It represents a type of costing procedure for mass production industries producing standard products. Thus, it is a method of costing used to ascertain the cost of product at each stage of manufacturing. Manufacturing companies use a cost accounting technique to track and allocate the costs of producing a product or service. Recall that Desk Products, Inc., has two departments—Assembly and Finishing. Although this chapter focuses on the Assembly department, the Finishing department would also use the four steps to determine product costs for completed units transferred out and ending WIP inventory.

The abnormal loss is the amount by which the actual loss exceeds the normal loss and it is expected to arise under inefficient operating conditions. The loss expected during the normal course of operations, for unavoidable reasons is called ‘normal loss’ and this is due to inherent result of the particular process and thus uncontro­llable in the short-run. Management usually able to identify an average percentage of normal losses expected to arise from the production process. Process costing is not required a complicated accounting or IT system to collect data and calculate it.

Recommended Reading – Process Costing: Definition, Types, Importance, Advantages and Disadvantages

Units in WIP must be converted to a base which can be equated with completed production. 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. (d) Rate arrived at by step No. 3 should be applied for valuation of both unit repre­senting abnormal loss and output of the process. (b) Determine the total accumulated cost relating to the process, i.e., cost transferred + cost introduced in the process (material, labour and proportionate share of overhead) – scrap value of normal loss. For this purpose a statement is prepared showing input and output of the process in physical units.

  • The following information is for the Mixing department for the month of March.
  • Process costing also has difficulty detecting cost fluctuations due to changes in production volume and product mix.
  • 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.
  • Instead of using the actual costs for each stage, this method uses an estimated standard cost.
  • However, rather than observing work in process as being made up of many individual/discrete jobs, see that it instead consists of individual/discrete processes like melting, skimming, and extruding.

The units that have been complete during the period have been completed in the above stage of the process costing. However, there are units that remain incomplete during the period that need to be considered as well. The process costing system allocates the cost of running the process to the batch of the products.

Materials Cost

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. A separate account is prepared for each process on the basis of double entry book keeping with quantity column alongside the amount (total cost) column. Depending on the nature of data and requirement, quantity column may be dispensed with. If desired, the prefix ‘To’ on the debit side and ‘By’ on the credit side may also be avoided.

As a result, the costs of the last units produced are given to the units remaining in inventory. Process costing is a method of cost accounting used to calculate the cost of producing a product or service in a manufacturing environment where products are made in large quantities and indistinguishable. It is commonly used in chemical manufacturing, oil refining, and food processing industries.

Analysis of the inventory

Recall the three components of product costs—direct materials, direct labor, and manufacturing overhead. Assigning these product costs to individual products remains an important goal for process costing, just as with job costing. However, instead of assigning product costs to individual jobs (shown on a job cost sheet), process costing assigns these costs to departments (shown on a departmental production cost report).

Better Cost Control

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. 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, ascertained at the end of the process is called historical cost which is of very small use for managerial control. Since it is based on historical costs, it has all the weaknesses of historical costing. Transfer – In the contract costing every contract is separate and independent from each job or contract. Output of one process, becomes input for the next process till it reaches to finished product. (2) Cost unit – Each Job or batch of product is the cost unit for which cost is ascertained. (1) Cost Calculation – Cost is determined for every job or batch or product.

After a production run has been completed, the estimated totals are compared to the actual totals, and the difference is added to a variance account, which is a record of the variances. Your inventory may need to be reported to the tax authorities, depending on your business type. It can be challenging for large companies to track thousands or even millions of products.

The cost flows are tracked using a cost of production report, which tracks the costs incurred in each process and the number of units produced. The prices are then accumulated and allocated to the units produced based on a predetermined allocation method. In process costing, costs are accumulated by a department or process and allocated to the production units that pass through the process. The total cost of a process is divided by the total number of units produced to determine the price per unit.

In an Oil refinery, petrol is the main product, while sulphur, chemical fertilisers, bitumen are the by-products. (ii) To analyse the efficiency or the inefficiency of each department or process involved the production. 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.

Comes out after the process, we can say that the normal process loss is 5%. It is applied for various industries like chemicals and drugs, oil refining, food processing, paints and varnish, plastics, soaps, textiles, paper etc. Process costing provides a more accurate estimate of each unit’s production cost since the costs are allocated based on a predetermined rate. Job costing is less accurate since the actual prices may vary based on the specific requirements of each job. Process costing is simpler than job costing since the production process is standardized, and costs are allocated based on a predetermined rate. Job costing is more complex since each job or project may have different requirements and costs.

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. In average cost method, the cost of opening WIP is added to material, labour and overhead costs incurred during the period. The cost per unit is obtained by dividing these costs by equivalent production.

It assumes that equal cost is incurred in each unit of production in the batch. The process costing is suitable for the manufacturing companies where identical/homogenous products are produced and there is no gap in the process of production. In job order cost production, the costs can be directly traced to the job, and the job cost sheet contains the total expenses for that job.

All units are processed in similar manner and it is assumed that the same amounts of materials, labour and overheads are chargeable to each unit processed. The waste, rejects and scrap are also accounted for in the same way as in- what are principles definition and meaning. Thus, basically there is no difference between process costing and operation costing and the two terms are often used interchangeably.