 units in the testingdepartment.The lost units cost can be computed by one of two methods.Method No.1:Determines a new unit cost work done in the preceding department and subtracts the precedingdepartments old unit costs figure from the adjusted unit cost figure. The difference between the twofigures is the additional cost due to the lost units. P1.80 new adjusted unit cost for work done in thepreceding department is obtained by dividing the remaining good units, 43,000 (45,000 - 2,000), intothe cost transferred in, P77,400. The old unit cost figure of P1.72 is subtracted from the revised unitcost to arrive at the adjustment of P0.08.
  • 11. Method No. 2:Determines the lost units share of total cost and allocates this cost to the remaining good units. totalcost previously absorbed by the units lost is P3,440, which is the result of multiplying the 2,000 lostunits by their unit cost of P1.72. The P3,440 cost must now be absorbed by the remaining good units.The additional cost to be picked up by each remaining good unit is P0.08 (3,440 / 43,000 units).The lost unit cost adjustment must be entered in the cost of production report. TheP0.08 is entered onthe "Adjustment for lost units" line. The departmental unit cost of P1.71 does not have to be adjustedfor units lost. In the testing department, the cost of any work done on lost units has automatically beenabsorbed in the departmental unit cost by using the equivalent production figure of 41,000 instead of43,000. The P1.72 unadjusted units cost for work done in the preceding department, the P1.71departmental unit cost, and the P0.08 adjustment for lost units are totaled in order to obtain the P3.51cumulative unit cost for work done up to the end of operations in the testing department.Timing of Lost Units:Lost units may occur at the beginning, during, or at the end of a manufacturing process. For purposesof practicality and simplicity, it is ordinarily assumed that units lost at the beginning or duringthe process were never put in process. The cost of units lost is spread over the units completed andunits still in process.When units are lost or are identified as lost at the end of a process, the cost of the lost units is chargedto completed units only. No part of the loss is charged to units still in process. Assume that the 2,000units lost by the testing department were the result of spoilage found at final inspection by the qualitycontrol department; their cost would be charged only the 40,000 finished units, as illustrated below: The Starex Corporation Testing Department (2nd Dept.) Cost of Production Report For the Month of January, 2011Quantity Schedule:Units received from the preceding department 45,000 ======Units transferred to next department 40,000Units still in process (1/2 labor and FOH) 3,000Units lost in process 2,000 45,000 ======Cost Charged To the Department: Total unit Cost CostCost from preceding department:Transferred in during the month P77,400 P1.72 -------- -------Cost added by the department:Labor 37,310 0.87Factory Overhead (FOH) 32,800 0.76 ------- -----Total cost added P70,110 P1.63 ------- ------Total cost to be accounted for P147,510 P3.35 ====== ======
  • 12. Cost Accounted for as Follows:Transferred to next department [(40,000 × P140,720P3.51+P0.167)]*Work in process - ending inventory:From preceding department (3,000 × P1.72) P5,160Labor (3,000 × 1/3 × P0.87) 870Factory Overhead (3,000 × 1/2 × P0.76) 760 6,790 ------ ------Total cost accounted for P147,510 ====== Additional Computations: Equivalent Production: Labor and factory overhead = 40,000 + 3,000 / 3 + 2,000 lost units = 41,000 units Unit Costs: Labor = P37,310 / 43,000 = P0.87 per unit Factory overhead = P32,800 / 43,000 = P0.76 per unit Lost unit cost = P3.35 × 2,000 units = P6,700 + 40,000 units P0.1675 per unit to be added to P3.35 to make the transfer cost P3.5175.*40,000 units P3.5175 = P140,700. To avoid a decimal discrepancy, the cost transferred is computed: P147,510 - P6,790 = P140,720.A comparison of the differences between the two cost of production reports for the testing departmentsas to amounts for costs of units transferred and work in process inventory is shown below theproduction report. Not the offsetting increases and decreases.In this illustration, the assumption has been made that the lost units, identified at the end of theprocess, were complete as to all costs. In sum companies, members of the quality control or inspectiondepartments make production checks prior to the end of the process. Such a procedure uncovers lostunits that are not complete when the loss is