Chapter Three Cost
Chapter Three Cost
Chapter Three Cost
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Job-Costing and Process-Costing Systems
Companies frequently adopt one of two basic types of product costing system to assign costs to
products or services: A product costing system is a set of procedures used to account for an
organization’s product costs and to provide timely and accurate unit cost information for pricing,
cost planning and control, inventory valuation, and financial statement preparation.
The product costing system enables managers to track costs throughout the management
process.
It provides a structure for recording the revenue earned from sales and the costs incurred
for direct materials, direct labor, and overhead.
1. Job-costing system. In this system, the cost object is a unit or multiple units of a distinct
product or service called a job. Each job generally uses different amounts of resources. The
product or service is often a single unit, such as a specialized car made at Ford, a construction
project managed by Afro Tsion, a repair job done at Local mobile maintenance, or an
advertising campaign produced by Serawit Fikrie Promotion. Each special car made by Ford
is unique and distinct. An advertising campaign for one client at Serawit Fikrie Promotion is
unique and distinct from advertising campaigns for other clients. Job costing is also used by
companies such as Furniture producers to cost multiple identical units of distinct furniture
products. Because the products and services are distinct, job-costing systems accumulate costs
separately for each product or service.
2. Process-costing system. In this system, the cost object is masses of identical or similar units
of a product or service. For example, Dashen bank provides the same service to all its
customers when processing customer deposits. Dashen Beer and MOHA soft drinks produce
identical beer and soft drinks, respectively. In each period, process-costing systems divide the
total costs of producing an identical or similar product or service by the total number of units
produced to obtain a per-unit cost. This per-unit cost is the average unit cost that applies to
each of the identical or similar units produced in that period.
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Comparison between Job costing and Process costing
Job costing Process Costing
Wide Variety of Distinct Products Homogeneous products
Costs accumulated by jobs Costs accumulated by processes or departments
Unit cost is computed by dividing total job costs by Unit cost is computed by dividing total process costs of
units produced in that job the period by the number of units produced in the period
Examples of job costing and process costing in the service, merchandising and manufacturing
sectors
Service Sector Merchandising Manufacturing
Sector Sector
Job Costing System Accounting Firm Sending a catalogue Aircraft assembly
audits to a mailing list House Construction
Advertising agency Special promotion
campaign of a new store
product
Process Costing Deposit processing Grain dealing Oil refining
System Postal delivery Processing new Beverages
magazine production
subscriptions
Features of Job Costing System
Each job has its own characteristics and need a separate treatment.
Each job is taken as a job unit.
For each job, a distinct number is assigned and a separate job cost sheet if used.
The costing department keeps a separate work in process account for each job.
Profit or loss is determined for each job.
The cost of production of every job is ascertained or known after the completion of each
job.
Steps to be involved in Job costing System
Step 1: Identify the Job That Is the Chosen Cost Object:
Step 2: Identify the Direct Costs of the Job.
Step 3: Select the Cost-Allocation Bases to Use for Allocating Indirect Costs to the Job.
Step 4: Identify the Indirect Costs Associated with Each Cost-Allocation Base.
Step 5: Compute the Rate per Unit of Each Cost-Allocation Base Used to Allocate Indirect Costs
to the Job.
Step 6: Compute the Indirect Costs Allocated to the Job.
Step 7: Compute the Total Cost of the Job by Adding All Direct and Indirect Costs Assigned to
the Job.
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Actual Costing Vs Normal costing
Actual costing is a costing system that:
1)Traces direct costs to a cost object by using the actual direct cost rates times the
actual quantities of the direct-cost inputs.
2) It allocates indirect costs based on the actual indirect-cost rates times the actual
quantities of the cost-allocation bases. The actual indirect-cost rate is calculated by
dividing actual total indirect costs by the actual total quantity of the cost-allocation base.
As its name suggests, actual costing systems calculate the actual costs of jobs.
Yet, actual costing systems are not commonly found in practice because actual
costs cannot be computed in a timely manner. The problem is not with
computing direct-cost rates for direct materials and direct manufacturing
labor.
