8 9 Process Costing Overview Financial and Managerial Accounting

Overall, when it is difficult or not economically feasible to track the costs of a product individually, process costing is typically the best cost system to use. 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.

A company that produces ink cartridges applies process costing through several departments. The first department—the design department—is where the overall shape, dimensions and other design elements of the cartridges are processed. The per-unit costs are then split according to the number of units completed & units that are under process. Direct CostDirect cost refers to the cost of operating core business activity—production costs, raw material cost, and wages paid to factory staff. Such costs can be determined by identifying the expenditure on cost objects.

Using the Process Costing Method

A production report has to be made under the process costing system. NetSuite’s ERP suite helps manufacturers manage every aspect of their business, from supply chain management and procurement to order fulfillment and customer relationship management . The fully integrated financial management solution helps businesses accelerate their financial close, provides strong expense management and real-time visibility into the company’s financial performance.

The equivalent units for the period will be 7,200 units, i.e., 6,000 + 40% of 3,000. If the costs incurred during the period is Rs. 14,400, the cost per equivalent unit will be Rs. 2, i.e., Rs. (14,400/7,200). In process industries there must be some partially finished units i.e., work-in-progress in each process at the end of an accounting period. The cost of such unfinished units is lower than a finished unit. Stock of raw materials represents the stock of unused materials in various processes. Stock of raw material in the first process of a product in a manufacturing concern, if any, shall represent the basic raw material of that concern to be returned to the Stores Department.

These ratios should be revised from time to time depending upon the factors affecting production and sales. This method can be applied when physical units of production are similar or can be correlated by a factor or coefficients. This method may not be helpful where costs have no relationship to the output weight of individual products. Credit is given to the process account for sale value less the cost after split off point. By products sales deduced from total cost – Under this method the sale proceeds of the by-products are treated as deductions from total costs. The sales value is deducted either from the production costs or cost of sales. Multiply equivalent units by cost per equivalent unit to determine the cost of completed production and work-in-progress.

Steps for Process Costing

In process costing, costs are assigned to products at the different stages of production. Thus, revenues and costs are gathered for batches of identical goods. As opposed to job costing, in process costing, costs are assigned to departments, and unit cost information comes from the departmental production cost report. There usually will be several different work-in-process inventory accounts in use.

The statement showing physical flow of units will also indicate normal or abnormal loss. Costs, both direct and indirect, are accumulated in cost accounts on a regular basis. At the end of the costing period, costs are charged to different processes. The waste, rejects and scrap are also accounted for in the same way as in- process costing. Thus, basically there is no difference between process costing and operation costing and the two terms are often used interchangeably. Process costing systems track costs by processing department, whereas job costing systems track costs by job. ITEMS OF EXPENSES BASIS OF DISTRIBUTION Rent, rates and taxes Area occupied by each process.

• Costs are assigned to products, usually in a large batch, which might include an entire month’s production.
• Production is divided into various stages and each process is carried out by separate cost centers or departments.
• When a company has units that are started and completed during a period and has an ending inventory of units in process, most often the weighted average method is used to calculate equivalent units.
• Costs are assigned first to production departments and then to units of output as they move through the departments.
• With any production process, outputs rarely match inputs.
• The sum of the departmental work in process costs is the total cost of the batch that is transferred to Finished Goods.
• One type of costing system that is used in certain industries is process costing that varies from other types of costing in some ways.

For these companies, it can be difficult or impossible to directly allocate costs to each item as it moves through the manufacturing process. Process costing enables companies to estimate item costs by adding up the expenses of each step in the manufacturing process, then dividing by the number of items. To ensure accuracy, companies need to include only product-related costs from each department involved in the process and correctly allocate cost to work-in-progress at each stage. 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.

Using the process costing method

With any production process, outputs rarely match inputs. Usually, there is some loss of materials during the manufacturing stages. In a process company, factory overhead represents those costs not directly assigned to one function. The journal entries that follow illustrate the accounting for general overhead costs.

• Costs of completed units of a department are transferred to the next processing department in order to arrive at the total costs of the finished products during a period.
• Each business will have different processing departments, depending on the product they are making.
• Process costing can be time consuming, and it can be difficult to accurately assign product costs to each manufacturing stage and to work-in-progress items.
• However, job costing is less appropriate when production is a continuous flow through processing departments, resulting in large quantities of homogenous products.
• Business owners allocate business costs according to the number of processes each good travels through in the production system.

Hence, when there are inventories of WIP, unit cost cannot be obtained by simply dividing the total cost by the number of units processed. Units in WIP must be converted to a base which can be equated with completed production. So equivalent unit may represent the production of a process in terms of completed unit. It also means converting the uncompleted units into equivalent of completed units. In a manufacturing unit generally it is not possible to complete the work on all the units on which work has been started. When total cost of the process is divided by the units produced in that process it results into per unit cost of that process. When there is abnormal gain, value of units representing abnormal gain should be debited to process account.

Process Costing Procedure (With Illustration)

With NetSuite, you go live in a predictable timeframe — smart, stepped implementations begin with sales and span the entire customer lifecycle, so there’s Process Costing continuity from sales to services to support. Performance – In contract costing work is performed generally outside the factory or at the work site.

