CIMA - C1 Fundamentals of Management Accounting
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11: Cost bookkeeping ⏐ Part D Costing and accounting systems
Chapter Roundup
•
Cost bookkeeping is based on the principles of double entry, the golden rule of which is that for every entry made in
one account, there must be a corresponding balancing entry in another account.
•
Integrated systems combine both financial and cost accounts in one system of ledger accounts.
•
The basic entries in an integrated system are as follows:
Expenditure on materials, wages and overheads
DR Resources account
CR Cash or accounts payable
Work in progress
DR WIP (for overhead, this is overhead absorbed)
CR Resources accounts (for overhead, this is overhead absorbed)
Finished goods
DR Finished goods
CR WIP
Cost of sales
DR Cost of sales
CR Finished goods
•
The ledger accounts related to production can be consolidated into a manufacturing account.
•
In a standard cost bookkeeping system, the variances are recorded as follows:
– The material price variance is recorded in the stores control account.
– The labour rate variance is recorded in the wages control account.
– The following variances are recorded in the work in progress account.
Material usage variance
Idle time variance
Labour efficiency variance
Variable overhead efficiency variance
– The production overhead expenditure variance will be recorded in the production overhead control account.
– The production overhead volume variance may be recorded in the fixed production overhead account. (Note.
Alternatively, you may find the volume variance recorded in the work in progress account.)
– Sales variances do not appear in the books of account. Sales are recorded in the sales account at actual
invoiced value.
– The balance of variances in the variance accounts at the end of a period may be written off to the income
statement.
•
The general principle in standard cost bookkeeping is that cost variances should be recorded as early as possible. They
are recorded in the relevant account in which they arise and the appropriate double entry is taken to a variance account.
•
Adverse variances are debited to the relevant variance account; favourable variances are credited in the relevant
variance account.
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Quick Quiz
1 What is the double entry for the following in an integrated accounts system?
(a) Production overhead absorbed in the cost of production
(b) Completed work transferred from the production process to inventory
2 GF Co bought $100,000 worth of materials and issued $75,000 to production. Which of the following entries represents
the correct bookkeeping treatment? (Select three options.)
I Dr Raw materials $75,000
II Dr Raw materials $100,000
III Cr Work-in-progress $75,000
IV Cr Raw materials $75,000
V Cr Raw materials $100,000
VI Dr Work-in-progress $75,000
VII Dr Work-in-progress $100,000
3 The wages control account for X Co for October looks like this.
WAGES CONTROL ACCOUNT
$'000
$'000
Bank
110
Work in progress
101
Production overhead
7
Balance c/d
2
110
110
Indicate whether the following statements are true or false.
True False
I Total wages incurred during October was $110,000
II Indirect wages incurred during October was $7,000
III Wages accrued at the end of October were $2,000
4 The material usage variance is recorded in the raw materials control account.
True
False
5 What is the double entry for recording sales variances in cost accounts?
6 Indicate whether the following statements are true or false.
True False
I Integrated systems conform to statutory requirements
II Integrated systems are preferable to two systems because they conform
to statutory requirements
III Integrated systems reduce the number of account reconciliations
IV Systems with separate cost and financial accounting systems can aid
provision of internal management information
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11: Cost bookkeeping ⏐ Part D Costing and accounting systems
7 Which three of the following variances are recorded in the work-in-progress control account in a standard cost
bookkeeping system?
Material price variance
Material usage variance
Labour rate variance
Variable overhead efficiency variance
Sales variance
Idle time variance
Answers to Quick Quiz
1 (a) Dr Work in progress control account
Cr Production overhead account
(b) Dr Finished goods control account
Cr Work in progress control account
2 II
IV
VI
Costs incurred are debited to the materials account, and those issued as direct materials to production are credited to
the materials account and subsequently debited to the work-in-progress account.
3 I False. Total wages paid was $110,000.
II True. Indirect wages of $7,000 were charged to production overhead.
III False. Wages were prepaid at the end of October
4 False. Material usage variances are recorded in the WIP account.
5 Sales variances do not appear in the books of account.
Sales are recorded in the sales account at actual invoiced value.
6 I True
II False. This is one of the disadvantages of an integrated system. It must conform to statutory requirements but
this is not necessarily useful for management purposes.
III True. Having one set of accounts instead of two eliminates the need to reconcile the two systems.
IV True. As mentioned above the integrated system must conform to statutory requirements. Internal management
information does not need to conform to statutory requirement and in some cases it is more useful if it doesn’t.
