BUS105 Study Guide

Unit 3: Process Costing

3a. Explain the differences between the job costing and process costing methods

  • Why is there a difference in costing methods between manufacturing and service companies?
  • What types of services or goods would lend themselves to job order costing?
  • Why is it not a good idea to use job order costing for all manufacturers? 

As opposed to job costing, where costs are assigned to unique jobs, process costing assigns costs to individual processes. This is used when many similar goods are produced in batches. Many manufacturers who produce a large quantity of the same product use process costing. 

In process costing, costs are assigned to products at the different stages of production. Thus, revenues and costs are gathered for batches of identical goods. From this, costs per unit can be calculated. As opposed to job costing, in process costing, costs are assigned to departments, and unit cost information comes from the departmental production cost report. There usually will be several different work-in-process (WIP) inventory accounts in use. 

Review Figure 4.1 and Table 4.1 in Comparison of Job Costing with Process Costing.

3b. Use a process costing system to assign direct material, direct labor, and manufacturing overhead costs to production departments

  • How are costs assigned to different production departments?
  • What happens to the costs of goods as the goods are moved from one production department to another?
  • What is the final account where all costs of goods are accumulated, prior to their being sold?

In process costing, costs are assigned to products at different stages of production. Different departments in the production process incur costs and these costs are assigned to the products as they pass through the various production stages. If direct materials are added in a particular production department, those costs will be added to a WIP account for that department. The same is true with direct labor and manufacturing overhead. 

When goods are finished being worked on in a particular department, they are transferred out of the WIP-inventory account from that department into the WIP account of the next department in the production process. These costs are referred to as transferred-in costs. This is repeated until the goods are finished when they are transferred to the finished goods inventory account. 

Review Product Cost Flows in a Process Costing System.

3c. Define equivalent units and use them to assign costs to products using the weighted average method

  • How are partially finished goods accounted for in inventory on the balance sheet?
  • What are the four steps used in assigning costs to WIP inventory and units transferred out?
  • What method is used to determine costs for the current period?

In order for companies to report an accurate amount of inventory on their balance sheet, units of production that are still in process need to be converted to equivalent units. This is done by multiplying the number of units in process by the percentage of completion. Since direct materials, direct labor, and manufacturing overhead enter into the production at varying stages (usually, direct material is added at the beginning and direct labor and overhead is added over time), equivalent units have to be calculated individually for each of these types of costs. 

When calculating the costs remaining in a work in process account and those that have already been transferred out, we use the weighted average method. This method adds costs in beginning inventory to current costs to determine total costs for the period. This is then used to determine the costs associated with the units transferred out to finished goods inventory and those left in work in process. 

Review Determining Equivalent Units and The Weighted Average Method.

3d. Prepare a production cost report for a processing department

  • In a process costing system, how is cost information periodically summarized?
  • What can management learn from a production cost report?
  • What effect will fixed costs have on per-unit cost data in a production cost report? 

For every reporting period, a production cost report is prepared. This report summarizes production and cost activity within a department. It uses the four steps performed to assign costs to units transferred out and units in ending work-in-process (WIP) inventory.

The production cost report is a very valuable resource for managers. They can use it to identify higher than normal costs and to see which departments in the production process may be spending too much or may be inefficient. However, care must be taken as some of the costs included in this report may be fixed and will not change with changes in production levels. 

Review Preparing a Production Cost Report.

Unit 3 Vocabulary

This vocabulary list includes terms you will need to know to successfully complete the final exam. 

  • departmental production cost report
  • equivalent units
  • finished goods inventory
  • process costing
  • production cost report
  • transferred-in costs
  • weighted average method
  • work-in-process (WIP) inventory