Normal costing is a costing system that
1) Traces direct costs to a cost object by using the actual direct-cost rates times the actual
quantities of the direct-cost inputs and;
2) Allocates indirect costs based on the budgeted indirect-cost rates times the actual
quantities of the cost-allocation bases.
The budgeted indirect-cost rate for each cost pool is computed as follows:
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b. Raw materials were requisitioned for use in production 380, 000 (360, 000 direct materials
and 20,000 indirect materials).
c. The following costs were incurred for employee services; direct labor, 75,000; indirect labor,
110,000; sales commission, 90,000; and administrative salaries, 200,000.
d. Utility costs were incurred in the factory, 43,000.
e. Advertising costs were incurred, 180,000.
f. Depreciation expenses were recorded for the year, 350,000 (80% to factory equipment, and
20 % selling and administrative activities).
g. Insurance expired during the year, 10,000 (70% relates to factory operations, and 30% for
selling and administrative activities).
h. Manufacturing overhead was applied to production. Due to greater demand than expected
for its products, the company worked 80,000 machine hours during the year.
i. Goods costing 900,000 to manufacture according to their job cost sheet were completed
during the year.
j. Goods were sold on account to customers during the year at a total selling price of
1,500,000. The goods cost 870,000 to manufacture according to their job cost sheets.
Required :- Prepare journal entries to record the preceding transactions.
Solution
a Raw Materials 410,000
Accounts payable 410,000
b Work in process 360,000
Manufacturing Overhead 20,000
Raw Materials 380,000
c Work in Process 75,000
Manufacturing Overhead 110,000
Sales commission expense 90,000
Admin. Salary Expense 200,000
Wages payable 475,000
d Manufacturing Overhead 43,000
Accounts payable 43,000
e Advertising expense 180,000
Accounts payable 180,000
f Manufacturing Overhead 280,000
Depreciation expense 70,000
Accumulated depreciation 350,000
g Manufacturing Overhead 7,000
Insurance Expense 3,000
Prepaid insurance 10,000
h Budgetd Annual Indirect Costs
Budgeted Indirect Cost Rate=
Budgetd annual quantity of cost allocation base
450,000
¿
75,000
= Br. 6 per machine hour
Manufacturing Overhead Applied = 6 x 80,000 = Br. 480,000
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Work in process 480,000
MOH Allocated 480,000
i Finished Goods 900,000
Work in process 900,000
j Accounts Receivable 1,500,000
Sales 1,500,000
Cost of goods Sold 870,000
Finished goods 870,000
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The adjusted allocation-rate approach restates all overhead entries in the general ledger and
subsidiary ledgers using actual cost rates rather than budgeted cost rates. First, the actual
manufacturing overhead rate is computed at the end of the fiscal year. Then, the manufacturing
overhead costs allocated to every job during the year are recomputed using the actual
manufacturing overhead rate (rather than the budgeted manufacturing overhead rate). Finally,
end-of-year closing entries are made. The result is that at year-end, every job-cost record and
finished goods record—as well asthe ending Work-in-Process Control, Finished Goods Control,
and Cost of Goods Sold accounts—represent actual manufacturing overhead costs incurred.
The adjusted allocation-rate approach yields the benefits of both the timeliness and convenience
of normal costing during the year and the allocation of actual manufacturing overhead costs at
year-end.
III.Write-off to cost of goods sold approach
In this case, the total under/over applied/allocated overhead cost is included in the current year’s
cost of goods sold amount.
Illustration
ABC company uses a normal costing with a single manufacturing overhead cost pool and
machine hours as cost allocation base. The following data were for 2013:
Budgeted MOH Br. 4,800,000
Overhead allocation base Machine hours
Budgeted machine hours 80,000
MOH Incurred Br. 4,900,000
Actual machine hours 75,000
Machine hours data and the ending balances (before proration of under/over allocated overhead)
are as follows:
Actual Machine hours 2013, end of year balances
Cost of goods sold 60,000 Br. 8,000,000
Finished goods 11,000 Br. 1,250,000
Work in process 4,000 Br. 750,000
Required:-
1. Compute the predetermined allocation rate for 2013.
2. Compute the under/over allocated MOH for 2013 and dispose the amount using:
a. Proration approach
1. If allocated MOH cost of Finished goods, cost of goods sold, and work in
process is the base for proration.
