13/08/2008 20:27

# Cost of Production Report - Testing Department (2nd Department):

Learning Objective:

1. Prepare a cost of production report of second department in a process costing system.
2. How  lost units are treated in process costing system when a cost of production report of subsequent to the first department is prepared?

We recommend to see the cost of production report of the first department before you continue.

Click here to see the cost of production report of the first department

The Clonex Corporation
Testing Department (2nd Dept.)
Cost of Production Report
For the Month of January, 19

## Explanation:

The Blending Department (first department) transferred 45,000 units to the Testing Department, where labor and factory overhead were added before the units were transferred to the Terminal Department (third or final department). Costs incurred in the testing department resulted in the additional departmental as well as cumulative unit costs.

The cost of production report of the testing department differ from that of the Blending Department (first department) in several respects. Several additional calculations are made, for which space has been provided on the report. The additional information deals with:

1. Cost received from the preceding department.
2. An adjustment of the preceding department's unit cost because of lost units.
3. Cost received from the preceding department to be included in the cost of ending work in process inventory.

The quantity schedule of the Testing Department shows that the 45,000 units received from the Blending Department (first department) were accounted for as follows:

1. 40,000 units sent to terminal department.
2. 3,000 units still in process.
3. 2,000 units lost.

An analysis of the work in process (WIP) indicates that units in process are but one third complete as to labor and factory overhead. Unit costs, \$0.91 for labor and \$0.80 for factory overhead, were calculated as follows:

Equivalent production of the testing department is 41,000 units [40,000 + \$1/3 × (3,000)], the labor unit cost is \$0.91 (\$37,310 / 41,000), and the factory overhead unit cost \$0.80 (\$32,800 / 41,000). There is no materials unit cost, since no materials were added by the department. The department unit cost is \$1.71, the sum of the labor unit cost of \$0.91 and the factory overhead unit cost of \$0.80.

The testing department is responsible for the labor and factory overhead used as well as for the cost of units received from the Blending Department (first department). This latter cost is inserted as a cost charged to the department under the title "cost from preceding department" which is immediately above the section of the report dealing with cost added by the department. The cost transferred in was \$77,400, previously shown in the cost report of the Blending Department (first department) as cost transferred out of that department by this journal entry:

Work in process - Testing department                    77,400
Work in process - Blending department                             77,400

The work in process account of the testing department is charged with cost received from the preceding department and with \$70,110 of departmental labor and factory overhead (FOH), a total cost of \$147,510 to be accounted for by the department.

## Units Lost in the Department Subsequent to the First:

The Blending Department (first department) unit cost was \$1.72 when 45,000 units were transferred to the Testing Department. However, because 2,000 of these 45,000 units were lost during processing in the Testing Department, the \$1.72 unit cost figure no longer applies and must be adjusted. The total cost of the units transferred remains at \$77,400, but 43,000 units must now absorb this total cost, causing an increase of \$0.08 in the cost per unit due to the loss of 2,000 units in the testing department.

The lost units cost can be computed by one of two methods.

### Method No.1:

Determines a new unit cost work done in the preceding department and subtracts the preceding departments old unit costs figure from the adjusted unit cost figure. The difference between the tow figures is the additional cost due to the lsot units. \$1.80 new adjusted unit cost for work done in the preceding department is obtained by dividing the remaining good units, 43,000 (45,000 - 2,000), into the cost transferred in, \$77,400. The old unit cost figure of \$1.72 is subtracted from the revised unit cost to arrive at the adjustment of \$0.08.

### Method No. 2:

Determines the lost units share of total cost and allocates this cost to the remaining good units. total cost previously absorbed by the units lost is \$3,440, which is the result of multiplying the 2,000 lost units by their unit cost of \$1.72. The \$3,440 cost must now be absorbed by the remaining good units. The additional cost to be picked up by each remaining good unit is \$0.08 (3,440 / 43,000 units).

The lost unit cost adjustment must be entered in the cost of production report. The\$0.08 is entered on the "Adjustment for lost units" line. The departmental unit cost of \$1.71 does not have to be adjusted for units lost. In the testing department, the cost of any work done on lost units has automatically been absorbed in the departmental unit cost by using the equivalent production figure of 41,000 instead of 43,000. The \$1.72 unadjusted units cost for work done in the preceding department, the \$1.71 departmental unit cost, and the \$0.08 adjustment for lost units are totaled in order to obtain the \$3.51 cumulative unit cost for work done up to the end of operations in the testing department.

## Timing of Lost Units:

Lost units may occur at the beginning, during, or at the end of a manufacturing process. For purposes of practicality and simplicity, it is ordinarily assumed that units lost at the beginning or during the process were never put in process. The cost of units lost is spread over the units completed and units still in process.

