Process Costing using The WEIGHTED AVERAGE METHOD and the FIFO method

Case Study – Mignonne Inc.: Navigating Challenges in Implementing Process Costing SystemWritten by: Dr. Hend Monjed
1. Introduction
A shoes manufacturing business, Mignonne Inc. was established in 2021. The company makes both
custom-made baby shoes, tailored to individual preferences, and mass-produced standard baby shoes for
wider market distribution. The company implements a hybrid costing system, adopting a job order
costing system and a process costing system. The company employs a process costing system to assign
the production costs of its mass-produced standard shoes. This system is suitable for industries that
produce identical products on a continuous basis. Examples include food processing, chemical
manufacturing, oil refining, and textile production. For custom-made shoes, the company uses a job order
costing system. This system allows the company to track and allocate costs more accurately for each
unique order. Unlike process costing, where products are homogeneous and produced in large quantities,
job order costing is suitable for industries that produce unique and one-of-a-kind products or services
based on specific customer requirements. Examples include companies that produce custom-made
products, such as custom furniture manufacturers, construction companies that take on projects with
unique specifications and requirements, agencies that create customized advertising campaigns for
clients.
The process costing system classifies costs into direct materials and conversion costs. In manufacturing
standard shoes, direct materials include materials such as leather, rubber for soles, laces, and other
components needed for the shoes whereas conversion costs involve direct labor cost and manufacturing
overhead cost. Manufacturing overhead costs are indirect costs associated with the production of goods
but cannot be easily traced directly to a specific product. Mignonne incurs various manufacturing
overhead costs such as factory rent, utilities, equipment depreciation, maintenance and repairs, factory
supplies, manufacturing facility insurance, and so on.
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2. The Regular Production Process for Mignonne standard shoes
Each month, Mignonne plans to produce 10,000 pairs of standard shoes. The production process
involves the Cutting & Stitching Department as well as the Assembly Department (See figure 1).
Figure 1: The production process of Mignonne baby shoes
In the Cutting and Stitching Department, skilled workers at Mignonne receive rolls of high-quality leather
and synthetic materials. Using precision cutting machines and templates, they meticulously cut the
various components that will form the upper part of the shoes. This department is equipped with stateof-the-art cutting tools and technology to ensure accuracy in the creation of each piece. Once the pieces
are cut, they are then skillfully assembled to create the upper part of the shoes. Experienced operators,
working with advanced sewing machines, stitch together components like vamp, quarters, and any
decorative elements. The use of high-quality thread and attention to detail are paramount in this
department to ensure the durability and aesthetic appeal of the finished product. Any necessary
reinforcements are added during this stage to enhance structural integrity. Once the upper is stitched
together, it is inspected for quality before moving to the next phase.
In the Assembly Department, the assembled uppers then move to the assembly department where the
shoes start taking their final form. In this stage, lasting machines are employed to stretch and shape the
upper over shoe lasts, giving each pair its distinctive shape. Skilled workers attach the sole to the lasted
upper, employing either adhesive or stitching methods. Additional components, such as insoles and
shanks, are carefully integrated to enhance comfort and support. This department is crucial in bringing
together all the components, ensuring that the shoes meet the design specifications and quality standards
set by Mignonne Inc.
The regular production process for the company typically occurs when all units enter the production
processes at the beginning of the month and are fully assembly (fully assembled shoes) by the month’s
end. Specifically, this standard production process is initiated when 10,000 units enter the Cutting and
Stitching Department at the start of the month. These units are then completed and transferred to the
subsequent Assembly Department as 10,000 pairs of fully assembled uppers. The Assembly Department
consolidates all the components, allowing the 10,000 pairs of shoes to begin taking their final form. By
the end of the month, the production process concludes, and all 10,000 pairs of shoes are prepared for
distribution.
The company uses the process costing system to accumulate costs from each department and allocates
them to the individual units produced. The total cost of direct materials is usually added at the beginning
of each department within the production process whereas conversion costs are added to each
department evenly over time. For example, the total cost of direct materials for producing 10,000 pairs
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of shoe uppers is $30,000, which is added to the Cutting and Stitching Department at the beginning of
the process. The total conversion costs for producing 10,000 pairs of shoe uppers are $20,000, the
company evenly allocates $20,000/10,000 pairs = $2 per pair for conversion costs. In other words, an
equal amount of conversion costs ($2 per pair) is added as each pair of shoe uppers progresses through
this process (See figure 2).
