(a) See section on job and process process costing costing systems in Chapter Chapter 2 and and the introduction introduction to Chapter 5 for the answer to this problem. (b) It would appear that a job costing system provides provides more accurate product product costs because a separate cost is calculated for each job whereas with a process costing system the cost per unit is an average cost. On the other hand, a greater proportion of the costs are likely to be direct under process costing. With a job costing system, a large proportion of costs will be treated as overheads and the problem of apportioning and allocating overheads will result in inaccurate product costs. In this sense process costing might yield more accurate product costs. However, one problem with process costing is that there is a need to estimate the degree of completion of closing stocks of WIP in order to estimate equivalent units and cost per unit. If it is difficult to produce an accurate estimate of the degree of completion then the product costs will also be inaccurate. Therefore it depends on the circumstances – in some situations job costing product costs will be more accurate and in other situations process costing product costs may be more accurate.
Solution IM 5.2
(a) The question does not indicate indicate the method method of overhead overhead recovery. recovery. It is assumed assumed that overheads are to be absorbed using the direct wages percentage method. Process A account Units Direct materials Direct materials added Direct wages Direct expenses Production overhead (250% direct wages) Abnormal gain account
Normal loss account (income due) Process A normal loss Process B normal loss Process C normal loss Process D normal loss Abnormal loss account Abnormal loss account
26
(£) 450 1152 1020 102 168 18
Abnormal gain account Abnormal gain account
(£) 90 140
PROCESS COSTING
(a) See ‘Methods of apportioning joint costs to products’ and ‘Limitations of joint Solution IM 5.3 cost allocations for decision-making’ in Chapter 6 for the answer to this question. (b) Stock – material Components stock Wages Expenses Production overhead Abnormal gain
Process 1 Units (£) 3000 15 000 Process 2 1 000 Normal loss 4 000 10 000 3 000 –––––– 33 000 100 1 200 –––– –––––– 3100 34 200 –––– ––––––
£33 000 £600 Cost per unit = 2700
Process 1 Components stock Wages Expenses Production overhead
Units 2800
–––– 2800 ––––
Process 1 Process 2
–––– –––––– 3100 34 200 –––– –––––– = £12
Process 2 (£) 33 600 Finished goods 780 Normal loss 6 000 Abnormal loss 14 000 7 500 –––––– 61 880 ––––––
£61 880 £700 Cost per unit = 2600 units
Balance b/f Process 2
Units (£) 2800 33 600 300 600
–––– –––––– 2800 61 880 –––– ––––––
= £23
Finished goods (£) 20 000 Cost of sales 59 800 Balance –––––– 79 800 –––––– Normal loss/scrap (£) 600 Abnormal gain (process 1) 700 Cash –––– 1300 ––––
Process 2
Abnormal loss (£) 1380 Cash Profit and loss account –––– 1380 ––––
Normal loss (100 £2) Profit and loss account
Abnormal gain (£) 200 Process 1 1000 –––– 1200 ––––
(a) Input – materials Normal loss (5%) Abnormal loss Completed production Balance (Closing WIP) (b)
Profit and loss account (£) 1080 Abnormal gain
(£) 1000
12 000 ––––– ––––– 600 100 9 500 1 800
Statement of completed production and calculation of cost per unit a Cost element
Total cost Completed Closing WIP Abnormal Total Cost per b (£) units equiv. units loss equiv. units unit (£) c Materials 79 800 9 500 1 800 100 11 400 7.00 Labour and overhead 41 280 9 500 720 100 10 320 4.00 ––––– 11.00 –––––
Value of WIP Materials (1800 units at £7) 12 600 Labour and overhead (720 units at £4) 2 880 ––––– Abnormal loss (100 units at £11) Completed units (9500 units at £11)
15 480 1 100 104 500 ––––––– 121 080 –––––––
Note aThe short cut method is used because the calculations suggest that it was the examiner’s intention that this method should be used. bIt is assumed that losses are detected at the completion stage. c See process account for calculation. (c) Materials: A B C
6 000 4 000 2 000 ––––– 12 000 Labour and overheads ––––– 12 000 –––––
Mixing process account 48 000 Normal loss 24 000 Abnormal loss 7 800 Completed production ––––– 79 800 Closing WIP 41 280 ––––– 121 080 –––––
600 — 100 1 100 9 500 104 500 1 800
15 480
––––– –––––– 12 000 121 080 ––––– ––––––
(d) See ‘Abnormal gains’ in Chapter 5 for the answer to this question
28
PROCESS COSTING
(a) See Chapter 5 for a description of each of the terms. (b) See ‘Normal and abnormal losses’ in Chapter 5 for the answer to this question.
