ACCA F2 Management Accounting - 2010 - Study text - Emile Woolf Publishing
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Chapter 10: Process costing
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Equivalent units: FIFO method
Assumption with the FIFO method of process costing
Equivalent units of work done in the current period
The three-stage calculation
FIFO method: summary
6 Equivalent units: FIFO method
6.1 Assumption with the FIFO method of process costing
With the weighted average cost method of costing, it is assumed that all units of
output in a period have the same cost per unit.
With the first-in, first-out (FIFO) method of process costing, it is assumed that the
opening units of work-in-process at the beginning of the month will be the first
units completed. The cost of these units is their value at the beginning of the period
plus the cost to complete them in the current period.
6.2 Equivalent units of work done in the current period
It is necessary to calculate the number of equivalent units of work done in the
period. This consists of:
The equivalent units of direct materials and conversion costs required to
complete the opening WIP. These are the first units completed in the period.
The equivalent units of finished output in the period that was started as well as
finished in the period. These have one equivalent unit of direct materials and
one equivalent unit of conversion costs. The total number of these units is:
-
the total finished output in the period
-
minus the quantity of opening WIP (which are completed first)
The equivalent units of closing WIP (calculated in the normal way).
A cost per equivalent unit, for direct materials and conversion costs, is now
calculated as:
period in the done work of units equivalent ofNumber
value) WIPopening (exclude periodcurrent in the process theof Costs
The equivalent units in the current period to complete the opening WIP are
calculated using the following percentage value:
100%
minus the degree of completion at the beginning of the period.
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For example, suppose that opening WIP is 1,000 units which is 100% complete for
direct materials and 70% complete for conversion costs. The number of equivalent
units in the current period to complete the opening WIP is 0 for direct materials (=
1,000
× (100 – 100)%) and 300 for conversion costs (= 1,000 × (100 – 70)%).
6.3 The three-stage calculation
The three-stage calculation with the FIFO method is similar to the calculation
method previously described, with the exception that in the statement of evaluation,
the cost of finished output consists of:
the finished cost of opening WIP (completed first) plus
the cost of finished output started as well as finished in the period.
The finished cost of opening WIP is the sum of:
the costs in the opening WIP value at the start of the period
the costs in the current period to complete these units.
Study the following example carefully.
Example: FIFO method of process costing
From the following information relating to Process 1 in March, calculate the cost of
finished output in the month and the value of the closing inventory, using the FIFO
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
Completed units in the month: 8,000 units
Closing inventory: 2,000 units 100% complete for direct materials and 60% complete
for conversion costs.
Chapter 10: Process costing
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Answer
Statement of equivalent units (work done in the current period)
Equivalent units
Direct
materials
Conversion
costs
Total
units
Equivalent
units
Equivalent
units
To complete opening inventory,
finished first
3,000
(0%)
0
(70% × 3,000)
2,100
Units started and completed in the
current period (8,000 – 3,000)
5,000
5,000
5,000
Finished output 8,000
5,000
7,100
Closing inventory
2,000
2,000
(2,000 × 60%)
1,200
Total equivalent units 10,000
7,000
8,300
Statement of cost per equivalent unit in the current period
Cost per equivalent unit Direct materials Conversion costs
Total cost in current period $28,000 $17,430
Total equivalent units in the current period
7,000
8,300
Cost per equivalent unit (current period)
$4.00
$2.10
Statement of evaluation
Direct materials Conversion costs Total cost
$ $ $
Finished units:
1. Opening WIP
Cost b/f
12,600
970 13,570
Cost to complete
0
(2,100
×
$2.1)
4,410 4,410
12,600
5,380 17,980
2. Units started and
finished
(5,000
×
$4)
20,000
(5,000
×
$2.1)
10,500 30,500
Finished units
32,600
15,880
48,480
Closing inventory
(2,000
×
$4)
8,000
(1,200
×
$2.1)
2,520
10,520
40,600
18,400
59,000
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
(
Tutorial note: If you compare this example using FIFO with the previous example
using the weighted average cost method, you might notice that the cost of finished
output and value of closing WIP is the same in each case. This is a coincidence.
Normally, the two methods provide different costs for finished output and different
closing WIP valuations.)