Figure 2: The cutting and stitching department
In the regular production process, the company calculates the cost of each pair of shoe uppers produced
(assembled) in the Cutting and Stitching Department, by averaging the total direct materials and
conversion costs, resulting in ($30,000 + $20,000)/10,000 pairs = $5 per pair. The regular production
process, with zero beginning and zero ending work-in-process inventory of pairs, represents the most
basic concept of process costing. It illustrates the averaging of costs, including total direct materials and
conversion costs. Mignonne Inc., founded in 2021, maintained a standard production process until March
2023.
3. Unexpected disruption in the production process for Mignonne Inc.
In the year 2023, the company faced an unexpected disruption in its production process, deviating from
the usual routine where all 10,000 pairs enter the Cutting and Stitching Department at the beginning of
the month and are fully completed within the same month. In March of that year, unforeseen logistical
challenges, including supply chain disruptions and workforce issues, resulted in a delay in the production
timeline.
As a result, out of the planned production of 10,000 pairs of shoe uppers for March, only 8,000 pairs were
completed by the end of the month. The remaining 2,000 units were partially finished and required
additional time to complete the cutting and stitching process. In April, the company faced the challenge
of completing the 2,000 units left unfinished from the previous month while simultaneously starting a
new production run of 10,000 pairs. The production status was as follows in April:
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1. Completion of Incomplete Units (March Production):
– During April, the 2,000 pairs that were partially finished in March were successfully
completed.
2. New Production (April Production):
– Out of the newly started 10,000 pairs in April, only half (5,000 pairs) were fully
completed in April.
The Cutting and Stitching Department’s supervisors and line managers were familiar with the conversion
costs as they provided estimated completion rates for the conversion costs of the pairs. The completion
rate of conversion costs is determined by the ratio of the total conversion costs required to finish a unit,
which has already been accrued, to the units that are still in the Cutting and Stitching process.
The data for the Cutting and Stitching Department in April were as follows:
•
Beginning work in process inventory (April 1)
2,000 pairs of shoe uppers
o Degree of completion: direct materials, 100%; conversion costs, 75%.
•
•
•
Units started during April 2023
10,000 pairs of shoe uppers
Units completed and transferred out during April 2023
7,000 pairs of shoe uppers
Ending work in process inventory (April 30)
5,000 pairs of shoe uppers
o Degree of completion: direct materials, 100%; conversion costs, 25%.
•
Costs of Beginning work in process inventory (April 1)
$3,000 for conversion costs.
Costs added during April
and $13,500 for conversion costs.
•
$6,000 for direct materials and
$30,000 for direct materials
Following the unexpected disruption in the production process, the junior management accountants at
the company found themselves perplexed about how to allocate the total cost of direct materials and
conversion costs incurred in the Cutting and Stitching Department to two types of output: fully assembled
and partially assembled pairs of shoe uppers.
4. Strategic Resolution: Ahmed Salih’s (CMA) Expert Guidance through the five steps of Process Costing
under the Weighted-average method
In response to this challenge, the company’s management decided to bring in a certified management
accountant, Ahmed Salih (CMA), to help resolve the issue. Upon his appointment, Ahmed engaged with
the management accounting team to address the confusion. Leveraging his expertise, Ahmed guided the
team through the following five-step process of process costing:
1.
2.
3.
4.
5.
Identify the units to be costed.
Determine the equivalent units.
Summarize the total costs: direct materials and conversion costs.
Calculate the cost per equivalent unit.
Allocate costs to completed and incomplete units.
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In step 2 of the process, Ahmed introduced the concept of equivalent units. To facilitate the allocation of
costs, he directed the team to convert the partially completed units in the Cutting and Stitching
Department into equivalent units. Equivalent units represent the work completed on partially finished
units, expressing them in terms of fully completed units. This approach allows for a more accurate
distribution of costs and provides clarity in tracking the progress of both fully assembled and partially
assembled units through the production stages. Ahmed further facilitated the implementation of the five
steps of process costing under the Weighted-average method (WA) by providing a comprehensive Excel
template (See figure 3). This tool served as a practical aid for the management accountants, guiding them
through the systematic allocation of costs to both completed and incomplete units.