Solution IM 5.5
(c) Workings Process 1 abnormal gain
= input (9000) (7300 completed units + 1800 normal loss) = 100 units.
Process 2 abnormal loss
= input (7300) (4700 completed units + 2000 WIP + 530 normal loss) = 70 units.
It is assumed that the intention of the question is that normal loss is 10% of the input which reached the final inspection stage where the inspection occurs. Therefore normal loss is 530 units [10% (7300 input 2000 WIP)]. The cost per unit of output for process 1 is: cost of production scrap value of normal loss expected output £14 964 + (2450 £6) (1800 £1.20) = (80% 9000) = £3.82 Process 1 Units (£) 9000 14 964 Completed units 14 700 (7300 £3.82) Normal loss 100 382 (1800 £1.20) –––––– 30 046 ––––––
Materials Conversion cost Abnormal gain (100 £3.82)
Normal loss Profit and loss account
Process 1 Process 1
Process 1 Conversion cost
Process 2
PROCESS COSTING
Units
(£)
7300 27 886 1800
Abnormal gain account (£) 120 Process 1 262 ––– 382 –––
Normal loss (income due) account (£) 2160 Abnormal gain (100 £1.20) 753 Cash (balance) –––– 2913 –––– Process 2 account (£) 27 886 Finished goods (W1) 6 300 Normal loss (530 £1.42) Abnormal loss (W1) Closing WIP (W1) –––––– 34 186 –––––– Abnormal loss account (£) 337 Cash (sale of £70 units at £1.42) Profit and loss account ––– 337 –––
Working (W1) The cost per unit calculation for Process 2 (not using the short cut method) is as follows: WIP Total Cost Completed Normal Abnormal equivalent equivalent per units loss loss units units unit (£) (£) 27 886 4700 530 70 2000 7300 3.82 6 300 4700 530 70 1000 6300 1.00 –––––– –––– 34 186 4.82 –––––– ––––
Previous process Conversion cost
(£) Completed units (4700 £4.82) Share of normal loss (530 £4.82) Less sale proceeds (530 £1.42) Cost of completed units Abnormal loss (70 £4.82) WIP
Note that the cost of the input (£34 186) less the sale proceeds of the normal loss equals the cost of the output. The question specifically states that losses occur at the end of the process. This statement, and the above calculations, suggests that the examiner’s intention was that the short cut method should not be applied. The normal loss of £1802 ought to be apportioned between completed units and abnormal loss where this will have a significant impact on the value of completed units and abnormal loss. If this approach is adopted, the normal loss of £1802 could be apportioned as follows: Completed units [4700/(4700 + 70)] £1802 = £1776 Abnormal loss [70/(4700 + 70)] £1802 = £26 Given that the above adjustment will only have a minor effect on the process costs, there is little point in reflecting this apportionment in the process accounts. Solution IM 5.6
Statement of input and output (Kgs) Process 1 Process 2 Opening WIP 3000 2250 Input for the period 4000 2400 –––– –––– Total input 7000 4650 –––– –––– Transferred to next process/finished stock 2400 2500 Closing WIP 3400 2600 Normal loss (10%) 400 240 Balance – Abnormal loss/(gain) 800 (690) –––– –––– 7000 4 650 –––– –––– Statement of completed production and calculation of cost per unit a (Process 1) Opening WIP
Materials Conversion cost
30
(£) 4 400 3 744
Current Total Completed Closing Abnormal cost cost units WIP loss b (£) (£) 22 000 26 400 30 000 c 33 744 –––––– 60 144 ––––––
2 400 2 400
3 400 1 360
800 800
Total equiv. units 6 600 4 560
Cost per unit (£) 4.00 7.40 ––––– 11.40 –––––
PROCESS COSTING
Completed production (2400 units at £11.40) Closing WIP: Materials (3400 units at £4) 13 600 Conversion cost (1360 units at £7.40) 10 064 –––––– Abnormal loss (800 units at £11.40)
27 360
23 664 9 120 –––––– 60 144 –––––– Statement of completed production and calculation of cost per unit (Process 2) a
Opening WIP (£) Previous process cost 4431 Less normal loss (240 units at £2) Conversion cost 5250
Current Total Completed Closing Abnormal cost cost units WIP gain b (£) (£) 27 360 31 791 (480) –––––– 31 311 37 500 c42 750 –––––– 73 061 ––––––
2500 2500
2600 1040
Completed production (2500 units at £22.10) Closing WIP: Previous process cost (2600 units at £7.10) Conversion cost (1040 units at £15)
