Process costing is an accounting methodology that traces and accumulates direct costs, and allocates indirect costs of a manufacturing process. Costs are assigned to products, usually in a large batch, which might include an entire month’s production. Eventually, costs have to be allocated to individual units of product. It assigns average costs to each unit, and is the opposite extreme of Job costing which attempts to measure individual costs of production of each unit. Process costing is usually a significant chapter. It is a method of assigning costs to units of production in companies producing large quantities of homogeneous products..
Process costing is a type of operation costing which is used to ascertain the cost of a product at each process or stage of manufacture. CIMA defines process costing as “The costing method applicable where goods or services result from a sequence of continuous or repetitive operations or processes. Costs are averaged over the units produced during the period”. Process costing is suitable for industries producing homogeneous products and where production is a continuous flow. A process can be referred to as the sub-unit of an organization specifically defined for cost collection purpose.
Standard cost refers to calculating costs for production units instead of actual costs. Actual costs are compared with the total costs accumulated based on standard costs, and the difference between the total costs accumulated and the actual costs accumulated is recorded and charged to another account, in this instance, a variance account.
Weighted Average Method of Process Costing
Here the actual cost is divided by the weighted average of products produced. This calculation is simple as compared to any other method. A weighted average of units means the summation of the product of the rate and quantity of each item.
This method of process costing focuses on assigning costs to units in the order that they are produced. Products that are produced first are assigned a cost first, and then, they are the first products to ship or otherwise put out. Furthermore, first-in, first-out assigns one set of costs to products started in prior accounting periods but not finished, and another set of costs for products started in the current accounting period.
Record of Inventory
This step involves the identification of inventory at the end of each process. The organization can identify such inventory by physically counting the units or through software inbuilt into the manufacturing process. In addition, the costs of inventory under each process are also identified at this change.
Conversion of Work in Process Inventory
Apply the percentage of completion to the units which are under any process & not yet completed the production. Say 1,00,000 units of soaps are under process & these are 65% completed. Then the equivalent completed units are 1,00,000*65% i.e. 65,000 units.
Calculation of Inventory Costs
Here, the organisation calculates the direct cost and indirect costs in the production phase. These costs are accumulated from the first process to the last process. The said is then bifurcated into an inventory of complete products & inventory of products that are under process.
Calculation of Per-Unit Cost of Inventory
We calculate this by dividing the total cost by equivalent completed units in the production phase. The cost per unit calculated here reflects the cost of only completed units. The basis of equivalent units can be the weighted average, standard cost, or first-in-first-out inventory method.
Allocation of Costs
The per-unit costs are then split according to the number of units completed & units that are under process.
The industries in which process costs may be used are many. In fact a process costing system can usually be devised in all industries except where job, batch or unit operation costing is necessary.
Chemical works, Steel, Soap making, Oil refining, Box making, Textiles, Distillation process, Rubber, Paper mills, Paints, Beer, Coke works, Ink and Varnishing, Meat products factory, Milk diary, Biscuit works, Food products, Canning factory.
Process costing deals with the flow of units and costs through several stages or operations. As such, when the homogeneous products are produced through continuous process, a process costing system is usually appropriate.
- It is easy to quote the prices with standardisation of process. Standard costing can be established easily in process type of manufacture.
- It is easy to allocate the expenses to processes in order to have accurate costs.
- It is possible to have managerial control by evaluating the performance of each process.
- It is simple and less expensive to find out the process cost.
- It is possible to determine process costs periodically at short intervals. Unit cost can be computed weekly or even daily if overhead rates are used on predetermined basis.
- The computation of average cost is more difficult in those cases where more than one type of products is manufactured and a division of the cost elements is necessary.
- There is a wide scope of errors while calculating average costs. An error in one average cost will be carried through all processes to the valuation of work in process and finished goods.
- Where different products arise in the same process and common costs are prorated to various cost units. Such individual products’ costs may be taken as only approximation and hence not reliable but may be taken as the best.
- Work in progress is required to be ascertained at the end of an accounting period for calculating the cost of continuous process. Valuation of work in progress is generally done on estimated basis which introduces further inaccuracies in total cost.
- Costs obtained at the end of the accounting period are only of historical value and are not very useful for effective control.