• In either costing system, the ability to obtain and analyze cost data is needed.
• Process industries may also have problems of joint/by-products.
• For this, the work- in-progress in each process, if any, is converted into equivalent units of finished products to ascertain the cost of work-in-progress and finished goods.
• It is concerned with the determination of the cost of each operation rather than the process.
• Within this costing technique, we assign costs to the Process itself.
• Standardised Products – Products and processes are completely standardised.

The net cost is divided by the number of units produced to determine the average cost per unit in that process. Companies that mass produce a product allocate the costs to each department and use process costing. For example,General Millsuses process costing for its cereal, pasta, baking products, and pet foods. Job order systems are custom orders because the cost of the direct material and direct labor are traced directly to the job being produced.

If there is normal loss, the loss is borne by the good units completed, thus increasing the average cost per unit.

Both systems maintain and use same basic accounts such as – raw materials control account, wages control account, production overhead account and finished stock account. But it results into weight loss of the quantity in output. This loss increases the cost of production of the product produced in the process. If the scrap is sold then the sale value of scrap is also shown on the credit of process account which results into decreasing the cost of production. Units representing abnormal gain are valued like normal output of the process. The value of abnormal gain is shown on the debit side of process account and credit side of the abnormal gain account. Since abnormal gain occurs as a result of actual loss being less than normal, the scrap realisation shown against normal loss gets reduced by the scrap value of abnormal gain.

Process costing is most often used when manufacturers release identical products. If mass produced televisions have the same parts, manufacturers can assign consistent prices to the products based on how much the products cost to manufacture overall. The most notable difference between job and Process costing is the WIP calculation. In Job Costing, we estimate the percentage of completion for each partially finished job.

The products require further processing to finish them into more useful and valuable products. Apportionment on a suitable basis – Where by-products are of major importance, cost should be apportioned on the most suitable basis, i.e. To decide whether to produce or to purchase the product of process from the market is profitable or not.

Cost Calculation – Cost is determined for every process. Completion of task – Completion of job is necessary for calculating of cost of a job, order. The percentage of the market value of each product to the total of the market values is found out. The resultant market value of all products are then added.

Getting a handle on production costs enables these companies to set the right prices for their products and determine whether costs are tracking in line with projections. They can use process costing to analyze the costs of each step of the production and distribution process and use the information to identify areas where they can reduce costs. When normal loss fetches no value, the cost of normal loss is absorbed by good production units of the process. If the normal loss-units have some realisable value as scrap, then the value is credited to the process account to arrive at normal cost of normal output. This method is used when degree of completion of opening WIP is not given. The opening WIP units are not shown separately in the equivalent production statement, but are included in the total units completed and transferred to the subsequent process/finished stock. The total cost of each process, after adjusting the value of work-in-progress for each cost period, being divided by the number of units produced by that process during the same period, gives the unit cost.

Business owners use process costing because it creates a flexible production process. Companies needing to refine their process can simply add or remove a process as necessary. This also allows companies to lower their production cost for each good. Business owners typically look for ways to refine a production process to increase cost savings. Eliminating redundant processes often achieves this goal. Adding a process allows companies to produce slightly different goods or improve product quality. Fourth, calculate the amount of cost assigned to the completed units of output and the equivalent of completed units of output still in the ending inventory.

Characteristics of Process Costing

Process costing assigns expenses to different departments in your business, and it accounts for various cost areas including materials and payroll. Those costs are then rolled up to determine an overall dollar figure and used to find the price-per-unit. All departments must use uniform reporting and not double count efforts. Enterprise resource planning software can help with this process.

It helps identify the specific cost assigned to each process. While both systems produce a cost of goods sold for a given period, https://www.bookstime.com/ focuses on the product’s progression through various stages of production. Job-order costing focuses on a specific product or service produced for a given customer.

Examples of Operations To Use Process Costing

So provision is to be created to value the stock at cost price when the concept of inter-process profit is introduced. In so many organisations the management may decide to transfer the product of one process to the next process not at the cost of production but at the market price or by adding profit in the cost. The profit may be agreed percentage either on cost price or on transfer price. Where several dissimilar products are produced in the same process, a close study of production and costs of each variety of products is essential. The relative importance of one as compared to others should also be indicated in terms of points. For the purpose of cost accounting, a process industry is divided into departments, each department representing a particular process.

• Harold Averkamp has worked as a university accounting instructor, accountant, and consultant for more than 25 years.
• The clearing account will be used to accumulate the actual costs, and a reconciliation will be done at the end of each period.
• Assigning these product costs to individual products remains an important goal for process costing, just as with job costing.
• Materials, labor, and factory overhead costs are added in each department.
• This also allows companies to lower their production cost for each good.

A physical base, e.g., raw materials, is the proportion used to apportion pre-separation point costs to joint products. In other word the physical volume of materials found in joints products at the point of separation is found out and on that very basis the cost is apportioned. Process loss is borne by joint products in the ratio of their output-weight.

Therefore, it is important to keep track of the cost per unit in order to make sure that the product is profitable. Study the process costing definition, examine process costing examples, and discover why process costing systems are so important.

Cost of process can be obtained even if product is incomplete. Controlling aspect – Since each job is separate and distinct, greater supervision and control is required by management. Transfer of product by adding profit to the next process. In both the systems, flow of cost is basically the same. The physical output of each product i.e. multiplied with the market price at the split off point.