Chapter8

PROCESS COSTING PROCESSCOSTING

Process costing is probably the most widely used method of cost ascertainment. It
is used in mass production industries producing standard products, like steel, is used in mass production industries producing standard products, like steel,
sugar and chemicals.
ESSENTIALCHARACTERISTICSOF
PROCESS COSTING PROCESSCOSTING
1.Theproductioniscontinuousandthefinalproductistheresultofasequence
ofprocesses.
2.Costsareaccumulatedprocesswise.
Th d t t d di d dh 3.Theproductsarestandardizedandhomogeneous.
4.Thecostperunitproducedistheaveragecostwhichiscalculatedbydividingthe
totalprocesscostbythenumberofunitsproduced.
5.Thefinishedproductofeachbutlastprocessbecomestherawmaterialforthe
nextprocessinsequenceandthatofthelastprocessistransferredtothefinished
goodsstock.
6 Th f ti i ifi d d t i d 6.Thesequenceofoperationsorprocessesisspecificandpredetermined.
7.Somelossofmaterialsinprocesses(duetochemicalaction,evaporation,
etc.)isunavoidable.
8.Processingofarawmaterialsmaygiverisetotheproductionofseveralproducts.
Theseseveralproductsproducedfromthesamerawmaterialmaybetermedas
jointproductsorbyproducts.
PROCESSCOSTINGANDJOB
COSTING ACOMPARISON
PROCESS COSTING PROCEDURE PROCESSCOSTINGPROCEDURE
Thefactoryisdividedintoa
numberofprocessesandan
Thefinishedoutputofthelast
process(i.e.,thefinalproduct)is p
accountismaintainedforeach
process.
p p
transferredtotheFinishedGoods
Account.
E h ti d bit d
Theoutputofaprocessis
Eachprocessaccountisdebited
withmaterialcost,labourcost,
directexpensesandoverheads
allocatedorapportionedtothe
process.
p p
transferredtothenextprocessin
thesequence.Inotherwords,
finishedoutputofoneprocess
becomesinputofthenext
process.
process.
PROCESSCOSTINGPROCEDURE
PROCESS LOSSES AND WASTAGES PROCESSLOSSESANDWASTAGES
In industries which employ process costing, a certain amount of loss occurs at
various stages of production It is therefore necessary to keep accurate records various stages of production. It is, therefore, necessary to keep accurate records
of both input and output.
Process losses may by classified into (a) normal and (b) abnormal Process losses may by classified into (a) normal, and (b) abnormal.
Th fl hi h b id db f h f
NormalProcessLoss
Thatamountoflosswhichcannotbeavoidedbecauseofthenatureof
materialorprocessisnormalprocessloss.Suchalossisquiteexpectedunder
normalconditions.Itiscausedbyfactors,likechemicalchange,
evaporation,withdrawalsfortestsorsamplingandunavoidablespoiled
quantities quantities
Thistypeoflossconsistsoflossduetocarelessness machinebreakdown
AbnormalProcessLoss
Thistypeoflossconsistsoflossduetocarelessness,machinebreakdown,
accident,useofdefectivematerials,etc.Thus,itarisesduetoabnormal
factorsandrepresentsalosswhichisoverandabovethenormalloss.
ACCOUNTINGTREATMENTOF
NORMAL AND ABNORMAL LOSS NORMALANDABNORMALLOSS
AccountingTreatmentofNormalLoss
Normal loss is generally determined as a percentage of input. Such a wastage is not
h i ll t b i l it t h l H h l l i physically present, obviously it cannot have any value. However, when normal loss is
physically present in the form of scrap, it may have some value, which is credited to the
Process Account.
Accounting Treatment of Abnormal Process Loss Accounting Treatment of Abnormal Process Loss
(a) Allow for normal loss in the manner described earlier.
(b) After considering normal loss, find out the cost per unit in that process.
Costperunit=(TotalcostValueofnormalloss)/UnitsintroducedNormalloss
units units
(c) Multiply the cost per unit by the number of units of abnormal loss. This gives the total
value of abnormal loss.
(d) Credit relevant Process Account with quantity(value) of abnormal loss.
