ACCA F2 Management Accounting - 2010 - Study text - Emile Woolf Publishing
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Chapter 10: Process costing
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The balance on this account should be taken to the costing income statement at the
end of the period, and will add to the reported profit.
3.3 Accounting for abnormal gain: where loss has a scrap value
When loss has a scrap value, the value of abnormal gain is actually less than the
amount shown in the WIP account. This is because actual revenue from scrap will
be less than the expected revenue, due to the fact that actual loss is less than the
expected loss.
Accounting for the scrap value of abnormal gain is similar to accounting for the
scrap value of abnormal loss.
In the process account (WIP), abnormal gain is valued at the cost per expected
unit of output.
The scrap value of normal loss is normal loss units × scrap value per unit.
The scrap value of abnormal gain is the scrap revenue that has been ‘lost’
because actual loss is less than expected loss. This is abnormal gain units
× scrap
value per unit.
The scrap value of abnormal gain is recorded as a debit entry in the abnormal
gain account (in a similar way to recoding the scrap value of abnormal loss as a
credit entry in the abnormal loss account).
The scrap value of the abnormal gain is set off against the value of the abnormal
gain in the abnormal gain account, not the process account.
The balance on the abnormal gain account is the net value of abnormal gain (=
value of abnormal gain minus the scrap value not earned). This balance is
transferred as a net benefit to the cost accounting income statement at the end of
the accounting period.
Example
The following information relates to a production process:
Input quantities of materials: 2,000 litres
Direct materials cost: $3,600
Conversion costs (= direct labour + production overhead): $900
Normal loss as % of input: 10%
Loss has a scrap value of $0.90 per litre.
Actual output is 1,850 litres, and actual loss is 150 litres. Normal loss = 200 litres;
therefore abnormal gain = 50 litres.
$
Direct materials 3,600
Conversion costs 900
4,500
Scrap value of normal loss (200 × $0.90)
180
4,320
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Expected output 1,800 litres
Cost per litre $2.40
Cost of actual finished output = 1,850 units
× $2.40 = $4,440
Value of abnormal gain = 50 units
× $2.40 = $120.
These costs could be set out in a process cost account as follows:
Process (WIP) account
litres
$
litres $
Direct materials 2,000
3,600
Cost of sales (at
$2.40)
1,850 4,440
Conversion costs -
900
Normal loss (at
$0.90 scrap value)
200 180
Abnormal gain
(at $2.40)
50
120
2,050
4,620
2,050 4,620
Abnormal gain account
litres
$
litres $
Scrap (at $0.90) 50
45
WIP 50 120
120
The balance on this account is $75. This is treated as an addition to profit in the cost
accounting income statement for the period.
Exercise 1: process costing and losses
From the following information, prepare:
the process account,
the abnormal loss or abnormal gain account.
Process: Input 6,000 units
Normal loss: 5% of input
Direct materials: $21,600
Direct labour: $8,000
Production overhead: $16,000
Actual output: 5,500 units
Loss has a scrap value per unit of $3.80.
Exercise 2: process costing and losses
From the following information, prepare the process account.
Chapter 10: Process costing
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Process: Input 10,000 units
Normal loss: 4% of input
Direct materials: $35,200
Conversion costs: $29,600
Actual output: 9,750 units
Loss has no scrap value.
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Process costing: inventory valuation and equivalent units
Sharing out process costs between finished units and unfinished inventory
Equivalent units
A three-stage calculation
Weighted average cost and FIFO valuation methods
4 Process costing: inventory valuation and equivalent
units
4.1 Sharing out process costs between finished units and unfinished
inventory
When manufacturing is a continuous process, there may be unfinished work-in-
progress (‘work-in-process’) at the beginning of an accounting period and at the end
of the period. Since inventory is unfinished, its cost or value is less than the cost of a
unit of completed output. The common costs of the process must be shared between
finished output and unfinished work-in-process on a fair basis. The basis of
apportionment used in process costing is equivalent units.
4.2 Equivalent units
An equivalent unit means ‘equal to one finished unit of output’.