7 Material usage variance, variable overhead efficiency variance and idle time variance. The material price variance is
recorded in the stores control account. The labour rate variance is recorded in the wages control account. The sales
variances do not appear in the books of account.
Now try the questions below from the Question Bank
Question numbers Page
57–64 364
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Topic list Learning outcomes Syllabus references Ability required
1 The distinguishing features of process costing D(iii) D(4) Analysis
2 The basics of process costing D(iv) D(4) Application
3 Dealing with losses in process D(iv) D(4) Application
4 Accounting for scrap D(iv) D(4) Application
5 Valuing closing work in progress D(iv) D(4) Application
6 Valuing opening work in progress D(iv) D(4) Application
7 Joint products and by-products D(iii) D(4) Application
Process costing
Introduction
We will look at costing systems in this part of the Study Text. These costing systems are
used to cost goods or services and which method is used depends on the way in which the
goods or services are produced. In Chapter 13 we will look at job, batch and contract
costing. In this chapter we will consider process costing. Process costing is applied when
output consists of a continuous stream of identical units. We will begin from basics and
look at how to account for the most simple of processes. We will then move on to how to
account for any losses which might occur, as well as what to do with any scrapped units
which are sold. Next we will consider how to deal with closing work in progress before
examining situations involving closing work in progress and losses. We will then go on to
have a look at situations involving opening work in progress and finally we shall consider
how to deal with situations where we have both opening and closing work in progress and
losses.
This chapter will conclude with an outline discussion of joint products and by-products.
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12: Process costing ⏐ Part D Costing and accounting systems
1 The distinguishing features of process costing
Process costing is a costing method used where it is not possible to identify separate units of production, or jobs,
usually because of the continuous nature of the production processes involved.
Process costing is used where there is a continuous flow of identical units and it is common to identify it with
continuous production such as the following.
• Oil refining
• The manufacture of soap
• Paint manufacture
• Food and drink manufacture
Process costing is a 'form of costing applicable to continuous processes where process costs are attributed to the
number of units produced. This may involve estimating the number of equivalent units in stock at the start and end of
the period under consideration.' CIMA Official Terminology
Don't worry about the term 'equivalent units'. All will become clear as you work through this chapter.
The features of process costing which make it different from other methods of costing such as job or batch costing are
as follows.
(a) The continuous nature of production in many processes means that there will usually be closing work in
progress which must be valued. In process costing it is not possible to build up cost records of the cost
of each individual unit of output because production in progress is an indistinguishable homogeneous
mass.
(b) There is often a loss in process due to spoilage, wastage, evaporation and so on.
(c) The output of one process becomes the input to the next until the finished product is made in the final
process.
(d) Output from production may be a single product, but there may also be a by-product (or by-products)
and/or joint products.
2 The basics of process costing
2.1 Process accounts
Costs incurred in processes are recorded in what are known as process accounts.
A process account has two sides, and on each side there are two columns – one for quantities (of raw materials, work
in progress and finished goods) and one for costs.
(a) On the left hand side of the process account we record the inputs to the process and the cost of these
inputs. So we might show the quantity of material input to a process during the period and its cost, the
cost of labour and the cost of overheads.
(b) On the right hand side of the process account we record what happens to the inputs by the end of the
period.
(i) Some of the input might be converted into finished goods, so we show the units of finished goods
and the cost of these units.
FAST FOR
WARD
Key terms
FA
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(ii) Some of the material input might evaporate or get spilled or damaged, so there would be losses.
So we record the loss units and the cost of the loss.
(iii) At the end of a period, some units of input might be in the process of being turned into finished
units so would be work in progress (WIP). We record the units of WIP and the cost of these units.
The quantity columns on each side of the account should total to the same amount. Why? Well think about it. If we put
100 kgs of material in to a process (which we record on the left hand side of the account) we should know what has
happened to those 100 kgs. Some would be losses maybe, some would be WIP, some would be finished units, but the
total should be 100 kgs.
Likewise the cost of the inputs to the process during a period (ie the total of the costs recorded on the left hand side of
the account) is the cost of the outputs of the process. If we have recorded material, labour and overhead costs totalling
$1,000 and at the end of the process we have 100 finished units (and no losses or WIP), then that output cost $1,000.
Here’s a very simple example of a process account.
