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CHAPTER 11
AVERAGE AND FIFO COSTING
Complete Study Guide with All Illustrative Problems
LEARNING OBJECTIVES
Upon the completion of this chapter, you should be able to:
1. Discuss the effect of beginning work in process inventories
2. Discuss the differences between the weighted average and FIFO methods used to account for beginning
work in process inventories
3. Discuss how to deal with spoiled units in a process cost system
4. Discuss how scrap and waste materials are handled in a process cost system
INTRODUCTION — THE PROBLEM OF BEGINNING WIP
The examples in the previous chapter are without beginning work in process inventories. This situation would
probably exist only in the first month of a new business or in a new production process because its usually
continuous and some units will therefore still be in process at the end of the period. The ending work in process
inventory of the previous period will become this period's beginning work in process inventory.
The existence of beginning work in process inventories creates a problem in process costing because of the
following questions that must be considered:
5. Should a distinction be made between completed units from beginning work in process inventory and
completed units from the current period?
6. Should all the units completed during the current period be included at 100% in equivalent production
regardless of the stage of completion of beginning work in process inventory?
7. Should the cost of the beginning work in process inventory be added to costs which have been added to
production during the current period to arrive at "Costs added during the period?"
The answers to these questions will depend on the method chosen to account for beginning work in process
inventory — weighted average costing or first-in, first-out (FIFO) costing. Under the weighted average method no
distinction is made between completed units from beginning work in process and completed units from the current
period. It is as if all completed units were started and completed during the period. Under FIFO method, units in
the beginning work in process inventory are reported separately from units of the current period.
METHODS OF COSTING UNDER PROCESS COSTING
1. FIFO Method
Under this method, there is an assumed flow of manufacturing operations and as such it is considered that those
units which are first placed into process are presumed to be the first ones completed and those that are first
completed are the ones transferred out.
Characteristics:
8. The work in process beginning in the department will require separate computations for its equivalent
production.
9. The units started, completed and transferred will have its own computation for the equivalent production.
2. Average (Weighted Average) Method
Under this method, there is no assumed flow of manufacturing operation. It involves the merging of the
departmental costs, by elements, of the initial work in process inventory with the costs incurred in the current
month and securing a representative average unit cost by dividing the total element of costs by the equivalent
production based upon the sum of units in the initial work in process inventory and the units placed into
production during the period.
Characteristics:
10. In the computation of the equivalent production, the stage of completion of the work in process beginning
is ignored and the total units completed and transferred during the period is considered to have 100%
completion.
DIFFERENCES BETWEEN FIFO AND AVERAGE
A. Computation of Equivalent Production
METHOD HOW BEGINNING WIP IS TREATED
FIFO Work done LAST MONTH on beginning WIP units IS considered. The work done needed to make the WIP 100% is the work assigned to the current month. Formula: (100% - work done last month) AVERAGE Work done last month on beginning WIP units is IGNORED and not considered in the computation of equivalent production.
B. Computation of Unit Cost
FIFO Unit Cost = Current period costs ───────────────────────────────────────── Equivalent units of current work done AVERAGE Unit Cost = Costs in beg. Invty. + Current period cost ───────────────────────────────────────────────────────── Equiv. units in beg. Invty. + Equiv. units of current work done
C. Computation of Cost of Goods Transferred Out and Cost of Ending Inventory
Using FIFO, the cost of goods transferred out equals the SUM OF THE FOLLOWING THREE ITEMS:
- The costs already in the beginning inventory at the beginning of the period.
- The current period costs to complete beginning inventory, which equals the equivalent units to complete
beginning inventory times the current period unit cost computed for FIFO.
- The costs to start and complete units, calculated by multiplying the number times the current units cost
computed.
Units in process, end (80% complete) : 7, Materials in this department are added 100% at the BEGINNING of the process.
a) Average Method
Take note that under average method, the work done on the work in process, beginning is NOT considered in the
computation of the equivalent production.
