Process Costing: A Method for Determining Production Costs in Continuous Manufacturing, Study notes of Accounting

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Process Costing

Meaning

❑Process costing is a method of operation costing which is used to ascertain the cost of production at each process, operation or stage of manufacture, where processes are carried in having one or more of the following features: ❑Where the product of one process becomes the material of another process or operation ❑Where there is simultaneous production at one or more process of different products, with or without by product, ❑Where, during one or more processes or operations of a series, the products or materials are not distinguishable from one another, as for instance when finished products differ finally only in shape or form.

Characteristics

❑Process Costing Method is applicable where the output results from a continuous or repetitive operations or processes. ❑Products are identical and cannot be segregated. ❑It enables the ascertainment of cost of the product at each process or stage of manufacture. ❑The output consists of products, which are homogenous. ❑Production is carried on in different stages (each of which is called a process) having a continuous flow. ❑The input will pass through two or more processes before it takes the shape of the output. The output of each process becomes the input for the next process until the final product is obtained, with the last process giving the final product.

❑The output of a process except the last may also be saleable in which case the process may generate some profit. ❑The input of a process except the first may be capable of being acquired from the outside sources. ❑The output of a process is transferred to the next process generally at cost to the process. It may also be transferred at market price to enable checking efficiency of operations in comparison to the market conditions. ❑Normal and abnormal losses may arise in the processes.

Disadvantages of Process Costing

❑Cost obtained at the end of the accounting period are only of historical value and are not very useful for effective control. ❑Valuation of work-in-progress is generally done of estimated basis which introduces further inaccuracies in total cost. ❑Where different products arise in the same process, it is not possible to exactly ascertain the total cost of the products. ❑If any error occurs while calculating average costs, it will be carried through all the processes to the valuation of work in process and finished goods. ❑The computation of average cost is more difficult in those cases where more than one type of product is manufactured and a division of the cost element is necessary.

Difference

between Process

and Job Costing

Basis for Comparison Job Costing Process Costing Cost Ascertainment Completion of the job. End of the cost period. Industry type Job costing is suitable for the industries which manufactures products as per customer's order Process costing is perfect for the industry where mass production is done. Losses Losses are usually not segregated. Normal losses are carefully ascertained and abnormal losses are bifurcated. Work-in-progress (WIP) WIP may or may not exist at the beginning or at the end of the financial year. WIP will always be present in the beginning or at the end of the accounting period.

Practical

The manufacture of product “Fanta” requires three distinct processes. On completion of the product is passed from Process 3 to finished stock. During the month of December 1992 , the following information was obtained: Production Overhead is absorbed by processes at a percentage of direct wages. Production during the period was 1 , 000 kgs. There was no stock of raw materials or work-in-progress at the beginning or at the end of the month.

Losses in Process

Normal Loss: The fundamental principle of costing is that the good

units should bear the amount of normal loss. Normal loss is

anticipated and in a process it is inevitable. It is included in total cost

of the product due to which cost per unit is increases. The cost of

normal loss is therefore not worked out. The number of units of

normal loss is credited to the Process Account and if they have some

scrap value or realizable value the amount is also credited to the

process account. If there is no scrap value or realizable value, only

the units are credited to the process account.

Abnormal Loss: If the units lost in the production process are more than the normal loss, the difference between the two is the abnormal loss. It is excluded from total cost due to which it does not affect the cost per unit of the product. The relevant process of account is credited and abnormal loss account is debited with the abnormal loss valued at full cost of finished output. The amount realized from sale of scrap of abnormal loss units is credited to the abnormal loss account and the balance in the abnormal loss account is transferred to the Costing Profit and Loss Account.

Treatment of Normal Loss

❑The cost of normal loss is considered as part of the cost of production in which it occurs. If normal loss units have any realizable scrap value, the process account is credited by that amount. If there is no abnormal gain, then there is no necessity to maintain a separate account for normal loss. ❑Generally the cost of normal loss is absorbed by the cost units. Normal Output = Units introduced – Units of normal loss Normal Cost of Normal Output = Total Cost – Scrap value of Normal Loss. ❑In process A/c units of normal wastage is shown in unit column of credit side and if there is any scrap value then that will be shown in amount column of the credit side corresponding to lost units.

Treatment of Abnormal Loss

Abnormal loss is transferred directly to P/L Account.

Value of Abnormal wastage =

Normal cost of normal output/Normal output * Units of abnormal

Wastage

Here,

Normal Cost of Normal Output = Total Cost – Scrap value of Normal

Loss.

Units of abnormal Wastage = Normal Output – Actual Output

Normal output = Units introduced – Units of normal loss