Chapter 5

Process costing and

operation costing

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 Outline
Process costing
Process costing with work in process
inventories
The effects of beginning and ending
work in process inventories
Process costing measurements
Process costing and spoilage
Hybrid costing systems
Other issues in process costing
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 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 average the
accumulated costs across all units
produced
Hybrid costing is a combination of job
(cont.)
and process costing
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 Process costing (cont.)
Two main steps
Estimate the cost of the production
process
Calculate the average cost per unit
Process costing can occur where
there is no opening or closing WIP
inventory (see Chapter 4)
More complex process costing takes
account of WIP inventory
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Process costing with work in
process inventories
WIP inventory
Production costs will be calculated after
taking into account
Units started in the previous period
(beginning WIP) and completed in the
current period
Units started and completed during the
period
Units that are incomplete at the end of the
(cont.)
period (ending WIP)
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 Process costing with work in
process inventories (cont.)
Partially completed WIP units need to
be converted to equivalent units
Equivalent units
The amount of production inputs that
have been applied to the physical units
in production
Conversion of WIP inventory into
equivalent units provides the basis for
calculating product cost (cont.)

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 Process costing with work in
process inventories (cont.)
Direct materials are input into production
at various stages
Assume that labour and overhead are
used uniformly throughout the
production process
Units in ending WIP are generally at
different stages of completion with
respect to material and conversion cost
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 Equivalent units
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
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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
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 Weighted average method, Spritz
Mixing Department
Step one: analyse the physical flow of units
Step two: calculate the equivalent units

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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 5-10
 Weighted average method, Spritz
Mixing Department (cont.)
Step three: calculate the unit costs

(cont.)

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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 5-11
 Weighted average method, Spritz
Mixing Department (cont.)
Step four: analyse the total costs

(cont.)
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 Weighted average method, Spritz
Mixing Department (cont.)
Departmental Production Report

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 FIFO method, Spritz Mixing
Department
Step one: analyse the physical flow of units
Step two: calculate the equivalent units

(cont.)

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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 5-14
 FIFO method, Spritz Mixing
Department (cont.)
Step three: calculate the unit costs

(cont.)

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 FIFO method, Spritz Mixing
Department (cont.)
Step four: analyse the total costs

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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 5-16
 FIFO method, Spritz Mixing
Department (cont.)
Departmental Production Report

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 Comparison of weighted
average and FIFO methods
Key difference is the treatment of the
beginning WIP
Under the weighted average method the
cost of beginning WIP and equivalent
units of work done on WIP are included
in the calculation of the average cost per
equivalent unit
Under FIFO the cost per equivalent unit
is based only on costs incurred in the
current month
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 Process costing and spoilage
Spoilage cost
The cost of defective products and
wasted resources that cannot be
recovered by rework or recycling
Three forms of output when spoilage
occurs
Units completed and transferred out
Spoiled units
Unfinished units remaining in WIP
(cont.)

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 Process costing and spoilage
(cont.)
Spoiled units are costed using cost per
equivalent unit along with the other two
outputs
Spoilage is accounted for depending on
whether it is normal or abnormal
Normal spoilage: inherent in the production
process and occurs even under efficient
operating conditions
Abnormal spoilage: should not occur under
efficient operating conditions
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 Process costing and spoilage
Spritz Mixing Department
Step One: Analyse the physical flow of unit including
spoiled units
Step Two: Calculate the equivalent units, including
spoiled units

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 Process costing and spoilage (cont.)
Step Three: Calculate units costs, including spoiled units

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 Process costing and spoilage (cont.)
Step Four: Analyse the total costs, including spoilage

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 Hybrid costing systems
Some businesses have repetitive
production processes but produce a
narrow range of products that differ in
some significant aspects
Batch manufacturing processes
individual product lines
produced in large batches
require specific combinations of direct
materials and a specific sequence of
production processes
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 Continuum of costing systems

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 Operation costing is a hybrid
costing system
Used in a batch manufacturing environment
Contains features of both job costing and
process costing
Direct material assigned to individual batches,
as in job costing
Conversion costs assigned to departments or
processes using a predetermined application
rate, as in process costing

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 Operation costing

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Other issues in process costing
A predetermined overhead rate may
be used in process costing
A predetermined conversion cost rate
may be used in operation costing
where costs and cost drivers are
unstable
The percentage of completion is
difficult to determine and is often only
a rough estimate (cont.)

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 Other issues in process
costing (cont.)
Standard costs are more likely to be
used than actual costs
Process costing and operation
costing are consistent with concepts
of responsibility accounting
In service firms some routine,
repetitive or similar services can be
costed using process or operation
costing
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 Summary
Process costing suits businesses that mass-
produce a small range of products
Weighted average or FIFO methods may be
used to assign costs to products and
inventory
The presence of WIP inventory requires
calculation of equivalent units
Simple forms of process costing do not entail
the costing of WIP inventory
Operation costing is a hybrid of job and
process costing
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