Ann Watkins owns and operates a company that mass produces wood desks used in classrooms throughout the world. Ann’s company, Desk Products, Inc., maintains an advantage over its competitors by producing one desk in large quantities—4,000 to 8,000 desks per month—using a universally accepted design. This enables the company to buy materials in bulk, often leading to volume price discounts from suppliers. Because the exact same desk is produced for all customers, Desk Products purchases precut wood materials from suppliers. As a result, Desk Products can limit the production process to two processing departments—Assembly and Finishing.
These three inventory accounts are used to record product cost information for both process costing and job costing systems. There are five steps in the process costing method. The weighted-average method combines units and costs across two periods in computing equivalent units. The FIFO method computes equivalent units based only on production activity in the current period. The objectives, concepts, and journal entries are the same under the weighted-average and FIFO methods; the computations of equivalent units differ.
Cost of Goods Sold
Job costing, in contrast, tracks all direct and indirect costs for each item or project. This is more commonly used by companies that offer custom products or services and price each one individually. For example, a construction company that makes custom homes needs to know exactly how much it costs to build each house so it can charge an appropriate amount and track whether each home-building project is profitable. Homogeneous items are products that cannot be distinguished from one another — for example, a bin of screws of the same size and type. These similar products all generally flow through a number of stages during the production process.
Instead, cost of finished goods may be immediately debited to the cost of goods sold account. Factory overhead is applied to processes by relating overhead cost to another variable such as direct labor hours or machine hours used. In many situations, a single allocation basis such as direct labor hours fails to provide useful allocations. As a result, management may use different rates for different production departments.
Process cost systems have a Work in Process Inventory account for each department or process. Many businesses produce large quantities of a single product or similar products. Pepsi-Cola makes soft drinks, Exxon Mobil produces oil, and Kellogg Company produces breakfast cereals on a continuous basis over long periods. For these kinds of products, companies do not have separate jobs. Products with a cost of $9,100 are completed and transferred from the Packaging department to the finished goods warehouse.
- Work in process begins with the first stage of production , continues with the second stage , and ends with the third stage .
- Relevant CostsRelevant cost is a management accounting term that describes avoidable costs incurred when making specific business decisions.
- It then totals the costs from each stage over an accounting period, dividing the overall process cost by the number of finished bottles to obtain a cost per bottle.
- Each production department has its own work-in-process inventory account when using process costing.
In addition, the costs of inventory under each process are also identified at this change. Match each costing system characteristic to job order costing, process costing, or both. Both job and process cost systems use predetermined overhead rates to apply overhead. The second entry records these indirect labor costs. In the case of a not-for-profit company, the same process could be used to determine the average costs incurred by a department that performs interviews. The department’s costs would be allocated based on the number of cases processed.
Similarities between Process Costing and Job Order Costing
This calculated number of units used is called equivalent units. The total costs include materials, labor, and overhead. Step 3 is to compute the cost per equivalent unit. Under the weighted-average method, the computation of EUP does not separate the units in beginning inventory from those started this period, as shown above. https://business-accounting.net/ Similarly, the weighted average method combines the costs of beginning work in process inventory with the costs incurred in the current period. This total cost is then divided by the equivalent units of production , to compute the average cost per equivalent unit. For direct materials, the cost averages $3.00 per EUP.
Accountants record production in separate accounts for materials inventory, labor, and overhead. Then, they transfer the costs to a Work in Process Inventory account. The first entry records overhead costs other than indirect materials and indirect labor for April. These overhead items include the costs of insuring production assets, renting the factory building, using factory utilities, and depreciating factory equipment not directly related to a specific process. Process costing is an important accounting method for manufacturers that make large volumes of identical items, such as companies in the food processing, oil and chemicals industries.
Choosing Between Process Costing and Job Order Costing
Any large-scale manufacturer that produces large quantities of identical goods will use a process costing system. The classic example of a process costing environment is a petroleum refinery, where it is impossible to track the cost of a specific unit of oil as it moves through the refinery. Equivalent units of production are the number of units that could have been manufactured from start to finish during an accounting period. Cost of manufacturing such as (direct materials cost + direct wages + direct overhead) per piece. All units completed and transferred out during March are sold by March 31. Products with a cost of $35,000 are completed and transferred from the Packaging department to the finished goods warehouse. Direct labor costs totaling $3,500 were incurred in the Molding department, to be paid the next month.
If the function has work‐in‐process inventory at the beginning of the period, the number of equivalent units must be calculated. Equivalent units represent the number of units that could have been 100% completed during the period. For example, if two employees each work 20 hours a week, this is the equivalent of one full‐time employee . On a production line, if one product is 40% complete and a second one is 60% complete, this is the equivalent of 100% complete for one unit . This number is needed to spread the costs of the function over all the units worked on during the period.
It accumulates cost from each process or department and allocates them to the individual products produced. Instead, the cost of goods manufactured is in a process costing system, each process will have a work in process inventory account. produced using process costing. The difference between process costing and job order costing relates to how the costs are assigned to the products.
It assigns average costs to each unit, and is the opposite extreme of Job costing which attempts to measure individual costs of production of each unit. It is a method of assigning costs to units of production in companies producing large quantities of homogeneous products..
If raw materials are not ordered or received until needed, a Raw Materials Inventory account might be unnecessary. Instead, materials cost is immediately debited to the goods in process inventory account. Similarly, a finished goods inventory account may not be needed.
A process costing system measures unit costs at the end of a period by combining the costs per equivalent unit from each separate department. In process costing, the cost object is the process. In a process operation, each process is identified as a separate production department. With the exception of the first process or department, each receives the output from the prior department as a partially processed product. Depending on the nature of the process, each process applies direct labor, overhead, and additional direct materials to move the product toward completion. Only the final process or department in the series produces finished goods ready for sale to customers. For certain types of manufacturers, process costing is the most practical and efficient accounting method for determining product costs.
3 Determining Equivalent Units
While the FIFO method is generally considered to be more precise than the weighted-average method, it requires more calculations. Often, the differences between the two methods are small.
- Similarly, the weighted average method combines the costs of beginning work in process inventory with the costs incurred in the current period.
- Each group has a vice president responsible for several departments.
- Alternatively, process costing that is based on standard costs is required for costing systems that usestandard costs.
- Various activities at Ming Corporation, a manufacturing company, are listed below.
- In a process cost system, costs are maintained by each department, and the method for determining the cost per individual unit is different than in a job order costing system.
- Companies that use process costing produce a single product, either on a continuous basis or for long periods.