Process Costing – Weighted Average Method

Process costing system is used for standardized production processes. Whenever a process cost sheet is prepared for a department, the department most likely has some unfinished units either in its beginning work in process, closing work in process or both. In such a situation, it is important to determine a cost flow assumption, i.e. to agree on the order in which costs are transferred out to the next department. There are two cost-flow assumptions: first-in-first-out (FIFO) and weighted average.

In the weighted average method of process costing, the costs are averaged out and evenly applied to both units transferred out and units in closing work in process. Unlike FIFO method, which assumes costs introduced first into a department are transferred out first, weighted average method does not assume any specific order.

Process costing under weighted-average method involves the following steps:

1. Preparing the quantity schedule: i.e. finding units in the beginning work in process for the period, units started or units transferred-in from prior departments, units transferred out to next department or units of finished goods, and units in closing work in process.
2. Bringing forward the cost of units in the beginning work in process from last period. The cost should be broken up into all its components: direct materials and conversion costs (=direct labor and manufacturing overheads).
3. Finding the costs added in the current department under different heads: direct materials, direct labor and manufacturing overheads.
4. Finding total cost to be accounted for under each head i.e. direct materials, direct labor and manufacturing overheads. This would involve adding the cost included in the opening work in process on account of direct materials, direct labor and manufacturing overheads to the corresponding amounts added during the period on account of the relevant cost component.
5. Finding total equivalent units.
6. Finding cost per equivalent unit for each cost component by dividing the total cost for the cost component by total equivalent units for the relevant cost component.
7. Allocating the cost between the units transferred out and units included in the closing work in process.

Example

Let us prepare a process cost sheet under weighted average method using the following data for Company ABC's packaging department for the month of December 2013.

• 20,000 units in work in process as at 1 December: $20,000 direct materials and$40,000 for conversion costs (i.e. $10,000 direct labor and$30,000 manufacturing overheads)
• 200,000 units transferred in from production department during the month: at a total cost of $555,000. • Costs added included: direct materials of$22,000 and conversion costs of $20,000. • 180,000 units transferred to finished goods • 40,000 units in work in process as at 31 December: 100% complete as to costs transferred-in, 80% complete as to materials and 50% complete as to conversion costs. Solution Let us prepare the quantity schedule.  As at 1 December 20,000 Transferred in 200,000 Units to be accounted for 220,000 Transferred out 180,000 As at 31 December 40,000 Units accounted for 220,000 Next, calculate the equivalent units. Transferred- in Direct Materials Conversion Costs Transferred out (A)180,000180,000180,000 Units as at 31 December (B)40,00040,00040,000 Percentage of completion (C)100%80%50% Equivalent units as at 31 Dec (D=B×C)40,00032,00020,000 Total equivalent units (A+D)220,000212,000200,000 Next, calculate the cost per equivalent unit. Transferred- in Direct Materials Conversion Costs Total As at 1 December$0$20,000$40,000$60,000 Added during the month$555,000$22,000$20,000$597,000 Costs to be accounted for$555,000$42,000$60,000$657,000 Total equivalent units220,000212,000200,000 Cost per equivalent unit$2.52$0.20$0.30$3.02 Now, we need to find the cost of units transferred out. It equals$543,600 [= $3.02 × 180,000]. We also need the figure for cost of work in process as at 31 December. It can be calculated as shown in the table below. Transferred- in Direct Materials Conversion Costs Total Units as at 31 December (A)40,00040,00040,00040,000 Cost per equivalent unit (B)$2.52$0.20$0.30$3.02 Percentage of completion (C)100%80%50% Total cost (A×B×C)100,9096,3406,000113,249 Since cost of opening WIP plus cost added must equal cost transferred out and cost in closing WIP, the cost of closing WIP can be calculated using as short-cut formula given below: Cost of closing WIP = Costs to be Accounted for − Costs Transferred Out In this example, it turns out a figure of$113,400 (total cost to be accounted for of $657,000 minus costs transferred out of$543,600). The minor difference is due to rounding off.

The final process cost sheet should look like as follows:

Company ABC
Packaging Department
Cost of Production Report
Dec-13
QUANTITY SCHEDULE
As at 1 December20,000
Transferred in200,000
Units to be accounted for220,000
Transferred out180,000
As at 31 December40,000
Units accounted for220,000
COST SCHEDULE
Direct materials20,000
Conversion costs40,000
As at 1 December (A)60,000
Costs-transferred in (B)555,000
Direct materials22,000
Conversion costs20,000