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Process Costing and Activity Based Costing

LO1 Describe the key features of a process costing system
  • Process costing is used by companies that produce homogeneous (similar) goods or services in a series of standardized processes.
  • The flow of costs in process costing is very similar to that in job order costing. Manufacturing costs are recorded in the Raw Materials, Work in Process, and Finished Goods Inventory accounts until the product is sold, at which point they become part of the cost of Goods Sold.
  • Process costing systems maintain a separate Work in Process account for each major production process. Actual direct materials and applied conversion costs are recorded in these work in process accounts. As the product flows through the various production processes, the total cost is transferred from one work in process account to the next.
LO2 Prepare journal entries to record product costs using process costing.
  • The three major categories of product costs are direct materials, direct labor, and manufacturing overhead. This chapter combined direct labor and manufacturing overhead into the single account Conversion Cost.
  • Product costs are recorded in one of three inventory accounts: Raw Materials Inventory, Work in Process Inventory, or Finished Goods Inventory. Each major process has a separate Work in Process Inventory account, and the costs are transferred to the appropriate account as the product is manufactured.
  • Actual and applied conversion costs can be recorded in a control account, much the same way that actual applied manufacturing overhead costs were dealt with in Chapter 19. Any under- or overapplied balance is closed directly to Cost of Goods Sold at the end of the accounting period.
LO3 Reconcile the number of physical units that were worked on during the period.
  • The first step in process costing is to reconcile the number of physical units.
  • The number of units in beginning inventory plus the number of units started must equal the number of units completed plus the number of units in ending inventory.
  • The number of units started and completed equals the number of units completed minus the number of units in beginning inventory or the number of units started minus the number of units in ending inventory.
LO4 Calculate equivalent units using the FIFO method.
  • The second step is to translate the physical units into equivalent units.
  • An equivalent unit is an adjustment that is made to the number of physical units to reflect the amount of work or effort that went into full and partially completed units during the period.
LO5 Prepare a process costing production report.
  • The production report summarizes the costs and units that flow into and out of the production process during a given period. It will summarize the following steps:
  • Step 1: Reconcile the number of physical units.
  • Step 2: Translate the number of physical units into the number of equivalent units.
  • Step 3: Calculate cost per equivalent units (Step 2 / Step 1).
  • Step 4: Reconcile the total cost of work in process by multiplying the number of equivalent units by the cost per equivalent unit.
  • Step 5: Prepare a production report by summarizing Steps 1–4.
LO6 Calculate the cost of products using activity based costing.
  • Activity based costing is a method of assigning indirect costs to products or services based on their underlying activity requirements.
  • Unlike traditional costing systems, which rely exclusively on volume-based cost drivers, ABC also incorporates nonvolumebased cost drivers, such as the number of set-ups, inspections, or design changes.
  • Step 1: Identify the firm's key activities and classify them as either unit-level, batch-level, product-level, customer-level, or facility-level activities.
  • Step 2: Form activity cost pools and assign the company's indirect costs to those cost pools.
  • Step 3: Select an activity driver for each activity cost pool and calculate the activity rate for each pool by dividing the total cost by the total value of the activity driver.
  • Step 4: Assign the indirect cost to individual products or services by multiplying the activity rates by their activity requirements.

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