What is process costing?

So provision is to be created to value the stock at cost price when the concept of inter-process profit is introduced. Less – Opening stock units completed during the previous period. 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. In selective processing system, products go through some but not each processing departments. According to the requirement, some portion of the output is processed further.

The main advantage of using a process costing system is that it provides managers with information they can use to improve the efficiency of the production process. For example, if the company produces 100 widgets at a cost of $10 per widget, the manager knows that each widget costs $0.10 in direct materials, $0.50 in direct labor, and $0.40 in overhead. This information can be used to reduce the cost per widget by improving the efficiency of the production process. The weighted-average and FIFO methods become very complicated when used in process industries that produce a wide variety of similar products. For example, a steel – rolling mill uses various steel alloys and produces sheets of various sizes and finishes. The different types of direct materials used and the operations performed are few, but used in various combinations, they yield a wide variety of products.

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The first step is to determine the number of units that are complete and the number of units that are incomplete. In this example, there are 10,000 units that are complete and 5,000 units that are incomplete. Spreadsheet programs (Excel, Lotus 1-2-3) are widely used in managerial accounting. When monthly information is entered, the formulae do all the math, and calculate the final cost allocations.

It is only in an ideal situation where all materials are fully used to produce complete units of a product. But in reality, when production process starts, there are many cases where the producer will experience availability of some unused raw materials either in the beginning bookkeeping for startups or at the end of the year or both. On the same breath, output can either be complete or partially finished. In the previous page, we discussed the physical flow of units (step 1) and how to calculate equivalent units of production (step 2) under the weighted average method.

Process Costing – Equivalent Production: Calculation and Procedure

If there is the scrap value of the units lost, such value is credited to an abnormal loss account, and the balance remaining after that in that account is written off to the costing profit and loss account. The cost of the process is to be apportioned between the units lost abnormally and good units in the ratio of such units. The cost of units representing abnormal loss is debited to the abnormal loss account and credited to the process account. When normal loss fetches no value, the cost of normal loss is absorbed by good production units of the process.

Hence, when there are inventories of WIP, unit cost cannot be obtained by simply dividing the total cost by the number of units processed. Units in WIP must be converted to a base which can be equated with completed production. In a manufacturing unit generally it is not possible to complete the work on all the units on which work has been started. (vi) When total cost of the process is divided by the units produced in that process it results into per unit cost of that process. For this reason, the amount standing at the credit of abnormal gain account will not be transferred to profit and loss account as it is. Amount of scrap value relating to five units will be debited to abnormal gain account and the balance thus arrived at will be transferred to profit and loss account for the year.

Which Industries Use Process Costing Aside Form Manufacturing Industry?

Again, this scenario is not easy to get or experience for most of the times there must occur some losses due to unavoidable circumstances. We want to make sure that we have assigned all the costs from beginning work in process and costs incurred or added this period to units completed and transferred and ending work in process inventory. For costs of units completed and transferred, we take the equivalent units for units completed x cost per equivalent unit. We do the same of ending work in process but using the equivalent units for ending work in process.

For example, if you sell widgets, you would use process costing to determine what it takes to make a widget. You might find out that it costs $1.00 to make a widget, but then you may discover that it costs more than that because you must pay someone else to do some of the work. We calculated total equivalent units of 11,000 units for materials and 9,800 for conversion. You cannot calculate the total output of the period by just taking the sum of completed units and work in process (ending inventory) because units in the work-in-process inventory are not 100% complete. Under process costing, the procedure used to manufacture a product is divided into well-defined processes.

Just In Time Inventory Management

The average method tends to narrow the wide fluctuations in prices. Units which have been introduced in the process and completed during the same period have their own unit cost. This cost may not be the same as the completed unit cost of units of opening WIP. Where several dissimilar products are produced in the same process, a close study of production and costs of each variety of products is essential. The relative importance of one as compared to others should also be indicated in terms of points.

The main benefit of Process Costing is that it provides information that can be used to make critical business decisions. For example, managers using this system can assess profit margin by product and isolate problem products before they become major issues. Process Costing also allows companies to set prices according to production costs. A student’s first thought is that this is easy—just divide the total cost by the number of units produced. However, the presence of work-in-process inventories causes problems. Manufacturing companies should follow best practices for cost accounting, such as GAAP and IFRS, to ensure that the process costing system is reliable, accurate, and compliant with regulations.

What Are the Key Factors to Consider When Selecting a Process Costing Method for Your Manufacturing Process?

The general factory labor costs are indirect labor costs that are added to factory overhead. Unlike the accounting for payroll under the job order cost system, the employee does not have to be physically involved in making a product to be assigned to a specific function. The accounting for the labor costs for June includes the following journal entries, shown in the following table. To calculate cost per equivalent unit by taking the total costs (both beginning work in process and costs added this period) and divide by the total equivalent units.

Units’ representing abnormal loss are valued like good units produced and the value of units representing abnormal loss is debited to a separate account which is known as abnormal loss account. The concept of abnormal gain is very common in production processes. Most of the times, the actual loss is less than the normal or computed loss at the beginning of the production process. The details of process costing account for a single product with abnormal gain is explained in the respective article.