Process Costing with Standard Costs and Hybrid Costing System

        Companies may prefer to use standard rather than actual costs for inventory valuation purposes. Actual costing requires that a new production cost be computed each period. Once a production process is established, however, the “new” costs are often not materially different from the “old” costs, so standards for each cost component can be developed and used as benchmarks to simplify the costing process and eliminate periodic cost recomputa- tions. Standards should be reviewed, and possibly revised, at a minimum of once per year to keep quantities and amounts current.

     EUP calculations for standard process costing are identical to those of FIFO process costing. Unlike the WA method, the emphasis of both standard costing and FIFO are on the measurement and control of current production activities and current period costs. The WA method commingles prior and current period units and costs, which reduces the emphasis on current effort that standard costing is intended to represent and measure.

        Use of standard quantities and costs allows material, labor, and overhead variances to be computed during the period. To illustrate the differences between using actual and standard process costing, the Flame 'N Scent example is continued. The company’s April production and per-unit standard cost information is given in Exhibit 6–10. Beginning inventory cost data must be restated from the original to reflect standard costs and to demonstrate the effect of consistent use of standard costs over successive periods. Beginning WIP Inventory consisted of 10,000 units that were fully complete as to material and 40 percent complete as to conversion. 

Hybrid Costing Systems

        Many companies now customize what were previously mass-produced items. In such cir- cumstances, neither a job order nor process costing technique is perfectly suited to attach costs to output. Thus, companies may design a hybrid costing system that is appropriate for their particular processing situation. A hybrid costing system combines characteristics of both job order and process costing systems. A hybrid system would be used, for example, in a manufacturing environment in which various product lines have different direct materials but similar processing techniques.

       To illustrate the need for hybrid systems, assume that you order an automobile with the following options: heated leather seats, a Bose stereo system, an iPod plug-in, and pearl- ized paint. Costs of these options must be traced specifically to your car, but the assembly processes for all cars produced by the plant are similar. A hybrid system allows the job order costing feature of tracing direct material to specific jobs to be combined with the process costing feature of averaging labor and overhead costs over all homogeneous production to derive the total cost of your automobile. It would not be feasible to use a job order costing system to trace labor or overhead cost to your car individually, and it would be improper to average the costs of your options over all the cars produced during the period.

        A hybrid costing system may be appropriate for companies producing items such as furniture, clothing, and special-order computers. In each instance, numerous kinds of raw materials could be used to create similar output. A table may be made from oak, teak, or mahogany; a blouse may be made from silk, cotton, or polyester; and computers may have different size hard drives and other internal components. The material cost for a batch run would be traced separately, but the production process of the batch is repetitive.

       Hybrid costing systems provide a more accurate accounting picture of the actual manu- facturing activities in certain companies. Job order costing and process costing are two ends of a continuum and, as is typically the case for any continuum, neither end is necessarily the norm. As the use of flexible manufacturing processes increases, so will the use of hybrid costing systems.

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Process Costing - Weighted Average and First-In, First-Out, Process Costing Methods

Introduction

        Companies choose product costing systems based, in part, on the nature of the products manufactured and customers served. Companies manufacturing products or performing services that conform to distinct customer specifications and are made in limited quantities use job order costing. However, some companies manufacture products in a continuous flow process or in batches of output containing units that are all basically identical. For example, Kellogg’s produces Rice Krispies in batches, and all “rice puffs” in each batch are the same. For Kellogg’s Pop-Tarts, the external pastry is the same for all batches, but the flavoring inside may differ or some external pastries may be frosted while others are not. Kellogg’s uses a process costing rather than a job order costing system to accumulate and assign costs to units of production. Manufacturers of food products, bricks, gasoline, candles, and paper, among many other types of firms, commonly use the process costing method.

          Both job order and process costing systems accumulate costs by cost component in each production department. However, the two systems assign costs to departmental output differently. In a job order system, costs are assigned to specific jobs and, if possible, to the units contained within each job. Process costing uses an averaging technique to assign costs to units produced during the period. In both systems, unit costs are transferred between departments as goods flow from one department to the next so that a total production cost can be accumulated.

          This chapter first illustrates the weighted average (WA) and first-in, first-out (FIFO) methods of calculating unit cost in a process costing system. These two methods differ only in the treatment of beginning Work in Process (WIP) Inventory units and costs. After unit cost has been determined, a total cost is assigned to (1) units transferred out of a depart- ment and (2) that department’s ending WIP Inventory.

       The chapter also describes standard cost process costing and hybrid systems. Standard costing systems are an often-used simplification of the FIFO process costing system. Hybrid systems are used in some companies that customize products that would commonly be accounted for using a process costing system. Appendix 1 provides alternative computa- tions for equivalent unit of product calculations. Appendix 2 briefly introduces the issue of accounting for spoilage in a process costing system.

Introduction to Process Costing

        Assigning costs to product units requires the use of an averaging process. In the easiest situation, a product’s actual unit cost is found by dividing a period’s departmental production costs by that period’s departmental production quantityas expressed by the following formula: Unit Cost = Production Costs/Production Quantity.

Production Costs: The Numerator

          The formula numerator is obtained by accumulating departmental costs incurred in a single period. Because most companies make more than one type of product, costs must be accumu- lated by product within each department. The accumulation can occur by using either sepa- rate WIP Inventory accounts for each product or a single WIP Inventory control account that is supported by detailed subsidiary ledgers containing specific product information.

         To illustrate, Flame 'N Scent manufactures scented candles for two different groups of customers. The company periodically contracts to make custom candles for client promo- tional activities in addition to its daily operations of making votive as well as 7- and 12-inch taper candles. For specialty candle production, Flame 'N Scent uses job order costing to accumulate direct material and direct labor costs associated with each distinctive order and assigns those costs directly to the individual customer’s job; overhead is allocated using a predetermined overhead rate. After each job is completed, the total material, labor, and allocated overhead costs are known and job cost can be determined. In contrast, for its basic product lines, Flame 'N Scent uses a process costing system to accumulate periodic costs for each department and each product type. Because the company manufactures several types of candles each period, the costs assignable to each product type must be individually desig- nated and attached to the specific production runs. Production run costs are then assigned to the units processed during the period.

Production Quantity: The Denominator

        The denominator in the unit cost formula represents total departmental production for the period. If all units started during a period were 100 percent complete at the end of the period, units could simply be counted to obtain the denominator. In most production processes, however, partially completed units comprise WIP Inventory at the end of one period and become the partially completed beginning WIP Inventory of the next period. Process costing assigns costs to both fully and partially completed units by mathematically converting partially completed units to equivalent whole units. 

        Units in beginning WIP Inventory were started last period but will be completed dur-ing the current period. This two-period production sequence means that some costs for the units in beginning inventory were incurred last period and additional costs for those units will be incurred in the current period. Additionally, the partially completed units in ending WIP Inventory were started in the current period but will not be completed until next period. Therefore, some of the current period costs should attach to the units in end- ing WIP Inventory, and more costs will be incurred and should attach next period. This production sequence is illustrated in Exhibit 6–2 (p. 214).

      Ending WIP Inventory units must be physically inspected to determine the percentages of completion for direct material, direct labor, and overhead for the current period. One hundred percent minus these percentages represents the proportion of work to be completed in a future period. Inspection at the end of last period provided informa- tion on the proportion of work that needed to be completed this period on beginning WIP Inventory.

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