What is process costing?
When there is no obvious start or finish because the manufacturing process is endlessly repetitive, the management turns to a process costing system to accumulate and allocate manufacturing costs. As opposed to the other costing techniques, process costing is a method where the cost of products is determined on the basis of different levels of production. A process costing system accumulates costs when a large number of identical units are being produced. In this situation, it is most efficient to accumulate costs at an aggregate level for a large batch of products and then allocate them to the individual units produced. The assumption is that the cost of each unit is the same as that of any other unit, so there is no need to track information at an individual unit level.
- From the viewpoint of cost accounting, there could be processes which may or may not have process losses.
- Equivalent production is obtained by multiplying the actual number of units in process by their stage of completion in terms of cost.
- The company does not need to invest in an expensive accounting system just for product costing.
- The stage at which material is introduced will significantly affect cost per unit of the process.
In March 200X, the Design and Cutting department incur the cost of direct material USD 100,000, direct labor cost of USD 150,000 and USD 80,000 of overhead cost. During month, this department has finished 10,000 pairs of shoes and passes them to next stage. When the units are completed, they are transferred to finished goods inventory and become costs of goods sold when the product is sold. The difference between process costing and job order costing relates to how the costs are assigned to the products. In either costing system, the ability to obtain and analyze cost data is needed. This results in the costing system selected being the one that best matches the manufacturing process.
Examples of Process Cost Accounting
Suppose, input in process A is 100 units, normal loss of process A should be 10 units and normal production of process A should be 90 units. (d) Rate arrived at by step No. 3 should be applied for valuation of both unit representing abnormal loss and output of the process. It is concerned with the determination of the cost of each operation rather than the process. In those industries where a process consists of distinct operations, the method of costing may be called operation costing, though it is still process costing in approach and application.
- 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.
- In an Oil refinery, petrol is the main product, while sulphur, chemical fertilisers, bitumen are the by-products.
- In Dairy industries, butter or cheese is the main product, but butter milk is the by-product.
- To ascertain the cost of each joint/by-product, common costs are apportioned among the joint-by-products on some equitable basis.
- The most important factors of process costing include the type of industry where the business is operating, and the type of product being manufactured.
The material storage unit stores the types of wood used (hickory, maple, and birch), the tips (nylon and felt), and packaging materials. Examples of the industries where this type of production occurs include oil refining, food production, and chemical processing. For example, how would you determine the precise cost required to create one gallon of aviation fuel, when thousands of gallons of the same fuel are gushing out of a refinery every hour? The cost accounting methodology used for this scenario is process costing. 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.
Process Stocks (With Illustrations)
Cost assigned to units produced or in process are recorded in the inventory asset account, where it appears on the balance sheet. When the goods are eventually sold, the cost is shifted to the cost of goods sold account, where it appears on the income statement. Costs follow the production process, i.e., costs incurred in one process are transferred to the next process along with the output. The first in first out (FIFO) method of costing is used to introduce the subject of materials costing. The FIFO method of costing issued materials follows the principle that materials used should carry the actual experienced cost of the specific units used.
When ABC Clothing starts production on a particular batch of shirts, costs are tracked in the work-in-progress account. All production costs will be accumulated and allocate equally to all products by assuming that they are consumed the same resource. Accountants will calculate the total overhead cost of each month and separate them to each finished product at the month-end. Process costing refers to a type of costing procedure commonly adopted by factories. In process costing, there is continuous or mass production and ongoing costs, which are accumulated regularly.
Process costing is employed by the industries whose production process is continuous and repetitive, as well as the output of one process is the input of another process. So, chemical industry, oil refineries, cement industries, textile industries, soap manufacturing industries, paper manufacturing industries use this method. Each unit’s cost is determined based on the overall cost of each department or stage involved in the manufacturing process. Errors can occur when non-production costs are also included in the calculation.
What is Process costing? Pros and Cons of process costing
The production needs to go through multiple processes which they called the departments. This matching process helps to determine and improve the profitability of the product. The cost allocated per unit is recorded on the balance sheet in the inventory asset account. Then, when the products are eventually sold, the cost is shifted to the cost of goods sold account on the income statement. Control over cost and production can be advantageously effected as pre-determined and actual data are available for each department or process. Performance – Work in process costing is performed within the factory premises.
As the manufacturing procedure becomes more and more automatic or capital intensive there the labour expenses start decreasing and overheads start increasing. Whatever the labour cost of the process is shown in the debit of that process. Output of Previous Process, Input of Next Process – The finished product of one process becomes the raw material for the next process. To ascertain the cost of each joint/by-product, common costs are apportioned among the joint-by-products on some equitable basis. If the product is processed in more than one process, the output of the first process is transferred to the second process.
Choosing Between Process Costing and Job Order Costing
When using this method, the accounting department can choose one of the process costing types based on what is most suitable for the situation. When we assign a cost to a product, we can use job costing if it is a unique product or a service and we can assign the costs directly. When a manufacturing process involves the continuous production of identical units rather than distinguishable job lots, there can be no job orientation.
Ascertainment of cost is the first and most important objective of costing. The objectives of costing are broadly divided how to prepare a trial balance into the following three areas. Obotu has 2+years of professional experience in the business and finance sector.
Features of Process Costing
(i) Opportunity or replacement cost method – This method is followed where by-products are utilised by the factory itself as input material for some other process. The opportunity cost or replacement cost which otherwise would have been incurred if the by-products were to be purchased from outside suppliers is taken as the basis for costing by-products. The process account is credited with the value of by-products so ascertained.
Rock City Percussion uses a process cost system because the drumsticks are produced in batches, and it is not economically feasible to trace the direct labor or direct material, like hickory, to a specific drumstick. Therefore, the costs are maintained by each department, rather than by job, as they are in job order costing. In this chapter, you will learn when and why process costing is used. You’ll also learn the concepts of conversion costs and equivalent units of production and how to use these for calculating the unit and total cost of items produced using a process costing system. 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.
