Appendix Standard-Costing Method of Process Costing

Chapter 7 described accounting in a standard-costing system. Recall that this involves making entries using standard costs and then isolating variances from these standards in order to support management control. This appendix describes how the principles of standard costing can be employed in process-costing systems.

Benefits of Standard Costing

Companies that use process-costing systems produce masses of identical or similar units of output. In such companies, it is fairly easy to budget for the quantities of inputs needed to produce a unit of output. Standard cost per input unit can then be multiplied by input quantity standards to develop a standard cost per output unit.

The weighted-average and FIFO methods become very complicated when used in process industries, such as textiles, ceramics, paints, and packaged food, that produce a wide variety of similar products. For example, a steel-rolling mill uses various steel alloys and produces sheets of varying sizes and finishes. The different types of direct materials used and the operations performed are few, but used in various combinations, they yield a wide variety of products. In these cases, if the broad averaging procedure of actual process costing were used, the result would be inaccurate costs for each product. Therefore, managers in these industries typically use the standard-costing method of process costing.

Under the standard-costing method, teams of design and process engineers, operations personnel, and management accountants work together to determine separate standard costs per equivalent unit on the basis of different technical processing specifications for each product. Identifying standard costs for each product overcomes the disadvantage of costing all products at a single average amount, as under actual costing.

Computations Under Standard Costing

We present standard costing for the assembly department of Pacific Electronics using the five-step procedure introduced in section Case 2: Process Costing With Zero Beginning and Some Ending Work-in-Process Inventory. We assume the same standard costs apply in February and March 2020. Data for the assembly department follow:

Spreadsheet screenshot shows physical units, direct materials, conversion costs, and total costs of Pacific Electronics for February and March 2020.

Details of the spreadsheet are as follows:

  1. Physical units

    • Work in process, beginning inventory as on March 1: 225

    • Started during March: 275

    • Completed and transferred out during March: 400

    • Work in process, ending inventory (March 31): 100

  2. Direct materials

    • Standard cost per unit: $74

    • Degree of completion of beginning work in process: 100%

    • Beginning work-in-process inventory at standard costs: $16,650 (refer to note a)

    • Degree of completion of ending work in process: 100%

    • Actual total costs added during March: $19,800

  3. Conversion costs:

    • Standard cost per unit: $54

    • Degree of completion of beginning work in process: 60%

    • Beginning work-in-process inventory at standard costs: $7,290 (refer to note a)

    • Degree of completion of ending work in process: 50%

    • Actual total costs added during March: $16,380

  4. Total costs (sum of direct materials and conversion costs):

    • Beginning work-in-process inventory at standard costs: $23,940

    • Actual total costs added during March: $36,180

      Note a: Work in process, beginning inventory at standard costs

    • Direct materials is equal to 225 physical units multiplied by 100% completed multiplied by $74 per unit which equals $16,650.

    • Conversion costs is equal to 225 physical units multiplied by 60% completed multiplied by $54 per unit which equals $7,290.

Exhibit 18-12 presents Steps 1 and 2. These steps are identical to the steps described for the FIFO method in Exhibit 18-6 because, as in FIFO, the standard-costing method also assumes that the earliest equivalent units in beginning work in process are completed first. Work done in the current period for direct materials is 275 equivalent units. Work done in the current period for conversion costs is 315 equivalent units.

Exhibit 18-12 

Summarize the Flow of Physical Units and Compute Output in Equivalent Units Using the Standard-Costing Method for the Assembly Department for March 2020

Spreadsheet screenshot shows the flow of physical units and compute output in equivalent units using the standard-costing method for the assembly department for March 2020.

Details of the physical units and equivalent units in terms of direct materials and conversion costs are as follows:

  1. Work in process, beginning (given on page 711)

    • Physical units: 225

  2. Started during current period (given on page 711)

    • Physical units: 275

  3. To account for

    • Physical units: 500

  4. Completed and transferred out during current period

    1. From beginning work in process (refer to note a)

      • Physical units: 225

      • Direct Materials (product of 225 and the difference of 100% and 100%): 0

      • Conversion Costs (product of 225 and the difference of 100% and 60%): 90

    2. Started and completed

      • Physical units: 175 (refer to note b)

      • Direct Materials (product of 175 and 100%): 175

      • Conversion Costs (product of 175 and 100%): 175

    3. Work in process, ending (given on page 711) (refer to note c)

      • Physical units: 100

      • Direct Materials (product of 100 and 100%): 100

      • Conversion Costs (product of 100and 50%): 50

  5. Accounted for

    • Physical units: 500

  6. Equivalent units of work done in current period

    • Direct Materials (product of 100 and 100%): 275

    • Conversion Costs (product of 100and 50%): 315

      Note a: Degree of completion in this department: direct materials, 100%; conversion costs, 60%.