ACTUAL MATERIALS WD MATERIALS EP LABOR & OH
WD
LABOR & OH EP
Units completed 18,000 100% 18,000 100% 18, Units IP, end 7,000 100% 7,000 80% 5, TOTAL 25,000 25,000 23, NOTE: Under Average method, all 18,000 completed units (whether from beg. WIP or started this period) are counted as 100% complete. The 5,000 beg. WIP units are simply included in the 18,000 completed — no separate treatment needed.
b) FIFO Method
No material was added to the units in process, beginning during the month because as of the end of last month,
the units were already 100% complete as to materials.
ACTUAL MATERIALS WD MATERIALS EP LABOR & OH
WD
LABOR & OH
EP
IP, beg. (to complete) 5,000 — (already 100%) — 60% (100%-40%) 3, Started & completed 13,000 100% 13,000 100% 13, Units IP, end 7,000 100% 7,000 80% 5, TOTAL 25,000 20,000 21, NOTE: Started & completed = Total completed - Beg. WIP = 18,000 - 5,000 = 13, units For Beg. WIP units (5,000):
- Materials: Already 100% at start of period → WD = 0%, EP = 0
- Labor & OH: Were 40% done → Need 60% more this period → EP = 5,000 x 60% = 3, ILLUSTRATIVE PROBLEM 2 — LMN COMPANY
The following information relates to the operations of LMN Company for the month of August, 2019.
UNITS:
In process, Aug. 1 (40% complete) : 1,
Received from Dept. 1 : 8, Completed & transferred : 8, In process, Aug. 31 (20% complete) : 800 COSTS: In Process 8/1 Cost-Aug. Cost from preceding dept. P 13,500 P 81, Materials 9,000 72, Conversion costs 5,036 83, Materials in this department are added 100% at the BEGINNING of the process. SOLUTION A — Average Method
Quantity Schedule & Equivalent Production
ACTUAL MATERIALS WD MAT EP LABOR & OH
WD
L&OH EP
Units IP, beg. 1, Units received 8, Total to account for 9, Units completed 8,200 100% 8,200 100% 8, Units IP, end 800 100% 800 20% 160 TOTAL 9,000 9,000 8,
Costs Charged to the Department
COST ELEMENT IN PROCESS 8/1 COST-AUG. TOTAL UNIT
COST
Cost from preceding dept. P 13,500 P 81,000 P 94,500 P 10. Materials 9,000 72,000 81,000 9. Labor & Overhead 5,036 83,580 88,616 10. TOTAL P 27,536 P 236,580 P 264,116 P 30.
Unit Cost Computations:
Cost from preceding dept. = (13,500 + 81,000) / 9,000 = 10. Materials = (9,000 + 72,000) / 9,000 = 9. Labor & overhead = (5,036 + 83,580) / 8,360 = 10. ───── TOTAL UNIT COST = 30.
Cost Accounted For
ITEM COMPUTATION AMOUNT
Costs Charged to the Department (FIFO — Current Period Only)
COST ELEMENT TOTAL COST ÷ EP = UNIT COST
Cost from preceding dept. P 81,000 ÷ 8,000 P 10. Materials P 72,000 ÷ 8,000 P 9. Labor & Overhead P 83,580 ÷ 7,960 P 10. TOTAL CURRENT UNIT COST P 264,116 P 29.