PROCESS ACCOUNT
Units
$
Units
$
Material
1,000
11,000
Closing WIP
200
2,000
Labour
4,000
Finished units
800
16,000
Overhead
3,000
1,000
18,000
1,000
18,000
As you can see, the quantity columns on each side balance (ie they are the same), as do the monetary columns. (Don’t
worry at this stage about how the costs are split between WIP and finished units.)
2.2 Example: basics of process costing
Suppose that Purr and Miaow Co make squeaky toys for cats. Production of the toys involves two processes, shaping
and colouring. During the year to 31 March 20X3, 1,000,000 units of material worth $500,000 were input to the first
process, shaping. Direct labour costs of $200,000 and production overhead costs of $200,000 were also incurred in
connection with the shaping process. There were no opening or closing inventories in the shaping department. The
process account for shaping for the year ended 31 March 20X3 is as follows.
PROCESS 1 (SHAPING) ACCOUNT
Units $ Units $
Direct materials 1,000,000 500,000 Output to Process 2 1,000,000 900,000
Direct labour 200,000
Production overheads
200,000
1,000,000
900,000
1,000,000
900,000
When preparing process accounts, balance off the quantity columns (ie ensure they total to the same amount on both
sides) before attempting to complete the monetary value columns since they will help you to check that you have missed
nothing out. This becomes increasingly important as more complications are introduced into questions.
When using process costing, if a series of separate processes is needed to manufacture the finished product, the
output of one process becomes the input to the next until the final output is made in the final process. In our example,
all output from shaping was transferred to the second process, colouring, during the year to 31 March 20X3. An
additional 500,000 units of material, costing $300,000, were input to the colouring process. Direct labour costs of
$150,000 and production overhead costs of $150,000 were also incurred. There were no opening or closing inventories
in the colouring department. The process account for colouring for the year ended 31 March 20X3 is as follows.
Assessment
focus point
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PROCESS 2 (COLOURING) ACCOUNT
Units $ Units $
Materials from process 1 1,000,000 900,000 Output to finished
Added materials 500,000 300,000 goods 1,500,000 1,500,000
Direct labour 150,000
Production overhead
150,000
1,500,000
1,500,000
1,500,000
1,500,000
Direct labour and production overhead may be treated together in an assessment question as conversion cost.
Added materials, labour and overhead in Process 2 are usually added gradually throughout the process. Materials from
Process 1, in contrast, will often be introduced in full at the start of the second process.
2.3 Framework for dealing with process costing
Use our suggested four-step approach when dealing with process costing questions.
Step 1
Determine output and losses
Step 2
Calculate cost per unit of output, losses and WIP
Step 3
Calculate total cost of output, losses and WIP
Step 4
Complete accounts
Process costing is centred around four key steps. The exact work done at each step will depend on the circumstances of
the question, but the approach can always be used. Don't worry about the terms used. We will be looking at their
meaning as we work through the chapter.
Step 1
Determine output and losses
• Determine expected output.
• Calculate normal loss and abnormal loss and gain.
• Calculate equivalent units if there is closing work in progress.
Step 2
Calculate cost per unit of output, losses and WIP
Calculate cost per unit or cost per equivalent unit.
Step 3
Calculate total cost of output, losses and WIP
In some examples this will be straightforward. In cases where there is work in progress, a statement of
evaluation will have to be prepared.
Step 4
Complete accounts
• Complete the process account.
• Write up the other accounts required by the question.
It always saves time in an assessment if you don't have to think too long about how to approach a question before you
begin. This four-step approach can be applied to any process costing question so it would be a good idea to memorise it
now. It will be useful as a framework for any workings that you may need to do.
Assessment
focus point
Assessment
focus point
FA
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3 Dealing with losses in process
Losses may occur in process. If a certain level of loss is expected, this is known as normal loss. If losses are greater than
expected, the extra loss is abnormal loss. If losses are less than expected, the difference is known as abnormal gain.
3.1 Losses
During a production process, a loss may occur.
Normal loss is 'expected loss, allowed for in the budget, and normally calculated as a percentage of the good output,
from a process during a period of time. Normal losses are generally either valued at zero or at their disposal values.'
Abnormal loss is 'any loss in excess of the normal loss allowance'.
Abnormal gain is 'improvement on the accepted or normal loss associated with a production activity'.
CIMA Official Terminology
Losses may occur due to wastage, spoilage, evaporation, and so on.
Since normal loss is not given a cost, the cost of producing these units is borne by the 'good' units of output.
Abnormal loss and gain units are valued at the same unit rate as 'good' units. Abnormal events do not therefore affect
the cost of good production. Their costs are analysed separately in an abnormal loss or abnormal gain account.
