When a product is manufactured through various processes, the output of each process is transferred to the subsequent process and that of last process is transferred to the finished stock. Process costing is used in mass production industries producing standard or identical products continuously through a series of processes or operations. It is assumed that the same amount of materials, labour and overhead is chargeable to each unit processed.
Process Costing – Opening Work-in-Progress: FIFO Method, Average Method and Weighted Average Method
A production report has to be made under the process costing system. In the case of a not-for-profit company, the same process could be used to determine the average costs incurred by a department that performs interviews. The department’s costs would be allocated based on the number of cases processed. For example, assume a not-for-profit pet adoption organization has an annual budget of $180,000 and typically matches 900 shelter animals with new owners each year. Process costing and job order costing are both acceptable methods for tracking costs and production levels.
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It uses most of the same journal entries found in a job costing environment, so there is no need to restructure the chart of accounts to any significant degree. This makes it easy to switch over to a job costing system from a process costing one if the need arises, or to adopt a hybrid approach that uses portions of both systems. This problem is handled through the concept of equivalent units of production. The process costing procedure is explained in more detail in the next example.
When there is abnormal gain, statement showing physical flow of units should indicate it. Kohler has defined process costing as – “a method of cost accounting whereby costs are charged to processes or operations and averaged over units produced”. The distinctive feature of process costing is that the unit costs of products are determined for the respective process through which the units pass. All costs relating to a process are charged to a separate account and then averaged out to determine the cost per unit. The similarities between job order cost systems and process cost systems are the product costs of materials, labor, and overhead, which are used determine the cost per unit, and the inventory values. The differences between the two systems are shown in Table 5.1.
Technology makes it easy to track costs as small as one fastener or ounce of glue. However, if each fastener had to be requisitioned and each ounce of glue recorded, the product would take longer to make and the direct labor cost would be higher. So, while it is possible to track the cost of each individual product, the additional information may not be worth the additional expense. While the costing systems are different from each other, management uses the information provided to make similar managerial decisions, such as setting the sales price. For example, in a job order cost system, each job is unique, which allows management to establish individual prices for individual projects. This method is used when degree of completion of opening WIP is not given.
Process Costing – Determination of Unit Cost
Process costing is a method of costing used mainly in manufacturing where units are continuously mass-produced through one or more processes. Examples of this include the manufacture of erasers, chemicals or processed food.In process costing it is the process that is costed (unlike job costing where each job is costed separately). The method used is to take the total cost of the process and average it over the units of production.
Important Features of Process Industries
Similarly, in respect of each process, there may or may not be work-in-progress at the beginning or at the end. In some industries, depending upon the plant arrangement, the output of the process may be transferred to the process stock account from which it may be issued to the next process as and when required. For the purpose of cost accounting, a process industry is divided into departments, each department representing a particular process.
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. (vi) To control the cost of production at the level of each process so that overall cost of production may remain under control or may be reduced.
- Lf we take the efficiency of the organisation in terms of completed units only then the efficiency for January 2019 will be zero because there is no complete unit produced.
- The percentage of the market value of each product to the total of the market values is found out.
- Performance – In contract costing work is performed generally outside the factory or at the work site.
- The cost per unit is obtained by dividing these costs by equivalent production.
- Compute the total costs for each cost element during the period.
- Abnormal gain exampleThere is a heat wave and staff have eaten less chocolate.
Companies that mass produce a product allocate the costs to each department and use process costing. For example, General Mills uses 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. For example, Boeing uses job order costing to manufacture planes.
If the loss is within the specified limit, it is referred to as normal loss. A company may state that normal loss in process A will be 5% of input or throughput. No process costing suitable for reference is made to normal loss in process, because it is shared by good production.
The balance of abnormal loss account, i.e., the value of units representing abnormal loss minus realisation value is written off to costing profit and loss account. Each department performs a different function and can be considered its own little business or mini-factory. As such, each department adds its own direct materials, direct labor, and factory overhead costs. These three costs accumulate in a departmental account called Work in Process – Department Name, which is like the “tab” of the manufactured item. There will be three debits to Work in Process for each department – one for direct materials, one for direct labor, and one for factory overhead.
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If input is 100 units, then its normal output will be 85 units. If actual output is 90 units, then 5 units is considered as abnormal gain. (d) Rate arrived at by step 3 should be applied for valuation of units representing abnormal gain and output of the process transferred to either next process or finished stock account. Under process costing generally all the material required for production is purchased and issued to the first process. The output in whatever form of the first process becomes the raw material for the next process and so on.
The equivalent unit is determined separately for direct materials and for conversion costs as part of the computation of the per-unit cost for both material and conversion costs. Process 1 involved preparing the raw materials for printing, process 2 is the actual printing, and process 3 is packaging the planners to be moved to finished goods inventory. Costing is simpler in this system because rather than having to prepare a costing sheet for many products, we only need to do costing for three departments or processes. 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.
Process costing is generally used in industries that deal with chemicals, distilled products, canned products, food products, oil refineries, edible oils, soap, paper, textiles, and others. The system of costing conceals weaknesses and inefficiencies in processing. The cost, ascertained at the end of the process is called historical cost which is of very small use for managerial control.
(2) Cost unit – Each distinct process of the production is cost unit. (iii) Apportionment on a suitable basis – Where by-products are of major importance, cost should be apportioned on the most suitable basis, i.e. The inventory costs brought forward from previous year is not added to the current costs. The objective of this method is to value the closing WIP at current costs. (iii) Calculate the cost per unit of Equivalent output according to each element of cost. A product passes through three processes, Process A, Process B and Process C, to completion.