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Meaning:

Process costing is an accounting methodology that traces and accumulates direct costs, and allocates indirect costs of a manufacturing process. Costs are assigned to products, usually in a large batch, which might include an entire month's production. Eventually, costs have to be allocated to individual units of product. It assigns average costs to each unit, and is the opposite extreme of Job costing which attempts to measure individual costs of production of each unit. Process costing is usually a significant chapter. it is a method of assigning costs to units of production in companies producing large quantities of homogeneous products.

Meaning: Process costing is an accounting methodology that traces and accumulates direct costs, and allocates indirect

Process costing is a type of operation costing which is used to ascertain the cost of a product at each process or stage of manufacture. CIMA defines process costing as "The costing method applicable where goods or services result from a sequence of continuous or repetitive operations or processes. Costs are averaged over the units produced during the period". Process costing is suitable for industries producing homogeneous products and where production is a continuous flow. A process can be referred to as the sub-unit of an organization specifically defined for cost collection purpose.

Process costing is a form of operations costing which is used where standardized homogeneous goods are produced. This costing method is used in industries like chemicals, textiles, steel, rubber, sugar, shoes, petrol etc. Process costing is also used in the assembly type of industries also. It is assumed in process costing that the average cost presents the cost per unit. Cost of production during a particular period is divided by the number of units produced during that period to arrive at the cost per unit.

Definition:

CIMA London defines process costing as “that form of operation costing which applies where standardize goods are produced”

Method for determining the total unit cost of the output of a continuous production run (such as in food processing, petroleum, and textile industries) in which a product passes through several processes (or cost centers). It involves the following steps:

(1) the 'total cost per process' is computed by estimating the number of products passing through each process in a given period; (2) the 'unit cost per process' is computed by dividing the 'total cost per process' by the number of units passing through the process in the given period; (3) the 'unit cost per process' is charged to each unit as it passes through each process so that, at the end of the production cycle, each product will have received an appropriate charge for each process through which it has passed.

a) The output of one process becomes the input to the next until the finished product
a) The output of one process becomes the input to the next until the
finished product is made in the final process.
Features of Process Costing
b) The continuous nature of production in many processes means
that there will usually be closing work in progress which must be
valued. In process costing it is not possible to build up cost
records of the cost per unit of output or the cost per unit of
closing inventory because production in progress is an
indistinguishable homogeneous mass.
  • c) There

is

often

a

loss

in

process

evaporation and so on.

due

to

spoilage,

wastage,

  • d) Output from production may be a single product, but there may also be a by-product (or byproducts) and/or joint products.

  • e) Both direct and indirect costs are accumulated in each process

  • f) If there is a stock of semi-finished goods, it is expressed in

  • g) terms of equalent units

  • h) The total cost of each process is divided by the normal output of

  • i) that process to find out cost per unit of that process.

Process accounts

Where a series of separate processes is required to manufacture the finished product, the output of one process becomes the input to the next until the final output is made in the final process. Direct labour and production overhead may be treated together in an examination question as conversion cost.

Steps for dealing with process costing

Step 1: Determine output and losses. This step involves the following.

Determining expected output

Calculating normal loss and abnormal loss and gain

Calculating equivalent units if there is closing or opening work in progress

Step 2:

Calculate cost per unit of output, losses and WIP. This step involves calculating cost per unit or cost per equivalent unit.

Step 3: Calculate total cost of output, losses and WIP. In some examples this will be straightforward; however in cases where there is closing and/or opening work in-progress a statement of evaluation will have to be prepared.

Step 4: Complete accounts. This step involves the following.

