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.
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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