Unit Cost Computations:
Cost from preceding dept. = 81,000 / 8,000 = 10. Materials = 72,000 / 8,000 = 9. Labor & overhead = 83,580 / 7,960 = 10. ────── TOTAL CURRENT UNIT COST = 29. Note: Total costs to be accounted for = 27,536 (beg. WIP) + 236,580 (current) = P 264, Unit cost for total = 264,116 / (9,000 equiv) = P 29.625 approx
Cost Accounted For (FIFO)
COMPLETED & TRANSFERRED:
From IP, beg.: Cost last month (beg. WIP cost) P 27, Cost added this month: Materials — Labor & overhead (600 x 10.50) 6,300 P 33, Received & completed (7,200 x 29.625) 213, Total completed & transferred P 247, IN PROCESS, END: Cost from preceding dept. (800 x 10.125) P 8, Materials (800 x 9.00) 7, Labor & overhead (160 x 10.50) 1,680 P 16, GRAND TOTAL P 264,116 ✓
Journal Entries — FIFO
- Work in Process – Department 2 81, Work in Process – Department 1 81,
- Work in Process – Department 2 155, Materials 72, Payroll/Factory Overhead Applied 83,
- Finished Goods 246, Work in Process – Department B 246,
ILLUSTRATIVE PROBLEM 3 — DENVER COMPANY
The following data were taken from the books of Denver Company which manufactures a single product through a
two-department manufacturing process — machining and finishing. In the production process, materials are
added to the product at the beginning in both departments. Normal spoilage occurs in the finishing department,
and the spoiled units are not detected until units are completed and inspected.
DATA MACHINING DEPT. FINISHING DEPT.
Beginning inventory 0 20, Stage of completion (beg.) — 50% Transferred in 0 60, Started in production 80,000 0 Transferred out 60,000 60, Ending inventory 20,000 18, Stage of completion (end) 25% 70% Spoiled (lost) units 0 2, Beg. inv. — Direct materials P 0 P 28, Beg. inv. — Conversion costs P 0 P 27, Beg. inv. — Prior dept. costs P 0 P 118, Current — Direct materials P 320,000 P 90, Current — Conversion costs P 130,000 P 193, REQUIREMENTS: Prepare cost of production report for April, 2019 using:
- FIFO method
- Average method KEY NOTES:
- Materials are added at the BEGINNING in BOTH departments
- Normal spoilage in FINISHING dept. only
- Spoiled units NOT detected until completed and inspected (END of process = A-3) MACHINING DEPARTMENT — FIFO METHOD
Since beginning inventory = 0 in the Machining Department, FIFO and Average produce IDENTICAL results.
When there is no beginning inventory, there is nothing to separate or blend.
Quantity Schedule & Equivalent Production
ACTUAL MATERIALS WD MAT EP LABOR & OH
WD
L&OH EP
IP, beg. — Started & completed 60,000 100% 60,000 100% 60,
- IP, beg. (20,000 units, 50% done last month): Materials: Already 100% at start → WD = 0% → EP = 0 Labor & OH: 50% done → need 50% more = 20,000 x 50% = 10,000 EP
- Rec'd & completed = Total completed - Beg. WIP = 60,000 - 20,000 = 40,000 units
- Lost units (2,000) at END: Assign 100% work done → EP = 2,000 each for mat & L&OH Cost of lost units will be ADDED to completed units (A-3 treatment)
Unit Cost Computations (FIFO — Current Period Costs Only)
Cost from preceding dept. = 360,000 / 60,000 = P 6. Materials = 90,000 / 60,000 = P 1. Conversion costs = 193,800 / 64,600 = P 3. ─────────────────────────── TOTAL UNIT COST (current period) = P 10. Total costs to be accounted for = P 817,
Cost Accounted For (FIFO — Normal Lost at END)
COMPLETED & TRANSFERRED:
From IP, beg.: Cost last month (173,500 = 28,000 + 27,500 + 118,000) P 173, Cost added this month: Materials — Conversion costs (10,000 x 3.00) 30,000 P 203, Received & completed (40,000 x 10.50) 441, Total completed & transferred (incl. lost units absorbed) P 644, IN PROCESS, END: Cost from preceding dept. (18,000 x 6.00) P 108, Materials (18,000 x 1.50) 27, Conversion (12,600 x 3.00) 37,800 P 172, GRAND TOTAL P 817,300 ✓ Completed & transferred breakdown: = (40,000 x 10.50) + (2,000 x 10.50) [lost units absorbed] = 420,000 + 21,000 = 441,000 from rec'd units PLUS 173,500 + 30,000 from beg. WIP = 203, Total = P 644,
Unit Cost Computations Detail
Materials = 90,000 / 60,000 = 1. Conversion = 193,800 / 64,600 = 3.