    • Note b: 400 physical units completed and transferred out minus 225 physical units completed and transferred out from beginning work-in-process inventory.

    • Note c: Degree of completion in this department: direct materials, 100%; conversion costs, 50%.

Exhibit 18-13 describes Steps 3, 4, and 5. In Step 3, total costs to account for (that is, the total debits to Work in Process—Assembly) differ from total debits to Work in Process—Assembly under the actual-cost-based weighted-average and FIFO methods. That’s because, as in all standard-costing systems, the debits to the Work in Process account are at standard costs, rather than actual costs. These standard costs total $61,300 in Exhibit 18-13. In Step 4, costs per equivalent unit are standard costs: direct materials, $74, and conversion costs, $54. Therefore, costs per equivalent unit do not have to be computed as they were for the weighted-average and FIFO methods.

Exhibit 18-13 Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Costs to Units Completed and to Units in Ending Work-in-Process Inventory Using the Standard-Costing Method for the Assembly Department for March 2020 Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Costs to Units Completed and to Units in Ending Work-in-Process Inventory Using the Standard-Costing Method for the Assembly Department for March 2020

Spreadsheet screenshot shows the total costs to account for, compute the cost per equivalent unit.

And assign costs to the units completed and units in ending work-in-process inventory using the standard-costing method for the assembly department for March 2020.

Details of the spreadsheet are as follows:

  1. Step 3

    1. Work in process, beginning

      • Total production costs (sum of direct materials and conversion costs): $23,940

      • Direct materials: Product of 225 and $74

      • Conversion cost: Product of 135 and $54

    2. Costs added in current period at standard costs

      • Total production costs (sum of direct materials and conversion costs): 37,360

      • Direct materials: Product of 275 and $74

      • Conversion cost: Product of 315 and $54

    3. Total costs to account for

      • Total production costs (sum of direct materials and conversion costs): $61,300

      • Direct materials: $37,000

      • Conversion cost: $24,300

  2. Step 4

    1. Standard cost per equivalent unit

      • Total production costs (sum of direct materials and conversion costs): $128

      • Direct materials: $74

  3. Step 5: Assignment of costs

    1. Completed and transferred out (440 units)

      1. Work in process, beginning (225 units)

        • Total production costs (sum of direct materials and conversion costs): $23,940

        • Direct materials: Product of 225 and $74

        • Conversion cost: Product of 135 and $54

      2. Costs added to beginning work in process in current period

        • Total production costs (sum of direct materials and conversion costs): $4,860

        • Direct materials: Product of 0 and $74 (refer to note a)

        • Conversion cost: product of 90 and $54 (refer to note a)

      3. Total from beginning inventory

        • Total production costs (sum of direct materials and conversion costs): 28,800

      4. Started and completed (175 units)

        • Total production costs (sum of direct materials, and conversion costs): 22,400

        • Direct materials: Product of 175 and $74 (refer to note b)

        • Conversion cost: Product of 175 and $54 (refer to note b)

      5. Total costs of units completed and transferred out

        • Total production costs (sum of direct materials and conversion costs): $51,200

    2. Work in process ending (100 units)

      • Total production costs (sum of direct materials and conversion costs): $10,100

      • Direct materials: Product of 100 and $74 (refer to note c)

      • Conversion cost: Product of 50 and $54(refer to note c)

    3. Total costs accounted for

      • Total production costs (sum of direct materials and conversion costs): $61,300

      • Direct materials: $37,000

      • Conversion cost: $24,300

  4. Summary of variances for current performance

    1. Costs added in current period at standard costs (refer to note d)

      • Direct materials: $37,000

      • Conversion cost: $24,300

    2. Actual costs incurred

      • Direct materials: $37,000

      • Conversion cost: $24,300

    3. Variance

      • Direct materials: $37,000

      • Conversion cost: $24,300

        (E) Note a: Equivalent units used to complete beginning work in process from Exhibit 18-12, Step 2.

      • Note b: Equivalent units started and completed from Exhibit 18-12, Step 2.

      • Note c: Equivalent units in ending work in process from Exhibit 18-12, Step 2.

      • Note d: From Step 3 above: Direct Materials: (275 multiplied by $74); Conversion Costs; (315 multiplied by $54).