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6.4 FIFO method: summary
The first-in, first-out method for process costing with opening WIP can be
summarised as follows.
The cost of the opening units completed in the current period is calculated
separately from the cost of the units that are started and finished in the current
period.
A cost per equivalent unit is calculated for the current period, as follows:
Direct
materials
Conversion
costs
Costs incurred in the current period TC
m
TC
c
Equivalent units of work in the current
period to complete opening WIP
A
D
Number of units started and finished in
the current period
B
E
Equivalent units of closing inventory at
the end of the current period
C
F
Total equivalent units of work in this
period
(A + B + C)
(D + E + F)
Cost per equivalent unit in the current
period
TC
m
/(A + B + C)
TC
c
/(D + E + F)
These costs are used to apportion the process costs in the current period
between:
-
the cost of completing the opening WIP
-
the cost of units started and finished in the current period
-
the value of closing inventory.
Having calculated costs for the current period, the valuation of output from the
process is calculated as follows:
Direct
materials
Conversion
costs
Total
costs
Value of opening inventory b/f M
1
C
1
M
1
+ C
1
Costs to complete in the current
period
M
2
C
2
M
2
+ C
2
Total cost of opening inventory,
finished first
M
1
+ M
2
= M
3
C
1
+ C
2
= C
3
M
3
+ C
3
Units started and completed in
the current period
M
4
C
4
M
4
+ C
4
Total cost of finished output M
3
+ M
4
= M
5
C
3
+ C
4
= C
5
M
5
+ C
5
Chapter 10: Process costing
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Exercise 4: FIFO 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 FIFO cost valuation method
(b) prepare the Process 2 account for the month.
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: 5,000 units 100% complete for direct materials and 40% complete
for conversion costs.
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Losses and gains at different stages of the process
Assumptions about when loss occurs
Equivalent units and abnormal loss part-way through the process
Equivalent units and abnormal gain part-way through the process
7 Losses and gains at different stages of the process
7.1 Assumptions about when loss occurs
In the earlier explanation of accounting for abnormal loss and abnormal gain, it was
assumed that losses occur at the end of the production process. This assumption is
not relevant for normal loss, but it is relevant for abnormal loss and abnormal gain,
because these are given a value.
If it is assumed that losses occur at the end of a process, units of abnormal loss or
gain are given a cost or value as if they are fully completed units – and so one
equivalent unit each.
If losses occur at a different stage in the process, this assumption should not be
applied. Instead, the concept of equivalent units should be used to decide the cost of
the abnormal loss or the value of the abnormal gain. Equivalent units can be used
provided that an estimate is made of the degree of completion of units at the time
that loss occurs in the process. Differing degrees of completion might be used for
direct materials and conversion costs.
7.2 Equivalent units and abnormal loss part-way through the process
When loss occurs part-way through a process, the cost of any abnormal loss should
be calculated by:
establishing the equivalent units of direct materials and conversion costs for the
loss
calculating a cost per equivalent units
using the calculations of equivalent units and cost per equivalent unit to obtain a
cost for finished output and abnormal loss in the period.
Example: abnormal loss and loss part-way through a process
The following information relates to a production process:
Input quantities of materials: 10,000 units
Direct materials cost: $27,000
Conversion costs: $13,200
Normal loss as % of input: 10%
Direct materials are added in full at the beginning of the process, and loss occurs
Chapter 10: Process costing
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60% of the way through the process.
Actual output is 8,500 units.
Actual loss is 1,500 units. Normal loss is 1,000 units (= 10% of 10,000); therefore
abnormal loss is 500 units.
The cost of finished output and abnormal loss can be calculated as follows.
Statement of equivalent units
Output Direct materials Conversion costs
Degree of
completion
Equivalent
units
Degree of
completion
Equivalent
units
Finished output 100% 8,500
100% 8,500
Abnormal loss 100% 500
60% 300
9,000
8,800
Statement of cost per equivalent unit
Direct materials Conversion costs
Total costs $27,000 $13,200
Equivalent units 9,000 8,800
Cost per equivalent unit $3 $1.50
Statement of evaluation
Finished
output
Abnormal
loss
$
$
Direct materials
(8,500
× $3)
25,500
(500 × $3)
1,500
Conversion costs
(8,500
× $1.50)
12,750
(300 × $1.50)
450
Total cost 38,250
1,950
These costs would be recorded in the process account as follows.
