Some companies have homogeneous or very similar products that are not made to order and are produced in large volumes. They continually process their product, moving it from one function to the next until it is completed. In these companies, the manufacturing costs incurred are allocated to the proper functions or departments within the factory process rather than to specific products. Examples of products that companies produce continuously are cereal, bread, candy, steel, automotive parts, chips, and computers. Companies that refine oil or bottle drinks and companies that provide services such as mail sorting and catalog order are also examples of continuous, homogeneous processing.
To illustrate, assume the Best Chips company manufactures potato chips. The company has three work areas they call preparation, baking, and packaging. The preparation area includes cutting potatoes and adding flavorings. Conveyor belts are used to move the product from one function to the next. In this company, raw materials are added in two of the functions: the preparation function and the packaging function. Labor and overhead are incurred in each function. Figure
1 shows the process flow and costs associated with Best Chip's process cost system.
Figure 1
Process Cost System Cost Flows
The cost report for Best Chips summarizes how manufacturing costs (direct materials, direct labor, and manufacturing overhead) are assigned to the three departments. The report for June is as follows:
Best Chips Cost Summary For the Month Ended June 30, 20X2 Work-in-Process Inventory
Raw Materials Inventory
Factory Labor
Factory Overhead
Preparation
Baking
Packaging
Beginning balance
5,200
3,200
June costs
4,600
7,100
2,300
Costs assigned
Direct materials
(6,500)
2,800
3,700
Indirect materials
(1,300)
1,300
Direct labor
(5,300)
2,900
500
1,900
Indirect labor
(1,800)
1,800
Factory overhead
(5,525)
435
3,000
2,090
Predetermined overhead rates
15%
600%
110%
The raw materials are assigned based on material requisition forms, the labor based on time tickets, and the overhead based on predetermined overhead rates based on direct labor dollars. The journal entries to record these transactions are made prior to the period end entries that transfer the amounts from one work-in-process inventory account to another, from work-in-process inventory to finished goods inventory, and from finished goods inventory to cost of goods sold. The letters of the journal entries used to illustrate the accounting for process cost systems correspond to the letters in Figure
1 .
Raw materials requisitioned
Best Chips started the month of June with $5,200 in raw materials inventory. Best Chips uses the perpetual inventory method, so raw materials purchased are added to the raw material inventory account when they are received. Raw materials requisitioned that become part of the final product or are used by a specific function are considered direct materials used. The costs of direct materials are added to the proper department's work-in-process inventory account. Raw materials requisitioned that are used for general production purposes are added to factory overhead. The journal entries related to raw material activity for June are:
General Journal
Date
Account Title and Description
Ref.
Debit
Credit
20X2
June 30
Raw Materials Inventory
4,600
(A)
Accounts Payable
4,600
Purchased raw materials on credit
(C)
Factory Overhead
1,300
Raw Materials Inventory
1,300
Indirect materials for June
(F)
Work-in-Process Inventory-Preparation
2,800
Work-in-Process Inventory-Packaging
3,700
Raw Materials Inventory
6,500
Transfer direct materials to work-in-process inventory
At the end of the month, $2,000 of materials remained in raw materials inventory.
Raw Materials Inventory
beginning balance
5,200
1,300
(C)
(A)
4,600
6,500
(F)
9,800
7,800
ending balance
2,000
Factory labor
As the factory labor payroll is prepared and recorded, the payroll costs are split between those employees who work in specific functions (departments) and those involved in the general functions of the factory. The specific function costs are called direct labor and are assigned to work-in-process inventory. The general factory labor costs are indirect labor costs that are added to factory overhead. Unlike the accounting for payroll under the job order cost system, the employee does not have to be physically involved in making a product to be assigned to a specific function. If a specific maintenance worker or supervisor is assigned to the preparation function, their wages are allocated to that function even though these workers are not directly involved in preparing the chips to be baked. The accounting for the labor costs for June includes the following journal entries, shown in the following table.
The balance in the factory labor account should be zero at the end of each period.
Factor Labor
(B)
7,100
1,800
(D)
5,300
(G)
7,100
7,100
0
Factory overhead
In a process company, factory overhead represents those costs not directly assigned to one function. For example, the depreciation expense of a machine used solely by the preparation function would be assigned to work-in-process inventory for the preparation department while depreciation expense for the plant (the factory building) would be assigned to factory overhead as all functions occupy the plant. The journal entries that follow illustrate the accounting for general overhead costs.
General Journal
Date
Account Title and Description
Ref.
Debit
Credit
20X2
June 30
Factory Overhead
2,300
(E)
Prepaid Insurance
1,000
Accounts Payable-Electric Utilities
1,200
Cash
100
June overhead × costs
(H)
Work-in-Process Inventory-Preparation
435
Work-in-Process Inventory-Baking
3,000
Work-in-Process Inventory-Packaging
2,090
Factory Overhead
5,525
Overhead allocated based on predetermined rates
At the end of the period, the factory overhead account has a credit balance of ($125). This is called overapplied overhead and an entry would be made at the end of the period to move it to cost of goods sold, or alternatively, to allocate the difference to work-in-process inventories, finished goods inventory, and cost of goods sold. After recording this entry, the balance in the factory overhead account is zero.
Current Liabilities
Traditional Cost Systems
