Case 3: Process Costing with Some Beginning and Some Ending Work-in-Process Inventory

Learning Objective 4: Use the weighted-average method and the first-in, first-out (FIFO) method of process costing

Weighted-Average Method

Combine the beginning inventory with work started this period.

1. Physical Units: Add up Beginning WIP with Work Started this Period. It should match Units completed and transferred out + Ending WIP (225+175=400+100)
2. Equivalent Units: Convert WIP accounts to Equivalent Units and add to their respective start and completed Units, these should equal each other. (For expediency, you only need to calculate Completed+Ending WIP)
3. Total Costs: Add up Beginning WIP Costs and Costs added during period
4. Cost/Equivalent Unit: It's just math
5. Allocate Costs: Where'd it go between completed and ending WIP

First-In, First-Out Method

I, look I know what FIFO is.

1. Physical Units: Beginning WIP -> Completed and Transferred first. The difference must be units started during this period that are Completed and Transferred. Any units started this period that aren't Completed and Transferred should end up in Ending WIP.
2. Equivalent Units: Note, Equivalent Units of work done this period. This means if Beginning WIP inventory is [100% | 30%], the Equivalent Units of work done this period is [0% | 70%]. Ending WIP is more of the same.
3. Total Costs: Duh
4. Cost/Equivalent Unit: Also Duh
5. Allocate Costs: Allocate to Work Done this period to your Beginning Inventory, then Work Started and Completed, then Ending Inventory.

Two Things to note: 

FIFO should look mostly the same as Weighted Average except that it shifts the Cost of Goods Completed and Transferred Out with the Ending WIP. This is because Costs from the Beginning WIP first go through Completed and Transferred Out before Ending WIP (if they even get there). Compare this to Weighted Average, which distributes that cost proportionally between Transferred out and Ending WIP.

FIFO mostly applies only to items being transferred out. While it is possible to apply FIFO to units coming in as well, matching both up is cumbersome and is generally avoided.

Comparing the Weighted-Average and FIFO Methods

It should be noted that Weighted-Average and FIFO only really differentiate if the cost of inputs fluctuate by a significant amount, or if the Ending WIP to Products Completed and Transferred ratio is particularly high.

If Inputs drop, this causes FIFO to carry these higher costs into what eventually will be CoGS. If Inputs increase, Weighted-Average will do this. The higher CoGS will make the income of the company look smaller (even though the actual money they make is the same either way). This helps avoid taxes. On the other hand, going the opposite route for a lower CoGS may make a manager look better in the short term, though it does end up getting taxed more.

What are the Weighted-Average and FIFO methods of process costing? Under what conditions will they yield different levels of Operating Income?

Weighted Average and FIFO are different ways of allocating Process Costs onto the products created. Weighted Average simply distributes leftover costs from the previous month into the next, while FIFO gets those previous costs out of the door first.

They're mostly the same until Costs fluctuate and if Ending Inventory is significantly large, at which point FIFO makes costs look bigger if costs are falling and vice versa.