incurred or the spoilage discovered and yet the loss maypertain only to units completed and not to units still in process. In such a case the lost units should beadjusted for their equivalent stage of completion. For example, 2,000 units lost at the 90% stage ofconversion would appear as 1,800 equivalent units with regard to labor and factory overhead costs.Normal Vs Abnormal Loss of units:Units are lost through evaporation, shrinkage, substandard yields, spoiled work, poor work man ship, orinefficient equipment. In many instances the nature of operations makes certain losses normal orunavoidable, because they are considered with in normal tolerance limits for human and machineerrors. The cost of these normally lost units does not appear as a separate item of cost but is spreadover the remaining good units.A different situation is created by abnormal or avoidable spoilage or losses that are not expected toarise under normal, efficient operating conditions. The cost of such abnormal spoilage or losses ischarged either to factory overhead as shown below, thereby appearing as an additional unfavorableable factory overhead variance, or directly to a current period expense account and reported as aseparate item in the cost of goods sold statement.Factory Overhead Control 6,700 Work in process - Testing Department 6,700 (lost units)
  • 13. The cost of production report would show the abnormal spoilage or loss as follows:Transferred to next department (40,000 units × P3.35) ..............P134,020*Transferred to factory overhead [40,000 units × P0.1675) or (2,000 lost units × P3.35)].......................................................6,700*40,000 units × P3.35 = P134,000. To avoid decimal discrepancy, the cost transferred is computed:P147,510 - P6,790 ending inventory - P6,700 = P134,020If the lost units were only partially complete, equivalent production calculations should consider theirstage of completion when lost or spoiled, and the costing of the abnormal loss should be weightedaccordingly. If one part of the loss is normal and another abnormal, each portion must be treated inaccordance with the above discussion. The critical factor in distinguishing between normal andabnormal spoilage or loss is the degree of controllability. Normal or unavoidable spoilage or loss isproduced by the process under efficient operating conditions, referred to as uncontrollable. Abnormal oravoidable spoilage or loss is considered unnecessary, because the conditions resulting in the loss arecontrollable. For this reason, within the limits set by the state of the art of production, the difference isa short-run condition; in the long run, management should adjust and control all factors of productionand eliminate all abnormal conditions.The cost of production report at the beginning of this page shows a total cost of P147,510 to beaccounted for by the Testing department. The department completed and transferred 40,000 units tothe Terminal Department (third or final department) at a cost of P140,000 (40,000 × P3.51). Theremaining cost is assigned to the work in process inventory. This balance is broken down by the variouscosts in process. When computing the cost of the ending work in process inventory of any departmentsubsequent to the first, costs received from the preceding departments must be included.The 3,000 units still in process, completed by the Blending Department (first department) at a unit costof P1.72, were later adjusted by P0.08 (to P1.80) because of the loss of some of the units transferred.Therefore, the Blending Departments (first department) cost of the 3,000 units still in process isP5,400 figure is not broken down further , since such information is not pertinent to the TestingDepartments operations. However, the amount is listed separately in the cost of production report,because it is part of the Testing Departments ending work in process inventory.Materials (if any), labor, and factory overhead (FOH) added by a department are costed separately inorder to arrive at total work in process (WIP). In the testing department, no materials were added tothe units received; thus, the ending inventory shows no materials in the process. However, labor andfactory overhead costs were incurred. The work in process analysis stated that labor and factoryoverhead used on the units in process were sufficient to complete 1,000 units. The cost of labor inprocess is P910 (1,000 × P0.91) and factory overhead is process is P800 (1,000 × P0.80). The total costof the 3,000 units in process is P7,110 (P5,400 + P910 + P800). This cost, added to that