Introduction: 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:
Ø Where the product of one process
becomes the material of another process or operation
Ø Where there is simultaneous
production at one or more process of different products, with or without by
product,
Ø 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’.
Definition: Process costing is defined by
Kohler as: “A method of accounting
whereby costs are charged to processes or operations and averaged over units
produced; it is employed principally where a finished product is the result of
a more or less continuous operation, as in paper mills, refineries, canneries
and chemical plants; distinguished from job costing, where costs are assigned
to specific orders, lots or units.
Features/Characteristics of Process Costing: The
following are the features of Process costing:
a)
Process
Costing Method is applicable where the output results from a continuous or
repetitive operations or processes.
b)
Products are
identical and cannot be segregated.
c)
It enables
the ascertainment of cost of the product at each process or stage of
manufacture.
d)
The output
consists of products, which are homogenous.
e)
Production
is carried on in different stages (each of which is called a process) having a
continuous flow.
f)
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.
g)
The output
of a process except the last may also be saleable in which case the process may
generate some profit.
h)
The input of
a process except the first may be capable of being acquired from the outside
sources.
i)
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.
j)
Normal and
abnormal losses may arise in the processes
Fundamental Principles of Process Costing: The following are the
fundamental principles of process costing:
a)
Cost of
material, wages and overheads expenses are collected for each process or
operation in a period.
b)
Adequate
records in respect of output and scrap of each processes or operation during
the period are kept.
c)
The cost per
unit of each process is obtained by dividing the total cost incurred during a
period by the number of units produced during that period after taking into
consideration the losses and amount realized from sale of scrap.
d)
The finished
product of one process is transferred as a raw material to the next process.
Application of Process Costing: There are number of industries
where Process costing system can be used except where job, Batch or Unit
Operation Costing is necessary. The following are examples of industries where
process costing is applied:
Ø Where the final product merges
only after two or more process such as paper-the raw material, bamboo is made
into pulp; pulp is a made into paper and then it is finished, glazed etc. for
sale;
Ø The product of one process
becomes the raw material of another process or operation e.g. refined groundnut
oil is the material for making vegetable ghee and
Ø Different products may have a
common prior process e.g. brass goods will require melting of brass commonly
for all goods. Another example is petroleum products by the same refinery.
Some other
industries where Process Costing is applied are:
Chemical
works Textiles,
weaving, spinning etc.
Soap
making Food
products
Box
making Canning
factory
Coke
works Paint,
ink and varnishing etc.
Difference between Job costing and Process Costing:
Job Costing
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Process Costing
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a)
Job costing is used when the cost object is an individual (or a
lot/batch) unit or a distinct product or service.
b)
Costs can be accumulated by each individual product or service.
c)
Job costing is done against a specific order being produced.
d)
Costs are calculated when a job is over.
e)
There are usually no transfers of costs from one job to another.
f)
There is more paper work.
g)
There is little or no inventory.
h)
It is less amenable to mechanization & automation.
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a)
Process Costing is generally used for a mass of identical
product or service.
b)
The Costs are accumulated in a period. The total costs in a
period are divided over the number of units to get an average unit cost.
c)
Costs are compiled for each process over a period of time.
d)
Costs are calculated at the end of a cost period like an
accounting year.
e)
Transfer of costs from one process to another is made as the
product moves from one process to the other.
f)
It has lesser paper work.
g)
There is regular and significant inventory.
h)
It is more amenable to mechanization & automation.
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Advantages of Process Costing: The following are the main
advantages of Process Costing:
Ø It is possible to determine
process costs periodically at short intervals. Average unit cost can be
computed weekly or even daily.
Ø It is simple and less expensive
to find out the process costs.
Ø It is possible to have managerial
control by evaluating the performance of each process.
Ø It is easy to allocate the
expenses to processes in order to have accurate costs.
Ø It is easy to quote the prices
with standardization of process. Standard costing can be established easily in
process type of manufacture.