(690) (690)
Total equiv. units
Cost per unit (£)
4410 2850
7.10 15.00 ––––– 22.10 –––––
55 250 18 460 15 600 –––––
Abnormal gain (690 units at £22.10)
34 060 (15 249) –––––– 74 061 ––––––
Notes a The short cut method is used based on the assumption that the calculations suggest that it was the examiner’s intention to apply this method. b It is assumed that losses/gains are detected at the completion stage c Labour cost plus overheads (150% of overhead cost)
WIP b/fwd Stock control Wages control Overhead control
WIP b/fwd Process 1 Wages control Overhead control Abnormal gain
B/fwd Process 1
PROCESS COSTING
(kgs) 3000 4000 –––– 7000 ––––
(kgs) 2250 2400
690 –––– 5340 ––––
Process 1 (£) 8144 Normal loss 22 000 Process 2 12 000 Abnormal loss 18 000 WIP c/fwd –––––– 60 144 –––––– Process 2 (£) 9 681 Normal loss 27 360 Finished goods 15 000 WIP c/fwd 22 500 15 249 –––––– 89 790 ––––––
Abnormal loss (£) (£) 1 400 Profit and loss a/c 9 120 ––––– 10 520 –––––
(kgs) 400 2400 800 3400 –––– 7000 ––––
(£) — 27 360 9 120 23 664 –––––– 60 144 ––––––
(kgs) 240 2500 2600
(£) 480 55 250 34 060
–––– 5340 ––––
–––––– 89 790 ––––––
10 520 ––––– 10 520 –––––
31
Normal loss Profit and loss a/c
Bank/expense creditors
Abnormal gain (£) (£) 1 380 B/fwd 14 169 Process 2 ––––– 15 549 –––––
300 15 249 –––––– 15 549 ––––––
Overhead control (£) 54 000 B/fwd Process 1 Process 2 Profit and loss a/c ––––– 54 000 –––––
Cost of sales (£) (£) 442 500 Profit and loss a/c 60 250 ––––––– 502 750 –––––––
502 750 ––––––– 502 750 –––––––
ABC plc – Profit and loss account for the year ended September (£) (£) Cost of sales 502 750 Sales Abnormal loss 10 520 Abnormal gain Overhead control 13 250 Profit 124 649 ––––––– 651 169 ––––––– ––––––– Solution IM 5.7
Material Labour and overhead
32
637 000 14 169 ––––––– 651 169 ––––––– –––––––
Statement of cost per unit using the short-cut method: Completed Abnormal Total equiv. Cost per units gain units unit (£) (£) 16 245 9580 (80) 9.500 1.71 28 596 ––––– 44 841 –––––
9580
(48)
9.532
3.00 –––– 4.71 ––––
PROCESS COSTING
(£) 45 121.80
Cost of completed production (9850 × £4.71) Abnormal gain: Materials (80 units × £1.71) Labour and overhead (48 × £3)
144.00 ––––––
Net cost Process account (£) 16 445 Finished goods 28 596 Normal scrap 280.80 –––––––– 45 321.80 ––––––––
Losses are detected at the start of the process and should be allocated between completed units and closing WIP. Therefore it is appropriate to use the short cut method. The calculations are:
Materials Conversion cost
PROCESS COSTING
Total Completed costs units (£) 330 077 a 92 400 a 256 792 92 400
WIP equiv. units
Total equiv. unit
28 200 14 100
120 600 106 500
Cost per unit (£) 2.7371 2.4112 –––––– 5.1482 –––––– 33
Note a £333 092 total cost (opening WIP plus current cost) less scrap value of normal loss (£3015). Production statement
(a) (ii)
Input: Opening WIP Materials input
(kg) 21 700 105 600 ––––––– 127 300 –––––––
Output: Completed units Closing WIP Normal loss (5% 105 600) Abnormal loss (balance)
92 400 28 200 5 280 1 420 ––––––– 127 300 –––––––
Statement of equivalent production and calculation of cost of completed production and WIP
Materials Conversion cost
Current cost (£) 274 296 a 226 195
Completed units less opening WIP requirements
Abnormal loss equiv. units
Closing WIP equiv. units
Total equiv. units
70 700 79 380
1420 —
28 200 14 100
100 320 93 480
Cost per unit (£) 2.7342 2.4197 –––––– 5.1539 ––––––
Note a £276 672 current cost less the scrap value of the normal loss (5 280 kg £0.45). Cost of completed production: Opening WIP (£56 420 + £30 597) 87 017 Materials (70 700 £2.7342) 193 309 Conversion cost (79 380 £2.4197) 192 076 472 402 Abnormal loss: Materials (1 420 £2.7342)
(b) Process account Opening WIP: Materials Conversion costs
56 420 30 597 87 017
Input costs: Materials Conversion costs
34
276 672 226 195 ––––––– 589 884 –––––––
Completed units Abnormal loss Normal loss (sale proceeds) Closing WIP
77 106 34 118 ––––––
111 224 ––––––– 587 508 –––––––
472 402 3 882 2 376 111 224
––––––– 589 884 ––––––– PROCESS COSTING
