Chapter 5 Process costing and operation costing Copyright ª 2006 McGraw­Hill Australia Pty Ltd 5­ 1 Process costing • Job costing and process costing are two extremes of the continuum of conventional product costing systems • Job costing systems accumulate the costs of each job • Process costing systems accumulate the cost of each process, then average these costs across all units produced • Many businesses use a combination of job and process costing; this is called hybrid costing Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 5-2 Process costing • Used by businesses that mass-produce one product or a small range of almost identical products – Involves a number of processes that are performed repetitively – Used by oil refineries, food processors, manufactures of tobacco, chemicals and paper – Also used by producers of repetitive services—routine processing of cheques in banks and delivery of standard letters in Australia Post continued Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 5-3 Process costing • Two main steps – Estimate the cost of the production process – Calculate the average cost per unit by dividing the cost of the process by the number of units produced • Process costing can occur where there is no opening or closing WIP inventory (see Chapter 4) • More complex process costing takes place where there is WIP inventory – Need to calculate equivalent units to apportion cost between production and inventory Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 5-4 Process costing with work in process inventories • WIP inventory – Not all products are complete at the beginning or end of the period (usually a month) • Production costs will be calculated after taking into account – Units started in the previous period and completed in current period (beginning WIP) – Units started and completed in the period – Units that are incomplete at the end of the period (ending WIP) continued Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 5-5 Process costing with work in process inventories • Partially completed goods at the beginning or end of the period change the way we allocate production costs • Equivalent units – The production inputs that have been applied to the physical units during production – Physical units are all units currently in production whether complete or incomplete – WIP inventory needs to be converted to equivalent units to provide the basis for calculating product cost continued Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 5-6 Process costing with work in process inventories • Materials are input into production at various stages • We usually assume that labour and overhead are used uniformly throughout the production process – Use the term ‘conversion costs’ • Units in ending WIP are generally at different stages of completion with respect to material and labour Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 5-7 Calculation of equivalent units • If WIP is 50% complete for 10 000 litres on hand at the end of the month, it is – 100% complete for direct materials, which are added at the start of the process 10 000 equivalent units of material – 50% complete for conversion costs, assuming that conversion costs occur uniformly across the production process 5000 equivalent units of conversion cost • Equivalent units are used to calculated unit costs when there is WIP Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 5-8 The effects of beginning and ending work in process inventories • Four steps in process costing 1.Analyse the physical flow of units 2. Calculate the equivalent units 3. Calculate the unit costs 4.Analyse the total costs • Products are costed using one of two assumptions about product flow – Weighted average method – First in, first out (FIFO) method Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 5-9 Process costing using the weighted average method • Step one: analyse the physical flow of units Physical units in beginning WIP Physical units started Physical units – completed and transferred out = Physical units in ending WIP continued Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 5-10 Process costing using the weighted average method • Step two: calculate the equivalent units – The equivalent units in beginning WIP are not identified separately; this is a key feature of the weighted average cost method Equivalent units completed and transferred out + Equivalent units in ending WIP Total equivalent = units continued Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 5-11 Process costing using the weighted average method • Step three: calculate the unit costs – The cost per equivalent unit for direct material is the total direct material (conversion costs) costs divided by the total equivalent units – Under the weighted average method, the cost per equivalent unit is based on the total costs incurred, including the cost of beginning WIP • Step four: analyse the total costs – Cost of units transferred to the next production process, or to finished goods – Cost of production remaining in WIP Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 5-12