Cost of Goods Manufactured (CGM) in Process Costing

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Permalink Reply by Richard Maitum on April 19, 2010 at 9:12am

The Closing WIP was already deducted during the process of computing the current period cost, so if you deduct it again that would be double counting.

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Permalink Reply by MAK on April 21, 2010 at 5:41am

Thanks Richard,

But would you please explain when and where the Closing WIP cost was already deducted???

I would really appreciate.

Thanks

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Permalink Reply by Sabin Shrestha on April 20, 2010 at 2:18am

You have already written the methods used in process costing. So far as I can say that these methods find out cost of finished output in the process and closing WIP separately but not calculate cost of goods sold which is what the formula as you have given calculates. As cost of finished output in the process does not include value of Closing WIP, there is no need to deduct its value here.

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Permalink Reply by CMA.Devarajan Swaminathan on April 20, 2010 at 5:27am

"But in process costing to calculate CGM we use different formulas under different methods:
Under Weighted average method we use : Cost of Opening WIP + Current period cost and under FIFO Method we use: Current Period Cost Only"

This is done to arrive at the cost of closing WIP.

You do this by finding out equivalent production to arrive at total equivalent goods produced during the period. This is done to arrive at the cost per unit, which in turn is used to calulate the cost of closing WIP for the period.

ASSUMPTIONS:
FIFO: This method assumes that opening wip is the first group of units to be manufactured and completed. Closing wip is assumed to come out of the new units started during the period.

Weighted average:
here one makes the assumption that the opening wip cannot be idenfied distinctly and separately and hence its part of the goods produced during the period.

For calculating CGM, closing WIP will be reduced.

Take the ledger of any process account say for e.g. Process X

Debit side:
Opening WIP XXXX
Add: Materials XXXX
add: conversion cost XXXX (this is direct labour + factory overheads)

Credit Side:
Completed production transferred to Process Y XXXX (this is your CGM)
Closing WIP XXXX

Put this in the type of formula that you have shown above and you arrive at your CGM.

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Permalink Reply by MAK on April 21, 2010 at 5:37am

Thanks Devarajan,

I really appreciate that. But please pay attention. My question was "Why don't we DEDUCT closing WIP in order to calculate CGM" just like when we are preparing Cost of Goods Sold Statement. We are not trying to arrive at the cost of ONLY closing WIP but also we have found out the other costs under the heading of :
Cost Accounted For As Follows: FIFO Method
1. Opening WIP cost--coming from the prior period
2. Current period cost incurred on the Opening WIP units
3. Current period cost incurred on units started and completed and shipped to next dept during the current period
4. Current period cost incurred on Closing WIP

You would see that we are not ONLY trying to find the closing WiP cost but we are also finding the other costs as well (as shown above).

When I have got the Per unit cost, I can calculate cost for any category, be it finished goods or WIP.

My question is: When we are calculating Per Unit Cost---then we are ONLY taking either the (Opening WIP + Current Period cost (Weighted Average Method)) OR (Current Period Cost--FIFO Method) divided by Equivalent units. BUT WE ARE NOT DEDUCTING CLOSING WIP like we do in Cost of Goods Sold Statement (Raw material used+Direct labor+FOh+Opening WIP-CLOSING WIP).

I hope now you understand the exact question.

Thanks

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Permalink Reply by CMA.Devarajan Swaminathan on April 21, 2010 at 10:37am

Mak, you have answered your own question. I will give it another shot.

you use the term "per unit cost". In order to calculate per unit cost for a period what all do we need.

(a) total costs (incurred during the period)
(b) total units.(produced during the period)

during the period you have incurred some costs in completing the opening WIP, you have incurred costs in manufacturing completed units AND you have incurred some costs in completing partially the closing WIP.

So Total costs for a period include(A):
Costs incurred to complete opening WIP ****
Add: Costs incurred to manufacture completed units ****
Add costs incurred to partially manufacture closing WIP ****

(i have broken the total period costs between completed units and closing wip for convenience )

Now, To arrive at total units manufactured during the period can we say that the finished goods units and WIP units are the same? NO. So what do we do, we find out equivalent units of WIP.

So total units manufactured during the period include (B):
Equivalent units of opening WIP
Add: units of completely produced goods
Add: equivalent units of closing WIP

Now cost per unit of goods produced during the period= Total cost (A) / Total Equivalent Units (B)

PLEASE NOTE: There is a difference between Cost of goods Manufactured and Cost of Equivalent units manufactured. Equivalent units ARE NOT COMPLETED UNITS. You need to first arrive at the total cost of equivalent units to find out cost per unit which is then used to caluclate the cost of goods manufactured. So YOU WILL ADD CLOSING WIP AND NOT DEDUCT IT. For obvious reasons.