Figure 3: The implementation of the five steps of process costing using WA method
Weighted Average Method (WA)
Step 1
Physical units
2,000
10,000
12,000
7,000
5,000
12,000
Flow of Production
Beginning WIP inventory
New units started during current period
Total units to account for
Units completed & transferred out
Ending WIP inventory
Total units accounted for
Total equivalent units
Total costs
Step 3
Cost of Beginning WIP inventory
Costs added in current period
Total costs to account for
Step 4
Costs incurred to date
Divide by equivalents units
Cost per equivalent unit
Step 5
Cost of units completed & transferred out
Cost of Ending WIP inventory
Total costs accounted for
Step 2
Direct Materials
Conversion Costs
7,000
5,000
7,000
1,250
12,000
8,250
Direct Materials
Conversion Costs
$
$
$
9,000 $
43,500 $
52,500 $
6,000
30,000
36,000
$
$
$
3,000
13,500
16,500
$
52,500 $
$
$
36,000
12,000
3
$
16,500
8,250
2
$
35,000 $
21,000
$
14,000
$
$
17,500 $
52,500 $
15,000
36,000
$
$
2,500
16,500
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5. Strategic Resolution: Ahmed Salih’s (CMA) Expert Guidance through the five steps of Process Costing
under the First-in First-out method
As the business continued to grow, the production volume of standard shoes also surged. The
management accounting department at Mignonne noticed limitations with the weighted-average process
costing system, particularly in accurately reflecting the current cost structure of mass-produced standard
shoes. The weighted-average method obscures the actual expenses incurred in the earliest stages of
production by averaging costs over the entire production process.
To address this issue, Ahmed helped the company make the strategic decision to switch to a First-in Firstout (FIFO) process costing system for the mass-produced standard shoes. This change enabled the
company to align production costs more closely with the current market conditions and accurately reflect
the costs associated with the earliest units produced. The switch to FIFO provided the company with a
more granular understanding of the costs associated with standard shoes, allowing for better decisionmaking and improved cost management. Ahmed clarified the distinctions between the inventoryvaluation methods WA and FIFO and additionally supported the execution of the five steps of process
costing using the FIFO method. He provided a detailed Excel template (see figure 4) to aid in the practical
application of the FIFO method in the cost allocation process.
Ahmed’s guidance proved instrumental in navigating the complexities of the disrupted production process
and ensuring a systematic and effective approach to process costing.
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Figure 4: The implementation of the five steps of process costing using FIFO method
First-in First-out Method (FIFO)
Step 1
Step 2
Physical units
Direct Materials Conversion Costs
2000
10000
12,000
Flow of Production
Beginning WIP inventory
New units started during current period
Total units to account for
1- Units completed & transferred out
a) From Beginning WIP inventory
b) From new units started & completed
2- Ending WIP inventory
Total units accounted for
Total equivalent units
2000
5000
5000
12,000
Total costs
Step 3
Cost of Beginning WIP
Costs added in current period
Total costs to account for
Step 4
Costs added in current period
Divide by equivalents units
Cost per equivalent unit
0
5000
5000
500
5000
1250
10,000
6,750
Direct Materials Conversion Costs
$
$
$
9,000 $
43,500 $
52,500 $
6,000 $
30,000 $
36,000 $
3,000
13,500
16,500
$
43,500 $
$
30,000 $
10,000
3 $
13,500
6,750
2
Step 5
Cost of Beginning WIP inventory
a) Costs added to complete Beginning WIP
inventory in current period
b) Costs of new units started & completed
1- Cost of Units completed & transferred out
$
9,000
$
6,000 $
3,000
$
$
$
1,000 $
25,000 $
35,000
$
15,000 $
1,000
10,000
2- Cost of Ending WIP inventory
Total costs accounted for
$
$
17,500 $
52,500 $
15,000 $
36,000 $
2,500
16,500
6. The effect of the unexpected disruption in the production process on the Assembly Department
In March 2023, the repercussions of the unexpected disruption in the company’s production process
manifested as the 8,000 pairs of shoe uppers that were assembled and completed in the Cutting and
Stitching Department were finally moved to the subsequent Assembly Department. However, due to the
unforeseen logistical challenges, including supply chain disruptions and workforce issues that transpired
in the company in March, the Assembly Department only managed to fully assemble 5,000 out of 8,000
pairs during March. The remaining 3,000 pairs represented the beginning work-in-process inventory in
the Assembly Department for the next month, April. During April, the Assembly Department
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encountered the arduous task of fully assembling not only the 3,000 uppers corresponding to March but
also an additional 7,000 uppers that were completed and transferred from the Cutting and Stitching
Department in April. The Assembly Department costs consist of transferred-in costs, as well as direct
materials and conversion costs added during assembly. Transferred-in costs (also called previousdepartment costs) refer to the costs incurred in one department and then transferred to the subsequent
department as the production process progresses. These costs include both direct materials and
conversion costs (direct labor and manufacturing overhead) associated with the partially completed units.
