Process Costing

In this video, we're going to discuss process costing, which stands out in contrast to what we talked about before, which is job order costing. And the key difference between these two is that with process costing, we have, we're dealing with a homogeneous product, right? So we're dealing with something like oil, right? Five quarts of oil over here is indistinguishable from five quarts of oil over here. We're just talking about standard oil. Now, job order costing, we've actually got some heterogeneous products. And so we end up with a job cost ticket, right? So we'll have like somebody says, okay, I want two chairs, a table, I want these different things. And that's in the job cost sheet. So we say like, okay, this is job 511, 511A. And then we will go ahead and put the materials cost. We put the direct labor, the overhead. All these things would be charged to a job. But in process costing, because all the jobs, so to speak, it's basically the same product. It's all just oil, right? So we don't really need like a different job ticket for each thing. So what we do is we just allocate the cost or do the cost flows through departments. Right? So instead of having what we have under the job order costing, well, we might have hundreds of jobs, right? We might have thousands of these job cost sheets. And that's basically how our costs are flowing, right? They're flowing through these jobs. Instead, we're flowing our, all our costs are just going through the departments. For example, like processing the oil, packaging it for sale, those types of things. So it's actually a little bit easier dealing with process costing as opposed to job order costing because it's all the costs just get dumped and come right through these departments instead of a bunch of individualized jobs. So let's take a look in an example of how process costing would look for a firm. So let's say in our example that you make cookies. This is a cookie factory. You produce cookies. And let's just, there's probably a lot more to cookies than I'll ever know, but let's just say that we've got three departments, right? So in our cooking, we've got the preparation. That's like getting the dough and getting the dough ready to go into the oven. Then actually baking the dough, baking the cookie dough and baking the cookies. And then we've got packaging, right? Because after we make the cookie, we have to actually put it in packages to get it ready for sale. So we've got, we've got these three departments here, right? So these are our departments. And so what we're going to do is, let's just draw a little value chain here. Excuse me. Just kind of an idea of how value is being created. So we're taking raw materials. That's our, that's what we start with, right? This dough. And we basically, we bring it in to the prep department, right? We start prepping the cookie dough. And of course, we're adding in labor and stuff. I shouldn't say stuff. Manufacturing overhead. These types of things are coming in at this point in the process. Right? And then once we've done kind of the preparation, that first, that first stage, now we move on to the baking. Bake the cookie. We put bake. And then we package. Now, when things are, when our product is going through here, it's really in process, right? So we'll call it work in process, right? That's work in process inventory, which we've talked about before. And then ultimately, it goes to finished goods. And then I've run out of space here. So I'll say after things are transferred out of finished goods, ultimately it's when we sell them, and they go to cost of goods sold. So I'll just abbreviate COGS. So what we really want to focus on mainly is the difference with process costing, is we're going to have a WIP account here. With these three, we're going to have this WIP account. We're going to have a WIP account for prep. We're going to have a WIP account for baking and a WIP account for packaging. Three different WIP accounts. Whereas under job order costing, there's just one WIP account. Just one work in process account under inventory. But we're going to have one for each department. And if you had two departments, then you would have two WIP accounts under process costing. And so we're going to start with these raw materials. And then as their requisition, it's going to go into the WIP account for prep. And then as we move our cookies from dough to actually being in the oven, we're going to take the WIP and decrease our WIP for the prep, and then we're going to increase our WIP account for baking. So let's look at some journal entries. And that will make it a little bit easier for you to understand when we look at how the entries will play out. So let's start in the beginning. We'll say we've got our requisitioning raw materials. Okay. And let's say that we requisition for each process. Let's take a look here. We'll have WIP for prep. Now this is our initial dough, right? We're just saying, okay, we need some dough here. And let's say that we take $105,000. Then we also need some, we've got some action here with the baking. And then we've got with the packaging. And you might think, okay, well, what kind of materials could we use for