Journal Entries — FIFO (Denver Company)
- Work in Process – Machining Dept. 320, Work in Process – Finishing Dept. 90, Materials 400,
- Work in Process – Machining Dept. 130, Work in Process – Finishing Dept. 193, Payroll/Factory Overhead Applied 323,
- Work in Process – Finishing Dept. 360, Work in Process – Machining Dept. 360, (Transfer of completed units from Machining)
- Finished Goods 644, Work in Process – Finishing Dept. 644, MACHINING DEPARTMENT — AVERAGE METHOD
For the machining department, the cost of production report using FIFO and weighted-average are the same
because there are no beginning inventories. The equivalent production and the allocation for costs to units
transferred out and to ending inventory are identical whether FIFO or weighted-average is used. Recall that these
methods are different only because the weighted-average method computes unit costs using a weighted average
of beginning inventory and current period amounts. If there is no beginning inventory, then the weighted-average
amounts are just the current period amounts.
ACTUAL MATERIALS WD MAT EP LABOR & OH
WD
L&OH EP
IP, beg. — Units started 80, Units completed 60,000 100% 60,000 100% 60, Units IP, end 20,000 100% 20,000 25% 5, TOTAL 80,000 80,000 65, Materials = 320,000 / 80,000 = P 4. Conversion = 130,000 / 65,000 = P 2. Total unit cost = P 6.
Cost Accounted For (Average — Machining)
Completed & transferred 360,000 (P 360,000) In process, end: Materials (20,000 x 4.00) 80, Conversion (5,000 x 2.00) 10,000 P 90, TOTAL P 450,000 ✓
Cost from preceding dept. (18,000 x 5.975 adj.) P 110, Materials (18,000 x 1.5128) 27, Labor & OH (12,600 x 3.0482) 38,407 P 175, GRAND TOTAL P 817,300 ✓
Journal Entries — Average (Denver Company)
- Work in Process – Machining Dept. 320, Work in Process – Finishing Dept. 90, Materials 400,
- Work in Process – Machining Dept. 130, Work in Process – Finishing Dept. 193, Payroll/Factory Overhead Applied 323,
- Work in Process – Finishing Dept. 360, Work in Process – Machining Dept. 360,
- Finished Goods 645, Work in Process – Finishing Dept. 645, Completed & transferred = (60,000 x 10.4165) + (2,000 x 10.4165) SAME DENVER COMPANY DATA — LOST UNITS CLASSIFIED AS NORMAL, DISCOVERED AT BEGINNING A. FIFO METHOD — Finishing Department (Normal Lost at BEGINNING)
When normal lost units are discovered at the beginning of the process, the cost is absorbed by both the units
received AND the units in process at the end (A-1 treatment). No work done is assigned to the lost units, and an
adjustment to the preceding department unit cost is required.
Quantity Schedule & Equivalent Production
ACTUAL MATERIALS
WD
MAT EP LABOR & OH
WD
L&OH EP
IP, beg. 20, Units received 60, IP, beg. (to complete) 20,000 — (0%) — 50% 10, Rec'd & completed 40,000 100% 40,000 100% 40, Units IP, end 18,000 100% 18,000 70% 12, Units lost (at BEG.) 2,000 — — — — TOTAL 80,000 58,000 62,
Lost at BEGINNING (A-1):
- No work done assigned to lost units
- EP denominator DECREASES by 2,000 (lost units excluded)
- Adjustment to preceding dept. cost required
- Cost absorbed by BOTH completed units AND WIP end
Unit Cost Computations with Adjustment
Cost from preceding dept. = 360,000 / 60,000 = P 6.00 (base) Materials = 90,000 / 58,000 = P 1. Labor & OH = 193,800 / 62,600 = P 3. Adjustment for lost units (Method a): = (360,000 / 58,000) - 6. = 6.206896 - 6. = P 0. Adjustment for lost units (Method b): = (2,000 x 6.00) / 58, = 12,000 / 58, = P 0. Total unit cost = 6.206896 + 1.551724 + 3.095846 = P 10.
