Skip to main content
Business LibreTexts

5.6: Summary and Key Terms

  • Page ID
    10427
  • Section Summaries

    5.1 Compare and Contrast Job Order Costing and Process Costing

    • The three categories of costs incurred in producing an item are direct material, direct labor, and manufacturing overhead.
    • Process costing is the system of accumulating costs within each department for large-volume, mass-produced units.
    • Process costing often groups direct labor and manufacturing overhead as conversion costs.
    • Costs under GAAP are categorized as period costs when they are not related to production and instead cover a time period.
    • Selling and administrative costs are period costs related to the sales of products and management of the company and are not directly tied to a specific product.
    • Process costing determines the cost per unit through the use of equivalent units, or the number of units that would have been produced if production was sequential instead of in batches.

    5.2 Explain and Identify Conversion Costs

    • Conversion costs are the costs of direct labor and manufacturing overhead used to convert raw materials into a finished product.
    • Materials are added during various stages of the manufacturing process, such as the beginning or end, while conversion of the product from raw material into finished goods is considered to occur uniformly through the process. Thus, it is possible for a product to have all of its materials and not be complete.
    • Equivalent units for direct materials can be different than the equivalent units for conversion costs because materials are added in steps through the manufacturing process, while conversion costs are incurred evenly throughout the process.

    5.3 Explain and Compute Equivalent Units and Total Cost of Production in an Initial Processing Stage

    • Process costing has a work in process inventory account for each department.
    • Equivalent units of production for materials may differ from the equivalent units for conversion costs.
    • The total units to account for is the number of units in the beginning work in process inventory plus the number of units started into production; this total also represents the sum of the number of units completed and the number of units in the ending work in process inventory.
    • The cost per equivalent unit for materials is the total of the material costs for the beginning work in process inventory and the total of material costs incurred during the period.
    • The cost per equivalent unit for conversion costs is the total of the conversion costs for the beginning work in process inventory and the total of conversion costs incurred during the period.
    • The cost of units transferred to the next department is the number of units transferred times the total of the cost per equivalent unit of material plus the cost per equivalent unit for conversion costs.

    5.4 Explain and Compute Equivalent Units and Total Cost of Production in a Subsequent Processing Stage

    • The total units to account for is the number of units in the beginning work in process inventory plus the number of units transferred from the prior department; this total also represents the number of units completed plus the number of units in the ending work in process inventory.
    • The cost per equivalent units for materials is the total of the material costs for the beginning work in process inventory plus the cost of material transferred in to the department plus the total of material costs incurred during the period.
    • The cost per equivalent unit for conversion costs is the total of the conversion costs for the beginning work in process inventory plus the conversion costs transferred in plus the total of conversion costs incurred during the period.

    5.5 Prepare Journal Entries for a Process Costing System

    • Traditional journal entries show the purchase of material and the incurring of overhead costs.
    • Each department records the transfer of material from the storeroom into production, its direct labor costs, the application of overhead, and the transfer of goods to the next department or finished goods.
    • The value of the inventory transferred to the next department or to finished goods equals the amount listed as transferred on the production cost report.

    Key Terms

    conversion cost
    total of labor and overhead for a product; the costs that “convert” the direct material into the finished product
    equivalent units
    number of units that would have been produced if the units were produced sequentially and in their entirety in a particular time period
    expense recognition principle
    (also, matching principle) matches expenses with associated revenues in the period in which the revenues were generated
    manufacturing costs
    (also, product costs) total of all costs expended in the manufacturing process; generally consists of direct material, direct labor, and manufacturing overhead
    period costs
    typically related to a particular time period instead of attached to the production of an asset; treated as an expense in the period incurred (examples include many sales and administrative expenses)
    prime costs
    direct material expenses and direct labor costs
    process costing
    costing system used when a standardized process is used to manufacture identical products and the direct material, direct labor, and manufacturing overhead cannot be traced to a specific unit
    product costs
    all expenses required to manufacture the product: direct materials, direct labor, and manufacturing overhead
    production cost report
    shows the costs used in the preparation of a product, including the cost per unit for materials and conversion costs and the amount of work in process and finished goods inventory
    selling and administrative (S&A) expenses
    period costs not directly assigned to the items produced or services provided; include costs of departments not directly associated with manufacturing but necessary to operate the business
    spoilage
    any units that are not fit for sale due to breakage or other imperfections