One fully-finished unit of production = 1 equivalent unit
One unit 50% complete = 0.50 equivalent units. 400 units 50% complete =
200 equivalent units.
One unit 20% complete = 0.20 equivalent units. 400 units 20% complete =
80 equivalent units.
Costs are shared between finished units and inventory by calculating a cost per
equivalent unit:
Cost per equivalent unit =
Costs of the process
Number of equivalent units produced
Equivalent units of closing inventory
It is normally assumed that direct materials are added to the production process at
the beginning of the process and that direct labour operations are carried out
throughout the process. When this assumption is used, units of closing inventory
are:
100% complete for direct material costs added at the beginning of the process,
but
Chapter 10: Process costing
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only partly-complete for direct labour and production overhead costs, and only
partly complete for additional materials that are added throughout the process.
The
number of equivalent units of direct materials cost in a period will therefore
differ from the number of equivalent units of conversion costs
(direct labour and
production overhead).
A cost per equivalent unit is therefore calculated separately for:
direct materials
conversion costs.
Costs for finished output and closing inventory can be calculated from the number
of equivalent units and the cost per equivalent unit.
4.3 A three-stage calculation
We recommend a three-stage calculation:
Prepare a statement of equivalent units. This should calculate the equivalent
units (direct materials and conversion costs) for output from the process and for
closing WIP
Next, prepare a statement of cost per equivalent unit. There should be a
separate cost per equivalent unit of direct materials and a cost per cost per
equivalent unit of conversion costs.
Third, prepare a statement of evaluation. This is a statement of the cost of
finished output and closing WIP, which is prepared from your statement of
equivalent units and statement of cost per equivalent unit.
Example
At the beginning of a financial period, there were no units of opening work-in-
process. During the period, input to the process was 4,000 units. During the period
3,500 units were output from the process and closing WIP was 500 units.
All the direct materials are added to production at the beginning of the process.
Closing inventory of 500 units was therefore 100% complete for materials, and
production was 40% complete.
Costs incurred during the period were:
Direct materials: $24,000
Conversion costs: $7,400
Required: calculate the cost of the finished output and the value of closing WIP.
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Answer
Statement of equivalent units
Output Total units Direct materials Conversion costs
Degree of
completion
Equivalent
units
Degree of
completion
Equivalent
units
Finished output
3,500
100%
3,500
100% 3,500
Closing WIP 500
100%
500
40%
200
4,000
4,000
3,700
Statement of cost per equivalent unit
Direct materials Conversion costs
Total costs $24,000 $47,400
Equivalent units 4,000 3,700
Cost per equivalent unit $6 $2
Statement of evaluation
Finished
output
Closing WIP
$
$
Direct materials
(3,500
× $6)
21,000
(500 × $6)
3,000
Conversion costs
(3,500
× $2)
7,000
(200 × $2)
400
Total cost 28,000
3,400
These costs would be recorded in the process account as follows.
Process (WIP) account
units
$
units $
Direct materials 4,000
24,000
Finished goods 3,500 28,000
Conversion costs -
7,400
Closing WIP 500 3,400
4,000
31,400
4,000 31,400
4.4 Weighted average cost and FIFO valuation methods
Another problem with establishing the cost of finished output and inventory in
process costing is the problem of how to work out costs when there is opening
inventory at the beginning of the period. When there is opening WIP, output from a
process(and closing WIP) can be valued on either of the following bases:
weighted average cost method
first-in, first-out (FIFO) method
You need to know how to apply each of these different valuation methods.
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Equivalent units: weighted average cost method
The underlying principle
The three-stage calculation
Weighted average cost method: summary
5 Equivalent units: weighted average cost method
5.1 The underlying principle
When the weighted average cost method is used, the assumption is that all units
produced during the period and all units of closing inventory should be valued at
the same cost per equivalent unit for materials and the same cost per equivalent unit
for conversion costs.
An average cost per equivalent unit is therefore calculated for all units of output
and closing inventory. This includes the units that were partly-completed at the
beginning of the period (and which were therefore valued as closing WIP at the end
of the previous period).
5.2 The three-stage calculation
The costs are worked out in a similar way to the previous example (where there was
no opening WIP).