(c) See introduction to Chapter 6 and ‘Accounting for by-products’ in Chapter 6 for the answer to this question. (a) The answer should include an explanation of the accounting treatment of normal Solution IM 5.9 and abnormal losses as indicated in Chapter 5. A discussion of the alternative treatment of losses might include the following: (i) The stage where the loss is assumed to occur will determine how much of the loss is allocated to completed production and closing WIP. If the loss is assumed to occur at the end of the process, it will be charged to completed production only. (ii) The normal loss may be charged to the good output only or apportioned between the good output and the abnormal loss. (iii) Losses may be valued at variable cost or absorption cost. If the loss has resulted in the consumption of scarce resources then a charge might be added to reflect the opportunity cost of the scarce capacity. (b)
(i) Calculation of units in closing WIP Units Total input: Opening assembly WIP Units added to assembly process
50 000 112 000 ––––––– 162 000 –––––––
Output to be accounted for (162 000 units): Good units completed Spoiled units Lost units Closing WIP (difference)
Notes a The opening WIP completed in this period is 50 000 units. Therefore 40 000 units out of the 90 000 completed units will be started and finished during the period. The opening WIP will be fully completed as far as components are concerned, so no additional equivalent units will be completed in this period. The opening WIP for assembly is 50% complete. Therefore the remaining 50% (i.e. 25 000 units) will be completed in this period. All the opening work in progress will be completed in this period in the finishing process. b Spoilage is recognized at the end of the finishing process. The 10 000 spoilt units will be passed from the assembly to finishing process and will not be considered to be spoilt until the end of the finishing process. Therefore it is inappropriate to allocate a share of the normal loss to the closing WIP of the assembly process. PROCESS COSTING
35
(iii) Calculation of cost per equivalent unit: assembly process
Cost element Bought in components Direct costs Overhead
Completed units less opening WIP equivalent Spoiled units units
(£) Closing WIP: Components (60 000 £1.071 43) 64 286 Closing WIP: Direct costs and overheads (20 000 £0.824 74) 16 495 –––––– Completed units plus spoiled units transferred: Components (50 000 £1.071 43) 53 571 Direct costs etc. (75 000 £0.824 74) 61 856 Add opening WIP (£60 000 + £25 000 + £25 000) 110 000 ––––––– Lost units (2000 £1.896 17) written off Total assembly costs accounted for
80 781
225 427 3 792 ––––––– 310 000 –––––––
Finishing process Completed units transferred from assembly process: 90 000 + 10 000 = 100 000 units. Finishing process costs: (£) (£) Transferred from assembly 225 427 Finishing costs 30 000 255 427 ––––––– Completed cost per unit = £2.554 27 (£255 427/100 000 units). Of the 100 000 units transferred, 90 000 units are completed and 10 000 units are spoiled. Therefore Normal loss = 5000 units (118 90 000) Abnormal loss = 5000 units (balance) The costs of £255 427 can be analysed as follows: Completed units = £242 656 (95 000 £2.554 27) Abnormal loss = £12 771 (5000 £2.554 27) Note that the normal loss is charged to the completed units. (a) The closing stock valuation for October which is given in the question does not Solution IM 5.10 distinguish between materials and conversion cost. It is therefore necessary to prepare the following statement for October: October cost schedule (weighted average basis)
Materials Conversion cost
Total cost (£) 58 500 99 000
Completed Closing WIP units equivalent units 2400 2400
1500 1200
Total Cost per equivalent units unit (£) 3900 15.00 3600 27.50 ––––– 42.50 –––––
WIP value (£) 22 500 33 000 –––––– 55 500 ––––––
November cost schedule (weighted average basis) Closing WIP Total Opening Current Total Completed equivalent equivalent Cost per WIP cost cost units units units unit (£) (£) (£) (£) Materials 22 500 48 600 71 100 2400 1800 4200 16.9286 Conversion cost 33 000 84 000 117 000 2400 900 3300 35.4545 ––––––– 52.3831 ––––––– 36