Cost Accounted For
COMPLETED & TRANSFERRED:
From IP, beg.: Cost last month (173,500) P 173, Cost added this month (conv. 10,000 x 3.095846) 30,959 P 204, Received & completed (40,000 x 10.854466) 434, Total completed & transferred P 638, IN PROCESS, END: Cost from preceding dept. (18,000 x 6.206896) P 111, Materials (18,000 x 1.551724) 27, Labor & OH (12,600 x 3.095846) 39,008 P 178, GRAND TOTAL P 817,300 ✓ EXPLANATION OF LOST UNIT COST ABSORPTION (Normal — Beginning): Under the assumption that units lost were discovered at the beginning or during the processing, the cost of the lost unit will be absorbed by the units received less units lost (58,000) which is represented by the units received & completed and the units in process, end (40,000 + 18,000 = 58,000). It is assumed further that the lost units are from the units received ONLY. However, if it is assumed that the lost units are from the in process, beginning AND
Materials (18,000 x 1.512821) 27, Labor & OH (12,600 x 3.048209) 38,407 P 175, GRAND TOTAL P 817,300 ✓ UNDER AVERAGE METHOD — LOST UNIT ABSORPTION RULES:
- If lost at BEGINNING or DURING process:
- The in process, BEGINNING will SHARE in absorbing the cost of lost units
- The in process, END will also SHARE
- If lost at END of process:
- The cost will be absorbed by the COMPLETED UNITS ONLY
- In process, end does NOT share MASTER SUMMARY — CHAPTER 11 TOPIC KEY POINT Why Beginning WIP Matters Ending WIP of prior period = Beginning WIP of current period; creates cost allocation challenge FIFO Core Principle Units first in = first completed; beginning WIP reported separately from current period units Average Core Principle No assumed flow; beginning WIP costs and EP blended with current period costs EP Under FIFO Beginning WIP: only remaining % counted; separate EP for (a) completing beg. WIP, (b) started & completed, (c) ending WIP EP Under Average Beginning WIP stage ignored; all completed units counted at 100% Unit Cost — FIFO Current period costs ÷ Current period EP only Unit Cost — Average (Beg. WIP costs + Current costs) ÷ (Beg. EP + Current EP) Transferred Out — FIFO Sum: beg. WIP costs + completion costs + started & completed costs Transferred Out — Average Total units transferred out × weighted average unit cost No Beginning WIP FIFO = Average (identical results) Normal Lost at END (A-3) Assign 100% WD; cost added to completed units; no adjustment to preceding dept. cost Normal Lost at BEG. (A-1) No WD assigned; adjustment to preceding dept. cost; cost absorbed by received & completed + WIP end Average + Lost at End Cost absorbed by completed units ONLY Average + Lost at Beg/During Beginning WIP AND ending WIP both share in absorption
FORMULA QUICK REFERENCE — CHAPTER 11 FIFO UNIT COST: = Current period costs / EP (current work done only) AVERAGE UNIT COST: = (Beg. WIP costs + Current period costs) / (Beg. EP + Current EP) FIFO EP for Beginning WIP: = Beginning WIP units x (100% - Stage of completion last period) FIFO — Started & Completed: = Total completed units - Beginning WIP units ADJUSTMENT for Normal Lost Units (A-1, A-2 — Beginning/During): Method 1: (Preceding dept. cost / Units received less lost) - original unit cost Method 2: (Units lost x original unit cost) / (Units received less lost) FIFO — Cost of Goods Transferred Out: = (Beg. WIP costs) + (EP to complete beg. WIP x current unit cost) + (Started & completed x current unit cost) AVERAGE — Cost of Goods Transferred Out: = Total units transferred out x weighted average unit cost
