## Analysis and Decision-making

### Learning Outcomes

• Use a production cost report for decision-making

Recall that there are three types of process costing, which are:

• Weighted average costs. This version assumes that all costs, whether from a preceding period or the current one, are lumped together and assigned to produced units. It is the simplest version to calculate.
• Standard costs. This version is based on standard costs. Its calculation is similar to weighted average costing, but standard costs are assigned to production units, rather than actual costs. After total costs are accumulated based on standard costs, these totals are compared to actual accumulated costs, and the difference is charged to a variance account.
• First-in first-out costing (FIFO). FIFO is a more complex calculation that creates layers of costs, one for any units of production that were started in the previous production period but not completed, and another layer for any production that is started in the current period.

So far, we have assumed that standard costs and actual costs are the same, but that is rarely if ever the case. However, for managerial accountants, the standard costs serve two purposes: (1) as a reasonable approximation of actual costs that give immediate financial information rather than waiting for the financial accountants to determine actual costs (as much as 30 days after the fact), and (2) as a way to micro-monitor costs through both quantity and cost variances.

In short, process costing allows a company, like the one that makes candy corn, to assign a cost to products. One important thing to note is that ultimately, the cost of a product should be assigned to the units in which it is sold. So, paint may be costed in ounces (which can be readily converted to gallons or quarts, and candy corn may be costed in pounds, but unlike job costing, process costing won’t assign a different cost to each item. For pie crusts, the unit cost in February may be higher or lower than it was in January, but that change will be spread across all the finished products.

Let’s take one last look at the production cost report for Dad’s Perfect Pies, for the Baking/Packaging Department, for the month of January using the weighted average method:

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And here is the summary of total inventory at the end of January based on the two production reports before the sale was recorded:

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The finished shells cost $4.50 each ($9,000 / 2,000 finished shells) and sold for $6 each, for a gross profit of$1.50 each. If selling, general, and administrative expenses run \$3,000 per month, the company would have to sell all 2,000 pies to break even. If they are running at capacity at 3,000 pies, they may start making a profit as soon as baking/packaging catches up with mixing, as long as sales can move all the product.

In addition to the big picture, the production cost reports help managers answer several important questions:

• How much does it cost to produce each unit of product for each department?
• Which production cost is the highest—direct materials, direct labor, or overhead?
• Where are we having difficulties in the production process? In any particular departments?
• Are we seeing any significant changes in unit costs for direct materials, direct labor, or overhead? If so, why?
• How many units flow through each processing department each month?
• Are improvements in the production process being reflected in the cost per unit from one month to the next?

Process costing then is used for:

• Controlling costs
• Evaluating performance
• Pricing products
• Identifying profitable and unprofitable products
• Preparing the financial statements

Now, check your understanding of the use of the production cost report.