2. If ending balance of Finished goods, cost of goods sold, and work in process
is the base for proration.
b. Write –off to cost of goods sold approach
Solutions
Budgetd Annual Indirect Costs
1. Predetermined Indirect Cost Rate=
Budgetd annual quantity of cost allocationbase
4,800,000
¿ = Br. 60/machine hour
80,000
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2. MOH allocated = Predetermined allocation rate x actual allocation base
= 60 x 75,000 = Br. 4,500,000
Under/ over applied MOH = Actual MOH incurred – MOH allocated
= 4,900,000 – 4,500,000
= Br. 400,000 (MOH under applied)
MOH applied for the three items will be:-
Cost of goods sold = 60,000 x 60 = Br. 3,600,000
Finished goods = 11,000 x 60 = Br. 660,000
Work in process = 4,000 x 60 = Br. 240,000
Total MOH applied = Br. 4,500,000
a. Proration approach
Item Account balance Proration Base Proration Proration Account balance
before Proration amount after proration
CGS 8,000,000 3,600,000 3.6 320,000 8,320,000
x 400,000
4.5
Finished goods 1,250,000 660,000 0.66 58,667 1,308,667
x
4.5
400,000
WIP 750,000 240,000 0.24 21,333 771,333
x
4.5
400,000
Total 10,000,000 4,500,000 100% 400,000 10,400,000
NB: - Some Companies base the ending balance of finished goods, CGS, and WIP to prorate
the under/over applied MOH.
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2) process costing
In process costing, the cost object is masses of identical or similar units of product or service.
Process costing is used in those industries which provide basically homogeneous products such
as bricks, flour, cement, screw, and pharmaceutical items. The basic idea of process costing is to
divide the total manufacturing costs of a period by the period’s output inorder to determine the
average unit cost. In the industries, relatively homogeneous products are processed in a very
similar manner and are hence assumed to receive the same amount of direct materials, direct
labor, and manufacturing overhead costs.
The principal difference between process costing and job costing is the extent of averaging used
to compute unit cost of products or services. The cost object in a job cost system is a job that
constitutes a distinctly identifiable product or service. In contrast, when similar units are mass-
produced and not processed as individual jobs, process costing averages manufacturing costs for
overall units produced.
Because quantities typically are small and unit costs relatively high in situations utilizing job
order costing, the focal point for cost accumulation is the job or contract. The emphasis is
different in process costing, however, large quantities of homogeneous products with relatively
low unit costs render it not only difficult but also unnecessary to cost by small lots. Instead, the
focal point for process cost accumulation is usually the department or process center. The
fundamental problem is to match the total department costs with the total number of units
processed in any given period. Since it is basic assumption of process costing that we are dealing
with identical units, a simple averaging is sufficient. The task of accumulating the major
manufacturing cost elements is not different under process costing with that of job costing.
Essentially, the same source documents recording techniques will develop for the input of direct
materials, direct labor, and factory overhead. The chief difference lie in the method measuring
units produced, reporting the product costs and valuing work in process inventories.
Knowing what product costs is helpful information for inventory valuation, pricing decisions,
and product profitability analysis.
Similarities between job and process costing
Both systems have the same basic purposes- to assign material, labor, and overhead cost
to products and to provide a mechanism for computing unit product costs.
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Both systems use the same basic manufacturing accounts, including manufacturing
overhead, raw materials, work in process, and finished goods.
The flow of costs through the manufacturing accounts is basically the same in both
systems.
Note:- Production Report is a report that summarize all activity in a department’s work in
process account during a period and that contains three parts; a quantity schedule and a
computation of equivalent units, a computation of total and unit cost, and a cost reconciliation. It
is prepared for each department in which work is done on products.