Process (WIP) account
units
$
units $
Direct materials 10,000
27,000
Finished goods 8,500 38,250
Conversion costs -
13,200
Normal loss 1,000 -
Abnormal loss 500 1,950
10,000
40,200
10,000 40,200
7.3 Equivalent units and abnormal gain part-way through the process
The same principles apply to the valuation of abnormal gain where the loss/gain
occurs part-way through the process. However, there is one important difference.
Equivalent units of abnormal gain are given a negative value and are subtracted
from the total equivalent units of output in the period.
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Perhaps the easiest way to think of the reason for this is that abnormal gain is on the
opposite side of the process account (the debit side) from actual finished output
(credit side) and abnormal gain equivalent units are subtracted because they offset
the cost of the finished output.
Example: abnormal gain part-way through a process
The following information relates to a production process:
Input quantities of materials: 6,000 units
Direct materials cost: $27,000
Conversion costs: $11,040
Normal loss as % of input: 10%
Direct materials are added in full at the beginning of the process, and loss occurs
40% of the way through the process.
Actual output is 5,600 units.
Actual loss is 400 units. Normal loss is 600 units (= 10% of 6,000); therefore there is
abnormal gain of 200 units.
The cost of finished output and abnormal loss can be calculated as follows. Note in
particular that abnormal gain is given a negative value for equivalent units.
Statement of equivalent units
Output Total
units
Direct materials Conversion costs
Degree of
completion
Equivalent
units
Degree of
completion
Equivalent
units
Finished output 5,600 100% 5,600
100% 5,600
Abnormal gain 200 100% (200)
40% (80)
5,400
5,520
Statement of cost per equivalent unit
Direct materials Conversion costs
Total costs $27,000 $11,040
Equivalent units 5,400 5,520
Cost per equivalent unit $5 $2
Statement of evaluation
Abnormal gain is given a value in the usual way based on equivalent units and cost
per equivalent unit.
Finished output Abnormal gain
$
$
Direct materials
(5,600
× $5)
28,000
(200 × $5)
1,000
Conversion costs
(5,600
× $2)
11,200
(80 × $2)
160
Total cost 39,200
1,160
Chapter 10: Process costing
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These costs would be recorded in the process account as follows.
Process (WIP) account
units
$
units $
Direct materials 6,000
27,000
Finished goods 5,600 39,200
Conversion costs -
11,040
Normal loss 600 -
Abnormal gain 200
1,160
6,200
39,200
6,200 39,200
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Process costing: joint products and by-products
Definition of joint products
Apportioning common processing costs between joint products
Definition of by-products
Cost accounting treatment of by-products
8 Process costing: joint products and by-products
8.1 Definition of joint products
In some process manufacturing systems, two or more different products are
produced. These are called
joint products if they have a substantial sales value (or
a substantial sales value after further processing).
Until the joint products are produced in the manufacturing process, they cannot be
distinguished from each other. The same input materials and processing operation
produces all the joint products together.
8.2 Apportioning common processing costs between joint products
The costs of the common process that produces the joint products are common
costs. In order to calculate a cost for each joint product, these common costs must be
shared (apportioned) between the joint products. The common costs of the process
must be apportioned between the joint products on a fair basis, in much the same
way that overhead costs are apportioned between cost centres.
One of the following three methods of apportionment is normally used:
Units basis: Common costs are apportioned on the basis of the total number of
units produced. the cost per unit is the same for all the joint products.
Sales value at the split-off point basis: Common costs are apportioned on the
basis of the sales value of the joint products produced, at the point where they
are separated in the process (the ‘split off point’).
Sales value less further processing costs basis: common costs are apportioned
on the basis of their eventual sales value after they have gone through further
processing to get them ready for sale.
Example
Two joint products JP1 and JP2, are produced from a common process. During
March, 8,000 units of materials were input to the process. Total costs of processing
(direct materials and conversion costs) were $135,880.
Output was 5,000 units of JP1 and 3,000 units of JP2.