transferred tothe Terminal Department (third or final department), P140,400, accounts for the total cost of P147,510charged to the Testing Department.Cost of Production Report - Terminal Department (3rd - Final Department):The cost of production report of 3rd and final department is illustrated below: The Starex Corporation Terminal Department (3rd Dept.) Cost of Production Report For the Month of January, 2011Quantity Schedule:Units received from the preceding department 40,000 ======Units transferred to finished goods storeroom 35,000Units still in process (1/4 labor and FOH) 4,000Units lost in process 1,000 40,000 ======Cost Charged To the Department: Total unit Cost CostCost from preceding department:Transferred in during the month P140,400 P3.51
  • 14. Cost added by the department:Labor 32,400 0.90Factory Overhead (FOH) 19,800 0.55 ------- -----Total cost added P52,500 P1.45Adjusted for lost units 0.09* ------- ------Total cost to be accounted for P192,600 P5.05 ====== ======Cost Accounted for as Follows:Transferred to finished goods storeroom (35,000 × P176,750P5.05)Work in process - ending inventory:Adjusted cost from preceding department [4,000 ×(P3.51 + P0.09)] P14,400Labor (4,000 × 1/4 × P0.90) 900Factory Overhead (4,000 × 1/4 × P0.55) 550 15,850 ------ ------Total cost accounted for P192,600 ====== Additional Computations: Equivalent Production: Labor and factory overhead = 35,000 + 4,000 / 4 = 36,000 units Unit Costs: Labor = P32,400 / 36,000 = P0.90 per unit Factory overhead = P19,800 / 36,000 = 0.55 per unit *Adjustment for lost units: Method No.1: P140,400 / 39,000 = P3.60; P3.60 - P3.51 = P0.09 per unit Method No.2: 1,000 units × P3.51 = P3,510; P3,510 / 39,000 = P0.09 per unitExplanation:Total and unit cost figures were derived by using procedures discussed for the cost of production reportof the Testing Department. The work completed is transferred to thefinished goods storeroom; thus,the title "Transferred to finished goods storeroom" is used in place of the title "Transferred tonext department." Cost charged to the Terminal Departmentcome from the payroll distribution and thedepartments expense analysis sheet. The journal entry transferring costs from theTesting Department follows: Work in process - Terminal Department 140,000 Work in process - Testing Department 140,000The entry to transfer finished units to the finished goods storeroom is presented below: Finished Goods 176,750 Work in process - Terminal Department 176,750Combined Cost of Production Report (CPR) - Process Costing:The three cost of production reports for the Starex Corpora have been discussed and computedseparately.
  • 15. These reports would most likely be consolidated in a single report summarizing manufacturingoperations of the firm for a specific period. Such a report, as illustrated below, should be reviewed inorder to observe the interrelationship of the various department reports. The Starex Corporation Cost of Production Report All Producing Departments For the Month of January, 2011Quantity Schedule: Blending Testing Terminal 1stDepartment 2ndDepartment 3rdDepartmentUnits started in process 50,000 ======Units received from the 45,000 40,000preceding department ====== ======Units transferred to next department 45,000 40,000Units transferred to finished goods 35,000storeroomUnits still in process 4,000 3,000 4,000Units lost in process 1,000 2,000 1,000 ------- ------- ------- 50,000 45,000 40,000 ====== ====== ======Cost Charged To the Department: Total unit Total unit Total cost unit Cost cost cost Cost CostCost from preceding department:Transferred in during the month P77,400 P1.72 P140,400 P3.51 -------- ----- -------- -----Cost added by the department:Materials P24,500 P.50Labor 29,140 .62 P37,310 P.91 P32,400 P.90Factory Overhead (FOH) 28,200 .60 32,800 .80 19,800 .55 ------- ---- ----- ---- ------- ----Total cost added P81,840 P1.72 P70,110 P1.71 P52,200 P1.45Adjusted for lost units P.08 P.09 ------- ---- ------- ----- -------- ----Total cost to be accounted for P81,840 P1.72 P147,510 P3.51 P192,600 P5.05 ====== === ====== === ====== ===Cost Accounted for as Follows:Transferred to next department P77,400 P140,400Transferred to finished goods P176,750storeroom (35,000 × P5.05)Work in process - ending inventory:Adjusted cost frompreceding department [4,000 × (P3.51 P5,400 P14,400+ P0.09)]Materials P2,000Labor (4,000 × 1/4 × P0.90) 1,240 910 900Factory Overhead (4,000 × 1/4 × 1,200 800 550P0.55) ------ ------ ------ 4,440 7,110 15,850 -------- ------ --------Total cost accounted for P81,840 P147,510 P192,600 ====== ====== ======