These transferred amounts are categorized as work-in-process (WIP) inventory, tracking partially completed goods. Overestimating or underestimating costs can distort financial statements and impact decision-making. To prevent this, companies use standard costing, assigning predetermined costs to materials and labor. Differences between actual and standard costs are recorded as variances, helping management identify inefficiencies and adjust operations.
The packaging materials are added at the beginning of the process, so all the materials have been added before the units are transferred out, but all of the conversion elements have not. As a result, the number of equivalent units for material costs and for conversion costs remaining in ending inventory is different for the testing and sorting department. As you’ve learned, all of the units transferred to the next department must be \(100\%\) complete with regard to that department’s cost, or they would not be transferred.
This report shows the costs used in the preparation of a product, including the cost per unit for materials and conversion costs, and the amount of work in process and finished goods inventory. A complete production cost report for the shaping department is illustrated in Figure 8.71. Determining the value of the work in process inventory accounts is challenging because each product is at varying stages of completion and the computation needs to be done for each department. Trying to determine the value of those partial stages of completion requires application of the equivalent unit computation.
This method is particularly useful in industries like chemicals, textiles, and food processing, where products move through multiple phases. By applying this approach, businesses determine the cost per unit at each stage, helping set prices and evaluate efficiency. The shaping department completed 7,500 units and transferred them to the testing and sorting department.
One department’s output becomes the next department’s input, requiring careful expense tracking for accurate financial reporting and cost control. Understanding how costs transfer between departments ensures transparency and helps assess efficiency. If a department consistently reports higher costs than expected, it may indicate inefficiencies in resource utilization or production bottlenecks. Management can use this data to improve processes, such as optimizing labor deployment or renegotiating supplier contracts. Regular reconciliation ensures reliable cost tracking, helping businesses make informed financial and operational decisions. Once the total cost of transferred units is determined, companies prepare cost reconciliation reports outlining the beginning inventory balance, costs added during the period, and the final transferred amount.
In addition to the equivalent units, it is necessary to track the units completed as well as the units remaining in ending inventory. The reconciliation involves the total of beginning inventory and units started into production. The total materials costs for the period (including any beginning inventory costs) are computed and divided by the equivalent units for materials. The total of the cost per unit for materials (\(\$1.50\)) and for conversion costs (\(\$6.90\)) is the total cost of each unit transferred to the testing and sorting department.
For the packaging department, the materials are \(100\%\) complete with regard to materials costs and \(40\%\) complete with regard to conversion costs. The \(6,500\) units completed and transferred out to the finishing department must be \(100\%\) complete with regard to materials and conversion, so they make up \(6,500 (6,500 × 100\%)\) units. The \(1,750\) ending WIP units are \(100\%\) complete with regard to material and have \(1,750 (1,750 × 100\%)\) equivalent units for material.
One reconciliation approach compares Department A’s recorded transfer-out costs with Department B’s recorded transfer-in amounts. If discrepancies exist, finance teams review production reports and cost allocation worksheets to pinpoint errors. Adjustments may be necessary and are typically recorded as journal entries to align financial records. The typical entry debits Department B’s WIP account and credits Department A’s WIP account, ensuring costs are neither duplicated nor omitted. This process aligns with Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS), which require accurate cost tracking. Errors in these entries can misstate cost of goods manufactured (COGM) and cost of goods sold (COGS), affecting profitability analysis.
For example, during the month of July, Rock City Percussion purchased raw material inventory of $25,000 for the shaping department. Although each department tracks the direct material it uses in its own department, all material is held in the material storeroom. The Wrigley Company has 14 factories located invarious parts of the world, including North America, Europe,Africa, India, and the Asia/Pacific region. According toWrigley Company, 50 percent of Americans chew gum,and on average, each person consumes 190 sticks per year. Thenumber drops to 130 sticks per person in the United Kingdom and to100 sticks per person in Taiwan. Sometimes that knowledge leads to management’s decision to stop production, but sometimes that decision isn’t as simple as it seems.
No units were lost to spoilage, which consists of any units that are not fit for sale due to breakage or other imperfections. Since the maximum number of units that could possibly be completed is 8,700, the number of units in the shaping department’s ending inventory must be 1,200. The total of the 7,500 units completed and transferred out and the 1,200 units in ending inventory equal the 8,700 possible units in the shaping department.
So the number of units transferred is the same for material units and for conversion units. The process cost system must calculate the equivalent units of production for units completed (with respect to materials and conversion) and for ending work in process with respect to materials and conversion. For the shaping department, the materials are 100% complete with regard to materials costs and 35% complete with regard to conversion costs. The 7,500 units completed and transferred out to the finishing department must be 100% complete with regard to materials and conversion, so they make up 7,500 (7,500 × 100%) units. The 1,200 ending work in process units are 100% complete with regard to material and have 1,200 (1,200 × 100%) equivalent units for material. The 1,200 ending work in process units are only 35% complete with regard to conversion costs and represent 420 (1,200 × 35%) equivalent units.
Understand how costs move between departments, how to record transferred amounts, and ensure accurate financial tracking in multi-stage processes. Notice that two different work-in-process inventory accounts areused to track production costs—one for each department. When costs leave Department A, department a completed and transferred to finished goods they must be recorded in Department B’s financial records as part of its beginning inventory.
Because Wrigley produces identical units ofproduct in batches employing a consistent process, it likely uses aprocess costing system. With such a system,Wrigley would need a separate work-in-processinventory account to track costs for each stage of the productionprocess. Standardized reporting formats require accurate inventory disclosures, including completed and partially completed goods. Misreporting equivalent units can inflate or understate inventory balances, affecting financial ratios like inventory turnover and gross margin percentage.