WIP value (£) 30 471 31 909 –––––– 62 380 –––––– PROCESS COSTING
(b) The difference in profits is due entirely to the difference between the average cost and FIFO stock valuations. Unit costs increased from £42.50 in October to £58 in November. With the average cost method, the stock valuation is based on both October and November costs. This is because the opening WIP value for November is merged with the current costs to calculate the average cost per unit. With the FIFO method, the cost per unit is based entirely on November costs. The closing WIP is assumed to come from the new units which have been started during the period. (c) 1. Use of standard costs: The statement is correct. Standard costs per equivalent unit produced would be used to value stocks, and costs per unit would be the same each period (except for where standards are periodically changed). Consequently standard cost per equivalent unit for the opening WIP would be identical to the standard cost per equivalent unit for the current period, and the two alternative methods of allocating opening WIP to the current period would result in the calculation of identical unit costs. The use of standard costs would also provide useful information for cost control purposes. Periodic comparisons of actual and standard performance could be made to determine whether the process was running efficiently. The standard costing system should pinpoint costs which may be out of control. It is necessary to ensure that standards set are attainable and that variances are not a result of unreasonable standards. 2. Use of current costs: If current costs are used for stock valuation purposes, it will be necessary to adjust this valuation for financial accounting purposes. Therefore using current costs is likely to involve additional work. In addition, profit will be affected by temporary price changes. The comparison of actual costs with standard costs can be inappropriate when costs change frequently throughout the year. The standard cost is likely to represent an average target cost for the year. If costs increase rapidly throughout the year then favourable variances will arise in the early part of the year and these variances will be compensated by adverse variances in the later part of the year. A possible solution is to change the standards each month or to separate the variances into their planning and operational elements (see Chapter 18 for a discussion of planning and operating variances). PROCESS COSTING
37
3. Use of direct cost valuation: Variable costing is preferable to absorption costing for managerial purposes. Monthly profit is a function of sales with a variable costing system, whereas monthly profit will be a function of sales and production with an absorption costing system. Managers might also be motivated to increase stocks in order to reduce the amount of fixed overheads allocated to an accounting period. For a more detailed discussion of the advantages of variable costing see ‘Some arguments in favour of variable costing’ in Chapter 7. The disadvantage of variable costing is that the control of fixed costs might be ignored. If a variable costing system is used, it will be necessary to convert the stock valuation to an absorption costing basis for financial accounting. Note that if a variable costing system is used, a decision will still have to be made whether to use the FIFO or the weighted average stock valuations. 4. Use of cash flow reports: It is important that profit statements be prepared at frequent intervals for control purposes. Annual profit statements are inadequate for control purposes. If stock levels change significantly during a period, cash flow statements will not provide an indication of profit and production performance for the period. Management should receive periodic profit statements and cash flow statements. It is important that both cash flows and profits be monitored at frequent intervals.