Exhibit 18-13, Step 5, assigns total costs to units completed and transferred out and to units in ending work-in-process inventory, as in the FIFO method. Step 5 assigns amounts of standard costs to equivalent units calculated in Exhibit 18-12: (1) first to complete beginning work-in-process inventory, (2) next to start and complete new units, and (3) finally to start new units that are in ending work-in-process inventory. Note how the $61,300 total costs accounted for in Step 5 of Exhibit 18-13 equal total costs to account for.

Accounting for Variances

Process-costing systems using standard costs record actual direct materials costs in Direct Materials Control and actual conversion costs in Conversion Costs Control (similar to Variable and Fixed Overhead Control in Chapter 8). In the journal entries that follow, the first two record these actual costs. In entries 3 and 4a, the Work-in-Process—Assembly account accumulates direct materials costs and conversion costs at standard costs. Entries 3 and 4b isolate total variances. The final entry transfers out completed goods at standard costs.

A table shows steps 1 through 3 of the final journal entry that transfers out completed goods at standard costs

The table depicts steps 1 through 3 of the final journal entry that transfers out completed goods at standard costs. The details of the table are as follows:

 

1. Assembly department direct materials control at actual costs: 19,800

2. Assembly department conversion costs control at actual costs: 16,380

Entries 3, 4, and 5 use standard cost amounts from Exhibit 18-13.

 

3. Work in process, assembly at standard costs: 20,350

A table shows steps 4a, 4b, and 5 of the final journal entry that transfers out completed goods at standard costs

The table depicts steps 4a, 4b, and 5 of the final journal entry that transfers out completed goods at standard costs. The details of the table are as follows:

 

4a. Work in process, assembly at standard costs: 17,010

4b. Assembly department conversion costs allocated: 17,010

5. Work in process, testing at standard costs: 51,200

Variances arise under standard costing, as in entries 3 and 4b. That’s because the standard costs assigned to products on the basis of work done in the current period do not equal actual costs incurred in the current period. Recall that variances that result in higher income (or lower costs) than the standard are favorable, while those that reduce income are unfavorable. In journal entries, favorable cost variances are credits, while unfavorable variances are debits. In our example, both direct materials and conversion cost variances are favorable, as indicated by the “F” designations in Exhibit 18-13.

Variances can be analyzed in little or great detail for planning and control purposes, as described in Chapters 7 and 8. Sometimes direct materials price variances are isolated at the time direct materials are purchased and only efficiency variances are computed in entry 3. Exhibit 18-14 shows how costs flow through the general-ledger accounts under standard costing.

Exhibit 18-14 

Flow of Standard Costs in a Process-Costing System for the Assembly Department for March 2020

Figure shows the flow of standard costs in a process-costing system of the assembly department for March 2020.

Details of inflow and outflow of costs through various T-accounts are as follows:

  1. Assembly department direct materials control

    Left side of the T-account:

    • 19,800

    Right side of T-account:

    • 3. 19,800 is transferred to work in process – assembly account

  2. Assembly department conversion costs control

    Left side of the T-account:

    • 2. 16,380

    Right side of T-account:

    • 4b. 16,380 is transferred to Assembly department conversion costs allocated

  3. Assembly department conversion costs allocated

    Left side of the T-account:

    • 4b. 17,010, 630 is transferred to conversion cost variances

    Right side of T-account:

    • 4a. 17,010 is transferred to work in process – assembly account

  4. Accounts payable control

    Left side of the T-account:

    • Nil

    Right side of T-account:

    • 19,800

  5. Various accounts

    Left side of the T-account:

    • Nil

    Right side of T-account:

    • 16,380

  6. Work in process – assembly

    Left side of the T-account:

    • Balance 23,940

    • 3. 20,350

    • 4a. 17,010

    • Balance: 10,100

    Right side of T-account:

    • 51,200 is transferred to work in process¬¬¬–testing

  7. Direct materials variances

    Left side of the T-account:

    • Nil

    Right side of T-account:

    • 3. 550 transferred in from assembly department direct materials control

  8. Conversion costs variances

    Left side of the T-account:

    • Nil

    Right side of T-account:

    • 4b. 630 transferred in from assembly department conversion costs allocated

  9. Work in process–testing

    Left side of the T-account:

    • 51,200

    Right side of T-account:

    • xx is transferred out to finished goods

  10. Finished goods

    Left side of the T-account:

    • xx is transferred in for from work in process–testing

    Right side of T-account:

    • xx is the cost of goods sold.