Particularly, the transferred-in costs include both direct materials and conversion costs for the shoe
uppers that are transferred from the Cutting and Stitching Department to the Assembly Department.
The completion rate of transferred-in costs is always 100% and such costs are added at the beginning of
the process in the Assembly Department.
The data for the Assembly Department in April were as follows:
•
Beginning work in process inventory (April 1)
3,000 pairs of shoe uppers
o Degree of completion: transferred-in costs, 100%; direct materials, 100%; conversion
costs, 45%.
•
•
•
Units transferred in during April 2023
7,000 pairs of shoe uppers
Units completed and transferred out during April 2023
8,000 pairs of shoes
Ending work in process inventory (April 30)
2,000 pairs of shoe uppers
o Degree of completion: transferred-in costs, 100%; direct materials, 100%; conversion
costs, 30%.
•
Costs of Beginning work in process inventory (April 1)
$15,000 for transferred-in
costs, $12,000 for direct materials and $8,100 for conversion costs
Costs added during April
$35,000 for transferred-in
costs, $28,000 for direct materials and $43,500 for conversion costs
•
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Requirements:
1. What is the hybrid costing system, and could you provide examples of real firms utilizing this
system?
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2. What are the key distinctions between process costing and job order costing systems?
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3. When are direct materials and conversion costs added to the production process in the Cutting
and Stitching Department?
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4. What is meant by conversion costs?
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5. Could you provide examples of manufacturing overhead costs for service companies?
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6. What are the differences between the weighted-average (WA) and first-in-first-out (FIFO)
methods when allocating costs to completed and incomplete units of output?
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7. What is the significance of equivalent units in a process costing system?
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8. What is meant by transferred-in costs?
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9. Utilizing the template below, assign costs incurred in April in the Assembly department to
completed and incomplete units using the weighted-average method.
10. Utilizing the template below, assign costs incurred in April in the Assembly department to
completed and incomplete units using the first-in-first-out method.
11. What challenges did Mignonne company face in March, and what repercussions did this
problem have on the production process? How were individual departments affected?
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Answer to requirement 9:
Weighted Average Method (WA)
Flow of Production
Beginning WIP inventory
New units started during current period
Total units to account for
Units completed & transferred out
Ending WIP inventory
Total units accounted for
Total equivalent units
Step 1
Physical units
Step 2
Transferred-In costs Direct Materials Conversion Costs
Total costs
Transferred-In costs Direct Materials Conversion Costs
Step 3
Cost of Beginning WIP
Costs added in current period
Total costs to account for
Step 4
Costs incurred to date
Divide by equivalents units
Cost per equivalent unit
Step 5
Cost of Units completed & transferred
out
Cost of Ending WIP inventory
Total costs accounted for
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Answer to requirement 10:
First-in First-out Method (FIFO)
Flow of Production
Beginning WIP inventory
New units started during current period
Total units to account for
1- Units completed & transferred out
a) From Beginning WIP inventory
b) From new units started & completed
2- Ending WIP inventory
Total units accounted for
Total equivalent units
Step 1
Physical units
Step 2
Transferred-In costs Direct Materials Conversion Costs
Total costs
Transferred-In costs Direct Materials Conversion Costs
Step 3
Cost of Beginning WIP
Costs added in current period
Total costs to account for
Step 4
Costs added in current period
Divide by equivalents units
Cost per equivalent unit
Step 5
Cost of Beginning WIP inventory
a) Costs added to complete Beginning WIP
inventory in current period
b) Costs of new units started & completed
1- Cost of Units completed & transferred out
2- Cost of Ending WIP inventory
Total costs accounted for
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