Completing the process account

Writing up the other accounts required by the question

Importance of process costing

Costing is an important process that many companies engage in to keep track of where their money is being spent in the production and distribution processes. Understanding these costs is the first step in being able to control them. It is very important that a company chooses the appropriate type of costing system for their product type and industry. One type of costing system that is used in certain industries is process costing that varies from other types of costing (such as job costing) in some ways. In process costing unit costs are more like averages, the process-costing system requires less bookkeeping than does a job-order costing system. Thus, some companies often prefer to use the process-costing system.

process applied ? costing When is
process
applied ?
costing
When
is

Process costing is appropriate for companies that produce a continuous mass of like units through series of operations or process. Also, when one order does not affect the production process and a standardization of the process and product exists. However, if there are significant differences among the costs of various products, a process costing system would not provide adequate product-cost information. Costing is generally used in such industries such as petroleum, coal mining, chemicals, textiles, paper, plastic, glass, and food.

Reasons for Use

Costing is an important process that many companies engage in to keep track of where their

Companies need to allocate total product costs to units of product for the following reasons:

A company may manufacture thousands or millions of units of product in a given period of time.

Products are manufactured in large quantities, but products

may be sold in small quantities, sometimes one at a time

(automobiles, loaves of bread), cookies), etc.

a

dozen or two

at

a

time (eggs,

Product costs must be transferred from Finished Goods to Cost of Goods Sold as sales are made. This requires a correct and accurate accounting of product costs per unit, to have a proper matching of product costs against related sales revenue.

Managers need to maintain cost control over the manufacturing process. Process costing provides managers with feedback that can be used to compare similar product costs from one month to the next, keeping costs in line with projected manufacturing budgets.

A fraction-of-a-cent cost change can represent a large dollar change in overall profitability, when selling millions of units of product a month. Managers must carefully watch per unit costs on a daily basis through the production process, while at the same time dealing with materials and output in huge quantities.

Materials part way through a process (e.g. chemicals) might need to be given a value, process costing allows for this. By determining what cost the part processed material has incurred such as labor or overhead an "equivalent unit" relative to the value of a finished process can be calculated.

Advantages of process costing:

  • 1. Costs are be computed periodically at the end of a particular period

  • 2. It is simple and involves less clerical work that job costing

  • 3. It

is easy

to allocate the expenses to processes in order to have

accurate costs.

  • 4. Use of standard costing systems in very effective in process situations.

costing

  • 5. Process costing helps in preparation of tender, quotations

  • 6. Since

cost

data

is

available

for

each

operation

process,

and

department, good managerial control is possible.

Limitations:

  • 1. Cost obtained at each process is only historical cost and are not very useful for effective control.

    • 2. Process costing is based on average cost method,

which is not that suitable for performance analysis, evaluation and managerial control.

  • 3. Work-in-progress is generally done on estimated

basis which leads to inaccuracy in total cost

calculations.

1. Costs are be computed periodically at the end of a particular period 2. It is
  • 4. The computation of average cost is more difficult in those cases where more than one type of products is manufactured and a division of the cost element is necessary.

  • 5. Where different products arise in the same process and common costs are prorated to various costs units. Such individual products costs may be taken as only approximation and hence not reliable.

DISTINCTION BETWEEN

JOB COSTING & PROCESS COSTING

Job order costing and process costing are two different systems. Both the systems are used for cost calculation and attachment of cost to each unit completed, but both the systems are suitable in different situations. The basic difference between job costing and process costing are

 

Basis of

Job order costing

Process costing

Distinction

1.

Specific order

Performed against specific

Production is

orders

contentious

2.

Nature

Each job many be different.

Product is homogeneous and standardized.

3.

Cost

Cost is determined for each

Costs are complied for

determination

job separately.

each process for department on time basis i.e. for a given accounting period.

4.

Cost calculations

Cost is complied when a job is completed.

Cost is calculated at the end of the cost period.

5.

Control

Proper control is comparatively difficult as each product unit is different and the production is not continuous.

Proper control is comparatively easier as the production is standardized and is more suitable.

6.

Transfer

There is usually not transfer from one job to another unless there is some surplus work.

The output of one process is transferred to another process as input.

7.