2. Accumulate materials, labor, and overhead costs for each separate processing center over
some specified time period.
3. Divide the materials, labor, and overhead costs by the equivalent units to get the unit cost of
production for each separate processing center.
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4. Add the unit costs of each separate processing center to get the total unit cost of fully
completed unit of a product.
MaterialsCosts: -As job costing, materials are drawn from the storeroom using materials
requisition form. Materials can be added in any processing department, although it is not
unusual for materials to be added only in the first department with subsequent departments
adding only labor and overhead costs as the partially completed units move along toward
completion.
At XYZ Company, some materials (sand, clay, cement) are added in the molding department, the
journal entry for placing materials into the first department is:
Work in process-Molding xx
Accounts payable xx
LaborCosts:- In process costing, labor costs are traced to departments; not to specific jobs.
Since XYZ company has two processing department, molding and firing, the following
journal entry will record labor costs for specific period:
Work in process-Molding xx
Work in process-Firing xx
Salary/wage Payable xx
OverheadCosts:- the following journal entry is used to apply overhead costs to units of
product for the molding and firing departments.
Work in process-Molding xx
Work in process-Firing xx
Conversion costsapplied xx
Work in process-Firing xx
Work in process-Molding xx
Note:- Transferred-in cost:- the cost attached to products that have been received from a prior
department.
After processing has been completed in the final department, the costs of the completed units are
then transferred to finished goods inventory account.
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Finished Goods xx
Work in Process – Firing xx
Finally, when a customer’s order is filled and units are sold, the cost of the units is transferred to
cost of goods sold.
Cost of goods sold xx
Finished Goods xx
Molding Firing
Dep’t Dep’t
There are three cases in application of process costing. We will use the production of A12 bricks
to illustrate the cases.
Case 1: Process costing with no beginning or ending work in process inventory of A12; i.e. all
units are started and fully completed by the end of the accounting period. This case illustrates the
basic averaging of cost idea that is a key feature of process costing systems.
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Case 2: process costing with no beginning work in process inventory but an ending work in
process inventoryA12; that is some units of A12bricks started during the accounting period are
incomplete at the end of the period. This case introduces the five steps of process costing and the
concept of equivalent units.
Case 3:Process costing with both beginning and ending work in process inventory of A12. This
case describes the effect of weighted average and first-in, first-out (FIFO) cost flow assumptions
and cost of units completed and cost of work in process inventory.
Note: - Often, as in our XYZ Company example, only two cost classifications—direct materials and conversion costs—are necessary to
assign costs to products. Why only two? Because all direct materials are added to the process at one time and all conversion costs
generally are added to the process evenly through time. If, however, two different direct materials were added to the process at different
times, two different direct-materials categories would be needed to assign these costs to products. Similarly, if manufacturing labor costs
were added to the process at a different time from when the other conversion costs were added, an additional cost category—direct
manufacturing labor costs—would be needed to separately assign these costs to products.
There was no beginning inventory of A12 during January, the company started, completed, and
transferred out to firing department 85,000 A12 bricks.
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The Journal entries to record the costs and transfer of units from molding department to firing
department are as follows:
To record direct materials used in production during February:
Work in process-Molding dep’t 340,000
Accounts payable 340,000
To record the molding department conversion costs such as labor, depreciation, energy,
utility, etc.)
Work in process-Molding dep’t 250,000
Various accounts 250,000
To record cost of goods completed and transferred out from molding department to firing
department:
Work in process-Firing dep’t 590,000
Work in process-Molding dep’t 590,000
Case 2:Process costing with no beginning work in process inventory but an ending work in
process inventory
Because all units placed into production in Januarywere completed, there is no beginning
inventory of partially completed units in the molding department on February 1. Some customers
order late, so not all units started in February are completed by the end of the month.
