INTRODUCTION :
Process costing is the type of costing applied in
industries where there is continuous or mass
production. The necessity for compilation of the
costs of a process or a department for a given
period, as distinct from the cost of a whole job or
a specific batch of production units, has given
rise to the concept of process cost accounting.
There are many industries engaged in
continuous processing in which the end products
are the results of a number of operations
performed in sequence. In such industries, it is
necessary to apply process costing.
Process costing is suitable for a large
number of mining, manufacturing and
public utility industries like mines and
quarries, cotton, wool and jute textiles,
chemicals, soap making, paper, plastics,
distillation processes, e.g. alcohol,
tanning, oil refining, screws, bolts and
rivets, canning, food products, dairy, and
electricity and gas undertakings.
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2)
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4)
The production is continuous and the end
product is the result of a sequence of
processes.
The product is homogeneous and the units
product are identical and standardized.
The sequence of operations for processing
the product is specific and predetermined.
The finished products of one process
works as raw material for the next or
process until completion.
A comparison of the basic principles of
process costing with those of job costing,
given below, will assist in appreciating
process costing procedures.
Job Costing
1.) Production is by specify orders.
Process Costing
1.) Production is in continuous flow,
the products being homogeneous
2.) Costs are determined by jobs or 2.) Cost are compiled on time basis,
batches of products
i.e. for production for a given
accounting period, for each
process or departments
3.) The various jobs are separate and 3.) Being manufactured in a
independent of each other
continuous flow, products lose
their individual entity
4.) Unit cost of a job is calculated by 4.) The unit cost of a process, which is
dividing the total cost incurred
computed by dividing the total
into the units produced in the lot
cost for the period (after
or batch
adjustment of the opening and
closing work-in-process), is an
average cost for the period
5.) Costs are calculated when a job is 5.) Costs are calculated at the end of
completed
the cost period
6.) There may or may not be any 6.)
Production
being
continuous
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2.
3.
4.
5.
6.
Process cost may be determined periodically at short intervals. When
predetermined overhead rates are in use, it may be possible to
complete unit cost weekly or even daily. This not always so under the
job costing system, particularly when jobs run for long periods and
there are no significant units of completed production during the
various accounting periods, falling between the total period of run of
the jobs.
It involves less efforts and less clerical expenses as the accounting
method is simpler than that in job costing.
Detailed cost, budgeted as well as actual, are made available for each
possible by evaluating the performance of each process etc.
Allocation of overhead to departments and processes can be made
fairly accurately on definite bases.
Since the material consumption ass the various operations are more or
less standardized, more accurate cost estimates are available for price
quotations.
It is easier to set effective and fairly stable standards in case of mass
production or continuous repetitive production. Process costing
situations are, therefore, more adaptable for installing standard costing
procedures.
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Being only average costs for the accounting period, process cost
cannot be considered to be very accurate for the purpose of
detailed analysis, evaluation, and control of individual
performance efficiency on a day-to-day basis.
Costs obtained at the end of the accounting period are only
historical and are not of much use for effective control unless
standard process cost are used. This is, no doubt, true in respect
of all other historical systems but the nature of process
accounting with its departmental divisions makes this
disadvantage more prominent.
When different products come out of one and the same process,
the common costs are prorated to the various products. Such
cost of individual products are not reliable as they may, at best,
be taken to be only approximations.
For the purpose of calculation of unit costs of continuous
processes, work-in-process is required to be determined at the
end of an accounting period. This is done mostly on estimated
basis which introduces further inaccuracies in costs.
The cost accounting system used by a company
depends upon the nature of its products or
services.
Process costing is more efficient for companies
that produce large quantities of homogenous
product in a continuous process.
1.- Summarize the physical flow of the
units to produce.
2.- Calculate production in terms of
equivalent units.
3.- Calculate equivalent unit costs.
4.- Summarize total costs to account for
5.- Assign total costs to the units already
completed and to units in ending work in
process inventory (WIP).
• Normal
losses cannot be avoided –Cost is absorbed by
good
production.
• Abnormal losses are avoidable –Cost is recorded
separately and treated as a period cost.
Example
Input
= 1 200 litres at a cost of £1 200
Normal loss
= 1/6 of input
Actual output
= 900 litres
CPU
= £1 200/Expected output (1 000
litres) = 1.20
Cost of completed production = £1 080 (900 ×£1.20)
Cost of abnormal loss
= £120 (100 × £1.20)
Sale proceeds from normal losses
Sale proceeds (normal and abnormal losses)
Example 2
As example 1 but output
CPU as example 1
= 900 litres (abnormal loss = 100 litres)
= £1.10 per litre
The sales value of the abnormal loss should be offset against the
cost of the abnormal loss.
Abnormal gains
Example
Input
Output
Normal loss
Scrap value
= 1 200 litres at a cost of £1 200
= 1 100 litres
= 1/6 of input
= £0.50 per litre
CPU = Cost of production less scrap value of normal loss
Expected output
= £1 100 /1 000 = £1.10 per litre
Equivalent Units:
 Measure the resources used in partially completed
units relative to the resources needed to complete the
units.
Equivalent Units Depend on the Pattern of Cost Flow:
Direct Materials:
*
Added at the beginning of the process
*
Added during the process
Conversion Costs:
*
Incurred uniformly throughout the process
*
Incurred non-uniformly
Chapter 6
Weighted Average Method:
Costs from beginning WIP (performed last
period) are averaged with costs incurred
during the current period and then
allocated to all units completed and ending
WIP.
Chapter 6
Equivalent production & closing WIP
Partly completed units are expressed as fully completed equivalent
units in order to compute CPU (e.g. 1000 units 50% complete equls
500 equivalent production.
Example
Opening WIP
Nil
Units introduced into the process
14 000
Units completed and trasferred to next process
10 000
Closing WIP (50% complete)
4 000
Materials cost (introduced at start)
£70 000
Conversion cost
£48 000
Note that materials are 100% complete.
Equivalent production and closing WIP
Previous process cost
Inclusion of inter-process profit creates
complications in the accounts. As the
internal profits remain merged in process
stock, work-in-progress, and finished
stock suitable adjustment is required to
be made in the Balance Sheet in order to
exclude such unrealized profit.
When inter-process profit is included in
the accounts, it is advisable to have three
columns in the ledger to indicate the
cost, profit, and the total. This facilitates
the calculation of the profit to be
provided for inclusion in closing stock in
each process and in the final finished
stock.