3.1.1 The bookkeeping
(a) In an abnormal loss account, the debit entry shows the units (and their value) from the process
account. The credit entry shows the impact on the income statement.
(b) In an abnormal gain account, the debit entry shows the effect on the income statement, while the credit
entry shows the units (and their value) from the process account.
3.2 Example: abnormal losses and gains
Suppose that input to a process is 1,000 units at a cost of $4,500. Normal loss is 10% and there are no opening or
closing inventories. Determine the accounting entries for the cost of output and the cost of the loss if actual output were
as follows.
(a) 860 units (so that actual loss is 140 units)
(b) 920 units (so that actual loss is 80 units)
Solution
Before we demonstrate the use of the 'four-step framework' we will summarise the way that the losses are dealt with.
(a) Normal loss is given no share of cost.
(b) The cost of output is therefore based on the expected units of output, which in our example amount to 90% of
1,000 = 900 units.
(c) Abnormal loss is given a cost, which is written off to the income statement via an abnormal loss/gain account.
(d) Abnormal gain is treated in the same way, except that being a gain rather than a loss, it appears as a debit entry
in the process account (as it is a sort of input, being additional unexpected units), whereas a loss appears as a
credit entry in this account (as it is a sort of output).
Key terms
FAST FORWARD
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12: Process costing ⏐ Part D Costing and accounting systems
(a) Output is 860 units
Step 1
Determine output and losses
If actual output is 860 units and the actual loss is 140 units:
Units
Actual loss
140
Normal loss (10% of 1,000)
100
Abnormal loss
40
Step 2
Calculate cost per unit of output and losses
The cost per unit of output and the cost per unit of abnormal loss are based on expected output.
Costs incurred
Expected output
=
$4,500
900 units
= $5 per unit
Step 3
Calculate total cost of output and losses
Normal loss is not assigned any cost.
$
Cost of output (860 × $5)
4,300
Normal loss
0
Abnormal loss (40 × $5)
200
4,500
Step 4
Complete accounts
PROCESS ACCOUNT
Units
$
Units
$
Cost incurred
1,000
4,500
Normal loss
100
0
Output (finished
goods a/c)
860
4,300
Abnormal loss
40
200
1,000
4,500
1,000
4,500
ABNORMAL LOSS ACCOUNT
Units
$
Units
$
Process a/c
40
200
Income statement
40
200
(b) Output is 920 units
Step 1
Determine output and losses
If actual output is 920 units and the actual loss is 80 units:
Units
Actual loss 80
Normal loss (10% of 1,000)
100
Abnormal gain
20
Step 2
Calculate cost per unit of output and losses
The cost per unit of output and the cost per unit of abnormal gain are based on expected output.
Costs incurred
Expected output
=
$4,500
900 units
= $5 per unit
(Whether there is abnormal loss or gain does not affect the valuation of units of output. The figure
of $5 per unit is exactly the same as in the previous paragraph, when there were 40 units of
abnormal loss.)
(× $5)
(× $5)
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Step 3
Calculate total cost of output and losses
$
Cost of output (920 × $5)
4,600
Normal loss
0
Abnormal gain (20 × $5)
(100
)
4,500
Step 4
Complete accounts
PROCESS ACCOUNT
Units $ Units $
Cost incurred 1,000 4,500 Normal loss 100 0
Abnormal gain a/c 20
(× $5) 100
Output 920
(× $5) 4,600
(finished goods a/c)
1,020
4,600
1,020
4,600
ABNORMAL GAIN
Units $ Units $
I
ncome statement
20
100
Process a/c
20
100
3.3 Example: abnormal losses and gains again
During a four-week period, period 3, costs of input to a process were $29,070. Input was 1,000 units, output was 850
units and normal loss is 10%.
During the next period, period 4, costs of input were again $29,070. Input was again 1,000 units, but output was 950 units.
There were no units of opening or closing inventory.
Required
Prepare the process account and abnormal loss or gain account for each period.
Solution
Step 1
Determine output and losses
Period 3
Units
Actual output
850
Normal loss (10% × 1,000)
100
Abnormal loss
50
Input
1,000
Period 4
Units
Actual output
950
Normal loss (10% × 1,000)
100
Abnormal gain
(50
)
Input
1,000
Step 2
Calculate cost per unit of output and losses
For each period the cost per unit is based on expected output.
Cost of input
Expected units of output
=
$29,070
900
= $32.30 per unit
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