Process Cost Accounting, Features, Types, Process, Advantages and Disadvantages, Example

Process cost accounting is a method used to determine the cost of production of goods in a manufacturing setting where products are produced through a series of continuous processes. The process cost accounting system tracks costs by process, rather than by job or specific product. This type of accounting is commonly used in industries that produce standardized goods in large quantities, such as chemical processing, food and beverage production, and paper manufacturing.

In process cost accounting, costs are accumulated and assigned to each production department or process, and then allocated to the products passing through those departments or processes. The total cost of each department is divided by the number of units produced in that department to arrive at the cost per unit.

The process cost accounting system provides a detailed and accurate picture of the cost of production for each unit, making it easier for companies to determine the profitability of their products and make informed decisions about pricing and production. However, it can be complex and time-consuming to implement, and may not be suitable for businesses with highly customized or unique products.

Features of process cost accounting include:

• Standardization of production processes: Production processes are standardized and repetitive, with little or no variation in the inputs and outputs.
• Accumulation of costs by process: Costs are accumulated by process or department, rather than by job or specific product.
• Calculation of equivalent units: The amount of partially completed units at the end of a production process is calculated in equivalent units, which helps in determining the total cost of production.
• Use of weighted-average method: The weighted-average method is used to determine the unit cost of production. This method takes into account the costs of both the beginning and ending inventory, as well as the costs incurred during the production process.

Process Accounting Types

There are two main types of process costing methods: weighted average and FIFO (first-in, first-out). Here are the formulas for each type:

Weighted Average Method:

Total cost of production in a department / Total units produced in the department = Cost per unit

The total cost of production in a department includes direct materials, direct labor, and overhead costs.

FIFO (First-in, First-out) Method:

Cost of beginning inventory + Cost of units added during the period / Total equivalent units produced during the period = Cost per equivalent unit

The cost of beginning inventory is added to the cost of units added during the period, and the total is divided by the total equivalent units produced during the period. The equivalent units are calculated by multiplying the number of partially completed units by the percentage of completion.

Both methods are used to determine the cost of production for each unit in a manufacturing process. The weighted average method takes into account the cost of all units produced during a period, while the FIFO method assumes that the first units produced are also the first units sold or transferred to the next stage of production.

The method chosen depends on the specific characteristics of the manufacturing process, as well as the goals of the organization in terms of cost control, inventory management, and pricing strategy.

Process Costing is important for several reasons:

• Cost Control: Process costing provides detailed information about the cost of producing each unit in a manufacturing process. This allows managers to identify areas where costs can be reduced, such as by improving efficiency, reducing waste, or renegotiating supplier contracts.
• Inventory Management: Process costing provides information about the cost of raw materials, work-in-progress, and finished goods inventory. This helps managers make informed decisions about inventory levels, reorder points, and production schedules.
• Pricing Strategy: Process costing provides information about the cost of production, which is an important factor in setting prices for products. By knowing the cost of each unit, managers can set prices that are competitive and profitable.
• Decision Making: Process costing provides information that can be used to make informed decisions about capital investments, product mix, and outsourcing. By understanding the cost of production, managers can make better decisions about where to invest resources and how to allocate production capacity.

Process Costing example in table format

Here’s an example of process costing in a table format:

Assume a company produces 10,000 units of a product during a month, with the following costs:

• Direct materials: $30,000
• Direct labor: $20,000
• Manufacturing overhead: $10,000
• Beginning work-in-process inventory: 1,000 units, 20% complete
• Ending work-in-process inventory: 2,000 units, 40% complete

Using the weighted average method, we can calculate the cost per unit as follows:

The total cost of production is $54,000, and the total equivalent units produced are 11,000. The cost per equivalent unit is calculated as $4.91 ($54,000 divided by 11,000). The cost per unit is then calculated based on the equivalent units in beginning and ending work-in-process inventory, and the units produced during the period.

Using the FIFO method, we would first calculate the equivalent units produced during the period, as follows:

The equivalent units are calculated by multiplying the number of partially completed units by the percentage of completion. For example, the 1,000 units in beginning work-in-process inventory are 20% complete, so they represent 200 equivalent units (1,000 units x 20%). Similarly, the 2,000 units in ending work-in-process inventory are 40% complete, so they represent 800 equivalent units (2,000 units x 40%).

The cost per equivalent unit is then calculated as $5.40 ($54,000 divided by 10,000 equivalent units). The cost per unit is then calculated based on the equivalent units in beginning and ending work-in-process inventory, and the units produced during the period.