Datafor molding department for February:
Physical units for February:
WIP, beginning 0 units
Started during February 62,000 units
Completed & transferred out during February 35,000 units
WIP, ending (February 28) 27,000 units
The work in process, 27,000 units, are fully processed with respect to direct materials, because
all direct materials in molding department are added at the beginning of the process. However,
conversion costs are added evenly during the process in the molding department. Based on the
work completedrelative to the work required to complete the A12 bricks still in process, the
moldingdepartment supervisor estimates that the partially completed units are, on average, 70%
complete from the perspective of conversion costs.
Total Cost for February:
Direct materials cost added during February $ 310,000
Conversion costs added during February $ 214,000
Total costs added in Molding Dep’t $ 524,000
How accurate the completion is with respect to conversion costs depends on the care, skill, and
experience of the estimator and the nature of the conversion process. The point to understand
here is that a partially completed unit is not the same as a fully completed unit.Estimating the
degree of completion is usually easier for direct material costs than for conversion costs, because
the quantity of direct materials needed for a completed unit and the quantity of direct materials in
a partially completed unit can be measured more accurately. In contrast, the conversion sequence
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usually consists of a number of operations, each for a specified period of time, at various steps in
the production process. The degree of completion for conversion costs depends on the proportion
of the total conversion costs needed to complete one unit (or a batch of production) that has
already been incurred on the units still in process. It is a challenge for management accountants
to make this estimate accurately.
The five steps of process costing are as follows:
Step 1: Summarize the flow of physical units of output.
Step 2: Compute output in terms of equivalent units.
Step 3: Summarize total costs to account for.
Step 4: Compute cost per equivalent unit.
Step 5: Assign total costs to units completed and to units in ending work in process.
Note:- Equivalent units are the number of complete units that could have been obtained from the materials and
effort that went into partially complete units. It is the product of the Number of partially completed units and their
percentage of completion with respect to a particular cost.
Equivalent units = # of partially completed units X %age of completion
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Cost per equivalent unit $5 $ 3.97
Assignment of costs:
Completed & transferred 313, 961 (35,000 x 5) (35,000x 3.97)
out (35,000 units)
The Journal entries to record the costs and transfer of units from molding department to firing
department are as follows:
In this case, we have both beginning and also ending work in process inventory of A12 bricks.
We use the five steps described earlier to calculate:
The cost of units completed and transferred out, and
The cost of ending work in process
To assign costs to each of these categories, we need to choose an inventory cost flow
assumptions.
Completed & transferred out 40,000 units 40,000 units 40,000 units
during March
Here, we have summarized the physical flow of products and computed the work done to date interms of equivalent units.
The next table summarizes the total costs to account for and how they are accounted for.
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Total production cost Direct materials Conversion costs
Assignment of costs:
WIP, ending
The following table summarizes total costs to account for ($660,039) and how they are
accounted for. The arrows indicate that the costs of units completed and transferred out and units
in ending work in process are calculated using weighted-average total costs obtained after
merging costs of beginning work in process and costs added in the current period.
Costs to Account For Costs Accounted for Calculated on a Weighted-Average Method
Beginning work in process $210,039 Completed and transferred out $476,474.25
Costs added in current period 450,000 Ending work in process 183,564.75
Total costs to account for $660,039 Total costs accounted for $660,039
The Journal entries to record the costs and transfer of units from molding department to firing
department are as follows:
To record direct materials used in production during February:
Work in process-Molding dep’t 290,000
Accounts payable 290,000
To record the molding department conversion costs such as labor, depreciation, energy,
utility, etc.)
Work in process-Molding dep’t 160,000
Various accounts 160,000
To record cost of goods completed and transferred out from molding department to firing
department:
Work in process-Firing dep’t 476,474.25
Work in process-Molding dep’t 476,474.25
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The first-in, first-out (FIFO) process-costing method
1. assigns the cost of the previous accounting period’s equivalent units in beginning work-
in-process inventory to the first units completed and transferred out of the process, and
2. assigns the cost of equivalent units worked on during the current period first to complete
beginning inventory, next to start and complete new units, and finally to units in ending
work-in-process inventory. The FIFO method assumes that the earliest equivalent units in
work in process are completed first.