Statement of equivalent units. Prepare a statement of equivalent units for
finished output (1 equivalent unit of direct materials and 1 equivalent unit of
conversion costs each) and for closing WIP.
Statement of cost per equivalent unit. Calculate the cost per equivalent unit for
direct materials and the cost per equivalent unit for conversion costs. However,
remember to include the cost of the opening WIP. The materials cost of the
opening WIP should be included in the total direct materials cost, and the
conversion costs in the opening WIP should be added to the conversion costs for
the current period.
inventoryclosing and output of units Equivalent
period thein incurred Costs+inventoryopening of Cost
= unit equivalent per Cost
Remember that you will normally have to calculate a separate cost per
equivalent units for materials and for conversion costs. This is because the
equivalent units of closing inventory will be different for materials and
conversion costs.
Statement of evaluation. Having calculated the equivalent units and a cost per
equivalent unit, prepare a statement of evaluation.
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Example
From the following information relating to a production process in March,
calculate the cost of finished output in the month and the value of the closing
inventory, using the weighted average cost valuation method:
Opening inventory on 1 March: 3,000 units
100% complete for direct materials
30% complete for conversion costs
Cost = $13,570 (= direct materials $12,600 + conversion costs $970)
Costs incurred during March:
Direct materials: 7,000 units input, cost $28,000
Conversion costs: $17,430
Units completed in the month (finished goods): 8,000 units
Closing inventory:
2,000 units: 100% complete for direct materials and 60% complete for conversion
costs.
Answer
Equivalent units Total Direct materials Conversion costs
Total units Equivalent units Equivalent units
Completed units
8,000
8,000
8,000
Closing inventory
2,000
2,000
(2,000 x 60%) 1,200
Total equivalent units 10,000
10,000
9,200
Statement of cost per equivalent unit
Costs Direct
materials
Conversion
costs
$
$
Opening inventory 12,600
970
Costs incurred in the period 28,000
17,430
Total costs 40,600
18,400
Equivalent units 10,000
9,200
Cost per equivalent unit $4.06
$2
Chapter 10: Process costing
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Statement of evaluation
Finished
output
Closing WIP
$
$
Direct materials
(8,000
× $4.06)
32,480
(2,000 × 4.06)
8,120
Conversion costs
(8,000
× $2)
16,000
(1,200 × $2)
2,400
Total cost 48,480
10,520
These costs would be recorded in the process account as follows.
Process (WIP) account
units
$
units $
Opening WIP 3,000
13,570
Finished goods 8,000 48,480
Direct materials 7,000
28,000
Conversion costs -
17,430
Closing WIP 2,000 10,520
10,000
59,000
10,000 59,000
5.3 Weighted average cost method: summary
The weighted average cost method for process costing with opening WIP can be
summarised as follows.
All output and closing inventory is valued at the same cost per equivalent unit
Cost of opening inventory + Costs in the period = Total costs
Units of closing inventory + Units of output in the period = Total equivalent
units
Cost per equivalent unit = Total costs/Total equivalent units
Direct
materials
Conversion
costs
Cost of opening inventory M
1
C
1
Costs incurred in the period M
2
C
2
Total costs M
1
+ M
2
C
1
+ C
2
Number of units output P
P
Equivalent units of closing inventory I
m
I
c
Total equivalent units P + I
m
P + I
c
Cost per equivalent unit (M
1
+ M
2
) ÷
( P + I
m
)
(C
1
+ C
2
) ÷
( P + I
c
)
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Exercise 3: weighted average cost method
From the following information relating to Process 2 in April:
(a) calculate the cost of finished output in the month and the value of the closing
inventory, using the weighted average cost valuation method
(b) prepare the process account for the period.
Opening inventory on 1 April: 2,000 units:
100% complete for direct materials
80% complete for conversion costs
Cost $20,900 (= direct materials $14,800 + conversion costs $6,100)
Costs incurred during April:
Direct materials: 14,000 units input, cost $70,000
Conversion costs: $34,200
Completed units in the month: 11,000 units
Closing inventory on 30 April:
5,000 units: 100% complete for direct materials and 40% complete for conversion
costs.