13.2 Process Costing and Backflush Costing
Key Takeaways
Process costing divides departmental costs by equivalent units of production, computed separately for materials and conversion costs.
Weighted average pools beginning WIP costs with current costs, while FIFO divides only current costs by the equivalent work done this period.
Normal loss detected at the end of the process is added to the cost of good units transferred out; abnormal loss is always charged to a period loss account.
Units received from a prior department carry transferred-in costs that are 100% complete, like materials added at the start.
Backflush costing records costs only at trigger points, such as the purchase of materials and the completion or sale of goods, flushing standard costs out of the inventory accounts.
Process Costing and Backflush Costing
Process costing is used when identical units flow continuously through departments (cement, flour milling, beverages, chemicals), and backflush costing is the simplified system used in just-in-time (JIT) plants. The AFAR syllabus (topics 13.3 and 13.4) tests the cost of production report under the FIFO and weighted average methods, the treatment of lost units, and backflush journal entries.
1. The Logic of Process Costing
Costs are accumulated by department, not by job, and divided by equivalent units of production (EUP), the number of complete units that the work done during the period represents. Materials and conversion costs (direct labor plus overhead) usually have different stages of completion, so each gets its own EUP. A cost of production report has four parts:
- Quantity schedule: units to account for (beginning WIP plus started or received) and units accounted for (completed and transferred, ending WIP, lost units);
- Equivalent units for each cost element;
- Cost per equivalent unit; and
- Assignment of costs to units transferred out, ending WIP, and any abnormal loss.
| Method | EUP Include... | Costs Divided |
|---|---|---|
| Weighted average | All units completed plus the equivalent work in ending WIP, including work done last period on beginning WIP | Beginning WIP costs plus current costs |
| FIFO | Only the work done this period: completing beginning WIP, units started and completed, and ending WIP | Current costs only; beginning WIP costs go to units transferred out as a separate layer |
2. Lost Units
| Type | Treatment |
|---|---|
| Normal loss detected at the end of the process (inspection at 100%) | Lost units receive full EUP for materials and conversion; their cost is added to the cost of the good units transferred out, because only completed units passed the inspection point |
| Normal loss detected earlier, or occurring evenly | Commonly ignored in EUP (the "method of neglect"), which spreads the loss over all good units, including ending WIP that has passed the loss point |
| Abnormal loss | Always given its EUP and costed separately; its cost is charged to Loss from Abnormal Spoilage, a period expense |
3. Worked Example: Cost of Production Report
The Mixing Department of Bulacan Chemicals adds all materials at the start of the process; conversion occurs evenly. Inspection is at the end of the process, where normal losses are found.
| Data | Units | Materials | Conversion |
|---|---|---|---|
| Beginning WIP (40% converted) | 2,000 | PHP 60,000 | PHP 20,000 |
| Started this period | 18,000 | PHP 540,000 | PHP 450,000 |
| Completed and transferred | 16,000 | ||
| Ending WIP (60% converted) | 3,000 | ||
| Normal loss (at end) | 1,000 |
Weighted average EUP: materials = 16,000 + 3,000 + 1,000 = 20,000; conversion = 16,000 + (3,000 x 60%) + 1,000 = 18,800.
Costs per EUP: materials = (60,000 + 540,000) / 20,000 = PHP 30; conversion = (20,000 + 450,000) / 18,800 = PHP 25; total PHP 55.
FIFO EUP: materials = 0 (beginning WIP already has its materials) + 14,000 started and completed + 3,000 + 1,000 = 18,000; conversion = (2,000 x 60%) + 14,000 + 1,800 + 1,000 = 18,000. Costs per EUP: 540,000 / 18,000 = PHP 30 and 450,000 / 18,000 = PHP 25.
| Cost Assignment | Weighted Average | FIFO |
|---|---|---|
| Beginning WIP costs | (in the pool) | 80,000 |
| Cost to complete beginning WIP (1,200 x 25) | 30,000 | |
| Started and completed | 16,000 x 55 = 880,000 | 14,000 x 55 = 770,000 |
| Normal loss added to transferred units (1,000 x 55) | 55,000 | 55,000 |
| Transferred out | 935,000 | 935,000 |
| Ending WIP: materials (3,000 x 30) + conversion (1,800 x 25) | 135,000 | 135,000 |
| Total costs accounted for | 1,070,000 | 1,070,000 |
The two methods agree here only because the beginning WIP was costed at the same unit costs as the current period; when prior-period unit costs differ, weighted average blends them and FIFO keeps them separate. If 200 of the 1,000 lost units had been abnormal, PHP 11,000 (200 x 55) would be charged to Loss from Abnormal Spoilage and only PHP 44,000 added to the transferred units.
In a subsequent department, units received are treated like materials added at the start, carrying a transferred-in cost that is always 100% complete.
4. Backflush Costing in a JIT Environment
Backflush costing skips recording costs as goods move through production and "flushes" them back at trigger points, typically the purchase of materials and the completion (or sale) of goods. It fits plants with minimal work in process and stable standard costs; direct labor is usually combined with overhead as conversion costs.
Example (trigger points: purchase of materials and completion of goods). A JIT plant buys materials of PHP 500,000, incurs conversion costs of PHP 700,000, completes 10,000 units at a standard cost of PHP 118 (materials PHP 48; conversion PHP 70), and sells 9,500 units.
| Event | Entry |
|---|---|
| Materials purchased | Dr. Raw and In-Process Inventory 500,000; Cr. Accounts Payable 500,000 |
| Conversion costs incurred | Dr. Conversion Costs Control 700,000; Cr. Payroll, Accumulated Depreciation, and others 700,000 |
| Units completed (backflush) | Dr. Finished Goods 1,180,000; Cr. Raw and In-Process Inventory 480,000; Cr. Conversion Costs Applied 700,000 |
| Units sold | Dr. Cost of Goods Sold 1,121,000; Cr. Finished Goods 1,121,000 |
Materials of PHP 20,000 remain in Raw and In-Process Inventory, and Finished Goods holds 500 units at PHP 59,000. Any difference between Conversion Costs Control and Conversion Costs Applied is closed to Cost of Goods Sold. If the second trigger point is the sale rather than completion, finished goods are not recorded at all and costs flush directly to Cost of Goods Sold.
A department adds materials at the start. Beginning WIP was 5,000 units (30% converted); 25,000 units were started; 26,000 units were completed; ending WIP is 4,000 units (50% converted); there are no lost units. What are the equivalent units for conversion costs under FIFO?
28,000
26,500
26,000
24,500
In a process where inspection occurs at the end, 800 units are lost; 600 are within normal limits and 200 are abnormal. The cost per equivalent unit is PHP 40 for materials and PHP 60 for conversion. How are the costs of the lost units treated?
All PHP 80,000 is added to the cost of good units transferred out
PHP 60,000 is spread over transferred units and ending WIP; PHP 20,000 is ignored
All PHP 80,000 is charged to a loss account
PHP 60,000 is added to units transferred out and PHP 20,000 is charged to a loss account
A JIT manufacturer uses backflush costing with trigger points at the purchase of materials and the sale of finished goods. Which account is NOT used in its journal entries?
Raw and In-Process Inventory
Conversion Costs Control
Finished Goods Inventory
Cost of Goods Sold
Sections you finish are checked off in the contents.