(e) The balance figure in the Process Account is the cost of good units produced in the (e) The balance figure in the Process Account is the cost of good units produced in the
process. This can also be found by multiplying cost per unit with the number of good
units produced.
(f ) Open Abnormal Loss Account and debit it with the quantity and value of abnormal
loss shown in the Process Account Sale proceeds from abnormal loss are credited to loss shown in the Process Account. Sale proceeds from abnormal loss are credited to
Abnormal Loss Account. Any balance left in this account is net loss and transferred to
Costing P&L Account.
ABNORMAL GAIN OR EFFECTIVENESS ABNORMALGAINOREFFECTIVENESS
Th l l t th l th t ldb t d d l Thenormalprocesslossrepresentsthelossthatwouldbeexpectedundernormal
conditions.Itisanestimatedfigure.
Theactuallossmaybegreaterorlessthanthenormalloss Iftheactuallossisgreater Theactuallossmaybegreaterorlessthanthenormalloss.Iftheactuallossisgreater
thannormalloss,itisknownasabnormalloss.
Butifactuallossislessthannormalloss againisobtainedwhichistermedas Butifactuallossislessthannormalloss,againisobtainedwhichistermedas
abnormalgainoreffectiveness.
Th l f b l i i l l t di i il t b ll Thevalueofabnormalgainiscalculatedinamannersimilartoabnormalloss.
ItisshownonthedebitsideoftheProcessAccountandcreditsideoftheAbnormalGain
Account Likeabnormalloss itisultimatelytransferredtoCostingProfitandLoss Account.Likeabnormalloss,itisultimatelytransferredtoCostingProfitandLoss
Account.
WHEN OUTPUT OF IS PARTLY SOLD AND WHENOUTPUTOFISPARTLYSOLDAND
PARTLYTRANSFERREDTOTHENEXT
PROCESS
Sometimestheoutputofaprocessmaybepartlysoldandpartlytransferredto
thenextprocessforfurtherprocessing.
Forexample,inatextilemill,partoftheoutputofaspinningprocessmaybe
soldandtheremainingoutputispassedontotheweavingprocessforfurther
processing.
Apartoftheoutputsosoldwillcontainanelementofprofitorlosswhichwill
berevealedintheProcessAccount.Butwhenapartoftheoutputissentto be evea ed t e ocess ccou t. ut w e a pa t o t e output s se t to
warehouseforsale,itisatcostanddoesnotcontainanelementofprofitorloss.
WORK IN PROGRESS WORKINPROGRESS
(EQUIVALENTPRODUCTION)
Process costing mainly deals with continuous type of production. At the end
of the accounting period, there may be some workinprogress, i.e., semi
finished goods may be in the pipeline. The valuation of such workinprogress is
Equivalent Production
finished goods may be in the pipeline. The valuation of such work in progress is
done in terms of equivalent or effective production.
Equivalent production represents the production of a process in terms of
completed units. Workinprogress at the end of an accounting period are
converted into equivalent completed units.
EVALUATIONOFEQUIVALENT
PRODUCTION
Ascertainthecostper
Findoutthetotalcost
(net)foreachelement
ofcost,i.e.,material,
labourandoverheads.
Scrapvalueofnormal
unitofequivalent
productionseparately
foreachelementofcost.
Thisisdonebydividing
thetotalcostofeach
Atthisrateofcostper
unit,ascertainthevalue
offinishedproduction
Scrapvalueofnormal
lossisdeductedfrom
thematerialcost.
thetotalcostofeach
elementbythe
respectivenumberof
equivalentunits.
p
andworkinprogress.
For the purpose of computation of equivalent production and its evaluation, the
following three statements are generally prepared:
(a) Statement of equivalent production (a) Statement of equivalent production
(b) Statement of cost (per unit)
(c) Statement of evaluation
These three statements may also be combined in one comprehensive statement called
Statement of Production, Cost and Evaluation.
EQUIVALENT PRODUCTION EQUIVALENTPRODUCTION
Whenthereisnoopeningstockandnoprocessloss
N lL E i l i f ll k il I NormalLossEquivalentunitsofnormallossaretakenasnil.In
otherwords,normallossisnotaddedintheequivalentproduction.