Work-in-

There may or may not be

There is always some

Progress

work-in-progress.

work-in-progress because of continuous production.

8.

Suitability

Suitable to industries where production is intermittent and customer orders can be identified in the value of production.

Suitable, where goods are made for stock and productions is continuous.

Process cost procedures

There are four basic steps in accounting for Process cost:

  • Summarize the flow of physical units of output.

  • Compute output in terms of equivalent units.

  • Summarize total costs to account for and Compute equivalent unit costs.

  • Assign total costs to units completed and to units in ending work in process inventory.

The journal entries for process costing are the same as those for job-order costing with one exception. The entry to transfer cost from one work-in- process account to another is:

Work-in-process inventory-second department Debit (Left) Work-in-process-first department Credit (Right)

For

There are four basic steps in accounting for Process cost:  Summarize the flow of physical

each

process an individual process account is prepared. Each process of production is treated as a distinct cost centre.

  • Items on the Debit side of Process A/c. Each process account is debited with

    • a) Cost of materials used in that process.

    • b) Cost of labour incurred in that process.

    • c) Direct expenses incurred in that process.

    • d) Overheads charged to that process on some pre determined.

    • e) Cost of ratification of normal defectives.

    • f) Cost of abnormal gain (if any arises in that process)

  • Items on the Credit side:

Each process account is credited with

  • a) Scrap value of Normal Loss (if any) occurs in that process.

  • b) Cost of Abnormal Loss (if any occurs in that process)

  • Cost of Process:

The cost of the output of the process (Total Cost less Sales value of

scrap) is transferred to the next process. The cost of each process is thus made up to cost brought forward from the previous process and net cost of material, labour and overhead added in that process after reducing the sales value of scrap. The net cost of the finished process is transferred to the finished goods account. The net cost is divided by the number of units produced to determine the average cost per unit in that process. Specimen of Process Account when there are normal loss and abnormal losses.

 Items on the Credit side: Each process account is credited with a) Scrap value of

Process Losses:

In many process, some loss is inevitable. Certain production techniques are of such a nature that some loss is inherent to the production. Wastages of material, evaporation of material is un avoidable in some process. But sometimes the Losses are also occurring due to negligence

of Labourer, poor quality raw material, poor technology etc. These are normally called as avoidable losses. Basically process losses are classified into two categories (a)Normal Loss (b) Abnormal Loss

  • 1. Normal Loss:

Normal loss is an unavoidable loss which occurs due to the inherent nature of the materials and production process under normal conditions. It is normally estimated on the basis of past experience of the industry. It may be in the form of normal wastage, normal scrap, normal spoilage, and normal defectiveness. It may occur at any time of the process. No of units of normal loss: Input x Expected percentage of Normal Loss. The cost of normal loss is a process. If the normal loss units can be sold as a crap then the sale value is credited with process account. If some rectification is required before the sale of the normal loss, then debit that cost in the process account. After adjusting the normal loss the cost per unit is calculates with the help of the following formula:

Cost of good unit: Total cost increased Sale Value of Scrap Input Normal Loss units

  • 2. Abnormal Loss:

Any loss caused by unexpected abnormal conditions such as plant breakdown, substandard material, carelessness, accident etc. such losses are in excess of pre-determined normal losses. This loss is basically avoidable. Thus abnormal losses arrive when actual losses are more than expected losses. The units of abnormal losses in calculated as under:

Abnormal Losses = Actual Loss Normal Loss The value of abnormal loss is done with the help of following formula:

Value of Abnormal Loss:

Total Cost increase Scrap Value of normal Loss x Units of abnormal loss Input units Normal Loss Units Abnormal Process loss should not be allowed to affect the cost of production as it is caused by abnormal (or) unexpected conditions. Such loss representing the cost of materials, labour and overhead charges called abnormal loss account. The sales value of the abnormal loss is credited to Abnormal Loss Account and the balance is written off to costing P & L A/c.