packaging? Well, we're going to have plastic, for example. You know, it would be our input here. When we think about the prep, obviously, the cookie dough, maybe the baking, there's some kind of oil. So we'll just say we've got a debit of $105,000 to the WIP account for the prep, right, the prep department. And then for baking, we'll say that it's $3,000 of raw material. And then we've got $12,000 for the packaging. And then we'll just credit, we'll credit raw materials. I'll just abbreviate here raw mass. And that adds up to $120,000. So this is our journal entry. We're just taking some raw materials and we're putting them into action. And we've got, again, now we've got a WIP account for each department. Now, as we go forward, we can also, we're going to apply direct labor, right. So obviously, when we go and actually have people that we pay to put the cookies in the oven, people we pay to lay the dough out and all those things, we're applying direct labor. And what's going to happen is just like job order costing, now we're going to have those direct labor costs flow through into the work in process account. So let's, but again, the difference from job order costing, now we're going to have the three separate WIP accounts. So we'll have WIP for prep. We'll have a WIP for baking. This is as we have people actually do direct labor in each of these departments. And then the WIP for packaging. Okay. So now, let's just say that the amounts here, let's say we're talking about $3,000 of direct labor for the prep, $5,000 for baking, and $6,000 for packaging. And then, well, what do we credit? Well, we just credit wages payable, wages payable for the total amount. That should be $14,000. Okay. So this is, now we're accounting here for the direct labor that has been applied to the product. And now, it's the cost of that labor is flowing through to work in process, right? We've applied some labor, some work to our product. And so we've got work in process. We don't have a finished cookie yet, but we've got some work in process. Now, we would do the same thing essentially for when we do the application of the overhead. So when we apply the overhead, apply overhead, we're going to, we're just going to have these three WIP accounts, right? And then, we're going to have a credit to the manufacturing overhead. So I'm not going to write all these out again, but I'll just tell you that instead of having wages payable, you'd have the overhead right here. Okay. So that gives you an idea of how the costs flow through the system. Now, what about between departments? Because if you remember, we say, okay, we go and we take the dough. We apply some labor to it. We do these things. That's in our prep department. But eventually, at some point, we move it to the baking department. So how do those costs flow between departments, right? We've just kind of talked about kind of putting raw materials in and doing some labor at each stage, but what about in between these departments? How would the costs flow? What would the journal entries look like? We're not dealing with that anymore. So what you would do, let's say, so now, we're saying between departments. So let's say that we had $47,000 worth of WIP that we've done in the prep department, and now, we want to transfer that. We've done $47,000 worth of work, and now, we want to transfer it to the next department, which is baking. We're ready to put the $47,000 worth of WIP into the oven. So what do we do? Well, we're going to take, we're going to be adding to the WIP account for baking. So we're going to make a debit there of $47,000, right? And then, we're going to credit or reduce, because remember, WIP is an inventory account. It's an asset. It's going to be reduced with a credit, $47,000. Okay? So what we've done here is we just say we're going to reduce the prep department's WIP account, and then, we're going to increase the baking department's WIP account. So that's just, we're just transferring the flows, or excuse me, the cost. They're just flowing right through the system, right? We've requisitioned the raw materials, and now, we're saying, okay, in between departments, we're moving along the work in process as we're processing this cookie and getting it to complete, the completed state, which will be at finished goods. So now, if we said, okay, well, how will we go getting cost, you know, once we've done the baking of this, how will we go to the ultimate, the next step, will we go to packaging? And again, you just do a similar process. You would just debit packaging, right? And then, you would credit the baking for whatever amount it is that you're transferring. And then, when you get to finished goods, now, at that point, you credit, or excuse me, you debit finished goods inventory, right? Now, you've got a finished cookie, and you're going to credit the packaging. So it's just that simple. We're just moving the cost along that value chain that we talked about. So ultimately, of course, when we go and sell our cookies, we're going to have, when we're debiting cost of goods sold, now, it's actually getting to the income statement, and then crediting the finished goods inventory as we get rid of the cookie.