So for arriving at the cost per unit, why woud you deduct the closing WIP?

Once you have the cost per unit, you arrive at the cost of WIP and the CGM.

As a derived formula:

Cost of Opening WIP

ADD: Total costs incurred to manufacture equivalent goods during the period

LESS: Cost of Closing WIP (equivalent units * cost per unit as calculated above)

= Cost of Goods Manufactured (CGM).

hope this helps.

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Permalink Reply by MAK on April 22, 2010 at 12:50am

Thanks Devarajan,

This time I got it. Actually I was not preparing T-account, that is why I was getting confused. When I prepared T-account, I got the answer that ACTUALLY WE ARE DEDUCTING CLOSING WIP TO ARRIVE AT COST OF GOODS MANUFACTURED.

Thanks a Lot

But now I would place another question? In process costing we always calculate equivalent units but we don't do so in job order costing.

Is it because of the nature of Process costing? Because in job order costing the units are not completed through sequential processing but whole job is ONE UNIT (so no need to calculate equivalent units) but in process costing the units are completed in SEQUENTIAL PROCESSING after passing through different departments, so we are bound to calculate equivalent units for each department to know Per Unit cost for each department.

Is it like that?

Thanks for all your help

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Permalink Reply by CMA.Devarajan Swaminathan on April 22, 2010 at 11:40am

Mak, you need to understand the purpose of Equivlent units. Equivalent units is to have a common unit measure. Finished goods and WIP are not common unit measure because they are at different levels of completion.

There are WIP's even in Job costing but depends upon the unit measure and how you work out the cost of WIP. One cannot generalize, it depends upon the industry and their costing system.

Similarly in case where inputs are in kgs and outputs are in mtrs or vice versa, you will need to find out equivalent units.

The purpose of equivalent units is to have a common unit factor.

I do not know what books you refer to, but if you are refering to Horngren or Drury, you should be fine. If you have access to N.K Prasad nothing like it.

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Permalink Reply by yasir sayeed on April 21, 2010 at 5:40am

IN PROCESS costing the scenario is a little bit different, this cost of ending wip used in accumulation in the total cost of workdone in current period account.dts y we not deduct wip closing..see the equivalent unit calculation again

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Permalink Reply by Muhammad Mubin Memon on April 21, 2010 at 7:10am

If you critically check, after calculating CoGM under process costing and then deducting it from total Inputed cost(WIP-op + RM + DL + FoH) will give WIP-ending

so either calculate CoGm then deduct it from Total Inputed Cost and get WIP ending
or Calculate WIP ending then deduct it from Total Inputed Cost and get CoGM

is mathematically same

But for Checking Purpose we can deduct WIP-Ending to arrive CoGM but for that we need WIP ending which shuold be calculated

WIP ending Calculation
cost of RM in ending (% of completion * Peruni Cost* Units ending)
cost of DL in ending (% of completion * Peruni Cost* Units ending)
cost of FoH in ending (% of completion * Peruni Cost* Units ending)


Means that method is simply a reconciling of first Method

In short, Both Way of Calculating CoGM are OK. but first method is illustrated to student just to give the basic idea of Manufacturing, at that tyme it is not suitable for them to tell how we estimate / calculate WIP ending, but in real/practical life, when it comes to Calculating Value of WIP ending, we need to look the % of completion of inventory ending to get the more accurate figure rather than estimating

What i think, you are confusing in Mathematical way of reconciling/ I wish i could have a Board sort of thing to illustrate!

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Permalink Reply by GILBERT PELAYO on April 22, 2010 at 12:56am

under process costing we normally compute equivalent units of production (EUP), in both methods (w.average and FIFO).
AFTER computing for EUP, we can now compute unit cost by dividing total current cost incurred plus cost of beg. wip (if w.average method) then unitcost multiply by total finished units equals cost of goods manufactured.
if fifo method is used total current cost divided by EUP completed for the current period only. since this is a fifo we assmed that part of these finished goods completed came from b.wip and units started in production. so cgm is equals to cost of beg inventory add cost of finished units.

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Permalink Reply by Suman Kumar Saha on April 22, 2010 at 3:58am

You are calculating CGM based on equivalent production unit. in calculating equvalent unit u already adjust the clasing stock. So why u further want to deduct closing stock there.

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