A distinctive feature of the FIFO process-costing method is that work done on beginning
inventory before the current period is kept separate from work done in the current period. Costs
incurred and units produced in the current period are used to calculate cost per equivalent unit of
work done in the current period. In contrast, equivalent-unit and costper-equivalent-unit
calculations under the weighted-average method merge units and costs in beginning inventory
with units and costs of work done in the current period.
Assume XYZ Company use the first in, first out method and assign the total costs to the units
completed and transferred out and in the work in process.
Steps 1 and 2: Summarize Output in Physical Units and Compute Output in Equivalent Units
Using FIFO Method of Process Costing for firing Department of XYZ Company for March 2012
Flow of production Physical units Equivalent units
Steps 3, 4, and 5: Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign
Total Costs to Units Completed and to Units in Ending Work in Process Using Weighted-Average
Method of Process Costing for firing Department of XYZ Company for March 2012
Total production cost Direct materials Conversion costs
WIP, beginning $ 210,039 Costs of work done before the current period
Assignment of costs:
WIP, ending
The goal is to use the cost of work done in the current period to determine total costs of all units
completed from beginning inventory and from work started and completed in the current period,
and costs of ending work in process.
The following table summarizes total costs to account for and costs accounted for of $660,039.
Notice how under the FIFO method, the layers of beginning work in process and costs added in
the current period are kept separate. The arrows indicate where the costs in each layer go—that
is, to units completed and transferred out or to ending work in process. Be sure to include costs
of beginning work in process ($210,039) when calculating costs of units completed from
beginning inventory.
Costs to Account for Costs Accounted for Calculated on a FIFO
Basis
Completed and transferred out
Beginning work in process $210,039 Beginning work in process $210,039
Costs added in current period 450,000 Used to complete beginning
Work in process 38,285
Started and completed 187,115
Completed and transferred out 225,400
Ending work in process 224,600
Total costs to account for $660,039 Total costs accounted for $660,039
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The Journal entries to record the costs and transfer of units from molding department to firing
department are as follows:
To record direct materials used in production during February:
Work in process-Molding dep’t 290,000
Accounts payable 290,000
To record the molding department conversion costs such as labor, depreciation, energy,
utility, etc.)
Work in process-Molding dep’t 160,000
Various accounts 160,000
To record cost of goods completed and transferred out from molding department to firing
department:
Work in process-Firing dep’t 435,439
Work in process-Molding dep’t 435,439
Transfer
Molding Firing
Dep’t Dep’t Finished Goods
Transferred-in costs are treated as if they are a separate type of direct material added at the
beginning of the process. That is, transferred-in costs are always 100% complete as of the
beginning of the process in the new department. When successive departments are involved,
transferred units from one department become all or a part of the direct materials of the next
department; however, they are called transferred-in costs, not direct material costs.
Transferred-In Costs and the Weighted-Average Method
Physical units for March:
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WIP, ending (March 31) 23,000 units
Direct materials (0% complete)
Transferred In (100%complete)
Conversion costs (70% complete)
Total costs
WIP, beginning
Transferred In $ 120,000
Direct materials 0
Conversion costs $ 45,000
Direct materials cost added during March $ 30,000
Conversion costs added during March 160,000
Total cost added in Marchin firing Dep’t 190,000
Transferred In cost $ 476,474.25
Steps 1 and 2: Summarize Output in Physical Units and Compute Output in Equivalent Units Using
Weighted-Average Method of Process Costing for firing Department of XYZ Company for March 2012
Flow of production Physical units Equivalent units
Steps 3, 4, and 5: Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and
Assign Total Costs to Units Completed and to Units in Ending Work in Process Using Weighted-
Average Method of Process Costing for firing Department of XYZ Company for March 2012
Total production cost Transferred-In Costs Direct materials Conversion costs
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Costs incurred to date 831,474.25 596,474.25 30,000 205,000
Assignment of costs:
WIP, ending
To record cost of goods completed and transferred from testing to Finished Goods.
Finished Goods
Work in Process—Firing dep’t
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