When units are lost or are identified as lost at the end of a process, the cost of the lost units is charged to completed units only. No part of the loss is charged to units still in process. Assume that the 2,000 units lost by the testing department were the result of spoilage found at final inspection by the quality control department; their cost would be charged only the 40,000 finished units, as illustrated below:

The Clonex Corporation
Testing Department (2nd Dept.)
Cost of Production Report
For the Month of January, 19

 Quantity Schedule: Units received from the preceding department 45,000 ====== Units transferred to next department 40,000 Units still in process (1/2 labor and FOH) 3,000 Units lost in process 2,000 45,000 ====== Cost Charged To the Department: Total Cost unit Cost Cost from preceding department: Transferred in during the month \$77,400 -------- \$1.72 ------- Cost added by the department: Labor 37,310 0.87 Factory Overhead (FOH) 32,800 ------- 0.76 ----- Total cost added \$70,110 \$1.63 ------- ------ Total cost to be accounted for \$147,510 \$3.35 ====== ====== Cost Accounted for as Follows: Transferred to next department [(40,000 × \$3.51+\$0.167)]* \$140,720 Work in process - ending inventory: From preceding department (3,000 × \$1.72) \$5,160 Labor (3,000 × 1/3 × \$0.87) 870 Factory Overhead (3,000 × 1/2 × \$0.76) 760 ------ 6,790 ------ Total cost accounted for \$147,510 ====== Additional Computations: Equivalent Production: Labor and factory overhead = 40,000 + 3,000 / 3 + 2,000 lost units = 41,000 units Unit Costs: Labor = \$37,310 / 43,000 = \$0.87 per unit Factory overhead = \$32,800 / 43,000 = \$0.76 per unit Lost unit cost = \$3.35 × 2,000 units = \$6,700 + 40,000 units \$0.1675 per unit to be added to \$3.35 to make the transfer cost \$3.5175. *40,000 units  \$3.5175 = \$140,700. To avoid a decimal discrepancy, the cost transferred is computed: \$147,510 - \$6,790 = \$140,720.

A comparison of the differences between the two cost of production reports for the testing departments as to amounts for costs of units transferred and work in process inventory is shown below the production report. Not the offsetting increases and decreases.

In this illustration, the assumption has been made that the lost units, identified at the end of the process, were complete as to all costs. In sum companies, members of the quality control or inspection departments make production checks prior to the end of the process. Such a procedure uncovers lost units that are not complete when the loss is incurred or the spoilage discovered and yet the loss may pertain only to units completed and not to units still in process. In such a case the lost units should be adjusted for their equivalent stage of completion. For example, 2,000 units lost at the 90% stage of conversion would appear as 1,800 equivalent units with regard to labor and factory overhead costs.

## Normal Vs Abnormal Loss of units:

Units are lost through evaporation, shrinkage, substandard yields, spoiled work, poor work man ship, or inefficient equipment. In many instances the nature of operations makes certain losses normal or unavoidable, because they are considered with in normal tolerance limits for human and machine errors. The cost of these normally lost units does not appear as a separate item of cost but is spread over the remaining good units.

A different situation is created by abnormal or avoidable spoilage or losses that are not expected to arise under normal, efficient operating conditions. The cost of such abnormal spoilage or losses is charged either to factory overhead as shown below, thereby appearing as an additional unfavorable able factory overhead variance, or directly to a current period expense account and reported as a separate item in the cost of goods sold statement.

Work in process - Testing Department                      6,700
(lost units)

The cost of production report would show the abnormal spoilage or loss as follows:

Transferred to next department (40,000 units × \$3.35) ..............\$134,020*
Transferred to factory overhead [40,000 units  × \$0.1675) or
(2,000 lost units × \$3.35)].......................................................6,700

*40,000 units × \$3.35 = \$134,000. To avoid decimal discrepancy, the cost transferred is computed: \$147,510 - \$6,790 ending inventory - \$6,700 = \$134,020

If the lost units were only partially complete, equivalent production calculations should consider their stage of completion when lost or spoiled, and the costing of the abnormal loss should be weighted accordingly. If one part of the loss is normal and another abnormal, each portion must be treated in accordance with the above discussion. The critical factor in distinguishing between normal and abnormal spoilage or loss is the degree of controllability. Normal or unavoidable spoilage or loss is produced by the process under efficient operating conditions, referred to as uncontrollable. Abnormal or avoidable spoilage or loss is considered unnecessary, because the conditions resulting in the loss are controllable. For this reason, within the limits set by the state of the art of production, the difference is a short-run condition; in the long run, management should adjust and control all factors of production and eliminate all abnormal conditions.

The cost of production report at the beginning of this page shows a total cost of \$147,510 to be accounted for by the Testing department. The department completed and transferred 40,000 units to the Terminal Department (third or final department) at a cost of \$140,000 (40,000 × \$3.51). The remaining cost is assigned to the work in process inventory. This balance is broken down by the various costs in process. When computing the cost of the ending work in process inventory of any department subsequent to the first, costs received from the preceding departments must be included.

The 3,000 units still in process, completed by the Blending Department (first department) at a unit cost of \$1.72, were later adjusted by \$0.08 (to \$1.80) because of the loss of some of the units transferred. Therefore, the Blending Department's (first department) cost of the 3,000 units still in process is \$5,400 figure is not broken down further , since such information is not pertinent to the Testing Department's operations. However, the amount is listed separately in the cost of production report, because it is part of the Testing Department's ending work in process inventory.

Materials (if any), labor, and factory overhead (FOH) added by a department are costed separately in order to arrive at total work in process (WIP). In the testing department, no materials were added to the units received; thus, the ending inventory shows no materials in the process. However, labor and factory overhead costs were incurred. The work in process analysis stated that labor and factory overhead used on the units in process were sufficient to complete 1,000 units. The cost of labor in process is \$910 (1,000 × \$0.91) and factory overhead is process is \$800 (1,000 × \$0.80). The total cost of the 3,000 units in process is \$7,110 (\$5,400 + \$910 + \$800). This cost, added to that transferred to the Terminal Department (third or final department), \$140,400, accounts for the total cost of \$147,510 charged to the Testing Department.