However,realizablevalueofnormalscrapisdeductedfromthecostof
materialsoastocalculatethenetmaterialcost.Thisnetmaterial
costbecomesthebasisofcalculatingthematerialcostperunitinthe g p
statementofcost.
AbnormalLossThisistreatedasifthisweregoodproductionlost.
Abnormalloss,thus,isaddedtoequivalentproductionwithdue
considerationtoitsdegreeofcompletion Unlessthedegreeof considerationtoitsdegreeofcompletion.Unlessthedegreeof
completionisspecified,itmaybeassumedthatabnormallossunitsare
100%completeinrespectofallelementsofcost.
AbnormalGainUnitsofabnormalgainarerepresentedbygood
finishedproduction.Itistherefore,alwaystakenas100%completein
respectofallelementsofcost,i.e.,material,labourandoverheads.
Abnormalgainisdeductedtoobtainequivalentproduction.
EQUIVALENT PRODUCTION(CONTD ) EQUIVALENTPRODUCTION(CONTD.)
When there is opening as well as closing stock of workinprogress
In such a case there are two methods of calculating equivalent production: In such a case there are two methods of calculating equivalent production:
1. FIFO: This method is based on the assumption that workinprogress moves on a first
infirst out basis. This means that unfinished work on the opening stock is completed first,
before work on any new units is taken up.
Statetheopeningstockofworkinprogressinequivalentcompletedunits.Thisisdoneby
ComputationofEquivalentProductionunderFIFOMethod.
1
applyingthepercentageofworkneededtocompletetheunfinishedworkoftheprevious
period.
Ascertainthenumberofunitsintroducedintotheprocessanddeductthenumberofunitsof
l i k i Thi i h b f i d d l dd i h
2
closingworkinprogress.Thisgivesthenumberofunitsstartedandcompletedduringthe
period.Addtheseunitstotheopeningstockofworkinprogresscalculatedin(i)above.
Addtotheabovetheequivalentcompletedunitofclosingworkinprogress.Thiscanbe
determinedbyapplyingthepercentageofworkdoneonthefinishedunitsattheendofthe
3
determinedbyapplyingthepercentageofworkdoneonthefinishedunitsattheendofthe
period.
EQUIVALENT
PRODUCTION(CONTD ) PRODUCTION(CONTD.)
2. Average Cost Method
In this method, the cost of opening workinprogress is not kept separately but is averaged
with the additional costs incurred during the period. This method thus combines the cost of
opening workinprogress and new production. Information relating to degree of
completion of opening WIP is not required.
In order to find out the cost per unit of equivalent production, the cost of each element
(material, labour and overheads) applicable to the opening workinprogress is added to the
cost incurred in the current period for that element.
A single cumulative total and unit cost is obtained. Units completed and transferred as
well as closing workinprogress will be valued at this average unit cost.
HOWTOCHOOSEBETWEENFIFO
ANDAVERAGEMETHOD
UseFIFO Ifthecostof
theopeningworkin
UseAverage Ifthecost
ofopeningworkin
progressisgiveninterms
progressinonelumpsum
figureandthestageof
completionisgiven.
progressisgiveninterms
ofmaterials,labourand
overheadbutthestageof
completionisnotgiven.
FIFOorAverageYour
Choice Ifthedegreeof
completionandthecostin Wherethequestion
termsofmaterials,labour
andoverheadsofthe
openingworkinprogress
aregiven,thenonehasa
choicebetweenFIFOand
specifiesamethodtobe
followed,thenthat
methodmustbe
followed.
Averagemethods.
INTERNAL PROCESS PROFITS INTERNALPROCESSPROFITS
(INTERPROCESSPROFITS)
In some businesses, it is a practice to charge the output of each process to the next process
not at cost but at a price showing profit to the transferor process. The transfer price may be
either the current market price or cost plus a fixed percentage either the current market price or cost plus a fixed percentage.
Inbrief,theobjectsofsuchinternalprocessprofitare:
( )T h h th th
(c)Toassistinmakingdecisions,
h t b tl d (a)Toshowwhetherthe
costineachprocess
competeswiththe
marketprices.
(b)Tomakeeach
processstandonitsown
efficiencyandeconomy.
suchastobuyapartlyprocessed
materialratherthantoprocess
workinternallyortosellapartly
processedproductortoprocessit
further. further.