Disadvantages of Process Costing: The following are the main
disadvantages of Process Costing:
Ø Cost obtained at the end of the
accounting period are only of historical value and are not very useful for
effective control.
Ø Valuation of work-in-progress is
generally done of estimated basis which introduces further inaccuracies in
total cost.
Ø Where different products arise in
the same process, it is not possible to exactly ascertain the total cost of the
products.
Ø 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.
Ø 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.
Costing Procedure
in process costing
The factory
or concern is divided into distinct processes or operations and a separate account
is opened for each process (cost centre). The account is debited with the value
of material, labour and overheads relating to the process. The value of by
products and scrap, if any, is credited to the account and the balance of this
account, representing the cost of partially worked out product, is passed on to
the next process becomes the raw material of the next process.
In some
industries, depending upon the plant arrangement, the partially worked out
product of a process may be transferred to a process stock account from which
it may be issued to the next process as and when required. The finished out of
the last process (i.e. finished product) is transferred to the Finished Goods
Account. All expenditure of materials,
labour, direct expenses and overheads are charged to the process concerned.
The
following are the main elements/components of costs involved in the
manufacturing process where process costing is adopted.
a)
Direct
Materials There are two types of materials that we come across in process
costing:
Ø Primary Material Materials that
are introduced in the initial process, which is passed on to the next process
after completion of processing.
Ø Secondary Material Materials,
which are introduced in the first or subsequent processes in addition to, the
main material introduced in the initial process. This gets mixed up with the
main material and is passed on to the subsequent processes as a part of the
output.
b)
Direct Labour
the direct labour cost is incurred in every process. Identification of direct
Labour cost is also relatively easy in process costing industry.
c)
Direct Expenses
in addition to Direct Material and Labor, which can be directly attributable to
a particular process. These are costs relevant to specific processes.
d)
Production
Overheads The overhead expenses are generally expended over all the processes
involved in production. These are to be apportioned over the various processes
in an amicable manner.
Treatment of Normal Loss, Abnormal Loss and Abnormal
Gain in process account
Normal or uncontrollable loss : Because of the nature of the raw materials,
some loss is inherent and is unavoidable. This is known as normal waste or
normal loss. And this type of loss is expected in normal condition for example,
weight loss, scrap loss, pilferage. Normal loss is calculated at a certain % of
input in unit in respective process. It may have scrap value. The cost of such
normal loss is included in the total process cost but the scrap value is
deducted with total cost by crediting scrap value in process account.
Abnormal or
Controllable Loss: It is the part of the process loss caused due to abnormal
circumstances in the factory. For Ex, labour strike, break down of machinery.
It is avoidable and controllable by mgmt. Abnormal loss occurs in addition to
normal loss. Abnormal spoilage or defective work may arise in a process due to
unforeseen factors.
The cost of
such abnormal loss is not included in the total process cost but the average
cost of the lost units is charged to an Abnormal Loss Account which is credited
with the scrap and closed to the Profit and Loss Account. Thus, in computing
the abnormal loss, scrap value of the abnormal lost units will be ignored but
in working out the loss for charging to Profit and Loss Account, this will be
taken into consideration.
Valuation of
abnormal loss = (Total cost – scrap value of normal loss)/ Normal Output x
Units of abnormal loss
Abnormal Gain or Effectiveness: Some times, the actual loss in a process may be smaller than what
so expected on the basis of experience. This represents an exceptional or abnormal
gain over what is normally anticipated. The value of abnormal gain is
calculated in the same manner as that of abnormal loss and is credited to Abnormal
Gain Account. The amount of scrap which would otherwise have been realised, had
there been normal and no abnormal gain, is debited to the Abnormal Gain Account
and the balance is credited to Costing Profit and Loss Account.
Value of
abnormal gain is calculated with the following formula: (Total cost – scrap value
of normal loss)/ Normal Output x Units of abnormal gain.
