Introduction: process costing

Calls for preparation

of process a\c
Method of costing used to
Determine
Total cost of a product
Which needs to pass through
Multiple process

Process costing is used when there is mass production of similar products, where the costs
associated with individual units of output cannot be differentiated from each other. In other
words, the cost of each product produced is assumed to be the same as the cost of every
other product. Under this concept, costs are accumulated over a fixed period of time,
summarized, and then allocated to all of the units produced during that period of time on a
consistent basis. When products are instead being manufactured on an individual basis, job
costing is used to accumulate costs and assign the costs to products. When a production
process contains some mass manufacturing and some customized elements, then a hybrid
costing system is used.
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.
Costing is an important process that many companies engage in to keep track of where
their money is being spent in the production and distribution processes. Understanding
these costs is the first step in being able to control them. It is very important that a
company chooses the appropriate type of costing system for their product type and
industry. One type of costing system that is used in certain industries is process
costing that varies from other types of costing (such as job costing) in some ways. In
process costing unit costs are more like averages, the process-costing system requires
less bookkeeping than does a job-order costing system. Thus, some companies often
prefer to use the process-costing system.

When process costing Applied:

Process costing is appropriate for companies that produce a continuous mass of like
units through series of operations or process. Also, when one order does not affect the
 production process and a standardization of the process and product exists. However, if
there are significant differences among the costs of various products, a process costing
system would not provide adequate product-cost information. Costing is generally used
in such industries such as petroleum, coal mining, chemicals, textiles, paper, plastic,
glass, food, banks, courier, cement, and soap.

There are four basic step in accounting for Process cost:

 Summarize the flow of physical units of output.

 Compute output in terms of equivalent units.
 Summarize total costs to account for and Compute equivalent unit costs.
 Assign total costs to units completed and to units in ending work in
process inventory.
The journal entries for process costing are the same as those for job-order costing with
one exception. The entry to transfer cost from one work-in-process account to another
is:
Work-in-process inventory-second department Debit (Left)
Work-in-process-first department Credit (Right)

Types of process costing

There are three types of process costing which can be used in different situations.

1. Weighted Average Costs – This is done by dividing the cost of goods that are available for sale
by the number of products that are available for sale which will give you an average cost per
unit.

2. Standard Costs – This is similar to the weighted average method but uses a standard cost rather
than the actual costs. Once this is measured, they are then matched against the actual costs
incurred and are the difference is charged to another variance account. This is used when a
company produces in large batches but have a varied mix of products to which they cannot
assign separate costs to.

3. First In First Out (FIFO) – This is the method of valuation where the first goods purchased are
the first ones sold which is one of the best methods for a business to use as the risk of
inventory going obsolete is reduced. It is a very complex calculation that uses layers of costs to
account for significant changes in costs over time. This method is the most logically correct of
all the process costing methods, and similarly, it is the hardest while the Weighted Average
method is the easiest. 
Now that we have a basic idea of what process costing is let’s move on to the full method of how
process is costing works.
 The 5 Steps For Process Costing

There are basically five steps in this method that a business would have to go through:

1. Analyze the flow of actual units

2. Convert the inventory to determine the equivalent units

3. Identify the total costs

4. Calculate the average cost per equivalent unit

5. Allocate these costs to finished units and Work in Process units 

1.Analyze The Flow Of Actual Units

The first thing that the business should do is to identify the flow of units during the
manufacturing process.

This type of costing relies on this distinct flow of units as it will determine exactly how the costs
should be added on during the whole process.

As you read about before, when producing homogenous products there are usually several
production processes involved.

Once these processes are identified, the costs will be added to each process in sequence until you
get a final value that determines the cost related to that specific method of production.

Different manufacturers will have varying types of processes which can range from just two to
over a dozen which will change the way costing is done drastically from each type of business.

2.Convert the Inventory determine the equivalent units

Equivalent units are the number of units that are completed during a certain stage of production.

As the production moves along the line, it is inevitable that not all units will be completed from
one stage to the next.

The units that are not fully complete when it moves on to the next process are called “Work in
Process”.

These units are calculated based on their stage of completion and how many processes it has
gone through until now.

This percentage will depend on the type of business and the value that they set on which process
the unit should be in to be called an equivalent unit.
 For example, a furniture manufacturer may identify a unit as “complete” when it passes the
cutting or assembling processes but are yet to go through the polishing process.

Whereas, a wine manufacturer would not be able to call their units complete until they have
passed the aging and bottling stage which would take a long time in the production process.

So if production during that stage has 4 processes and 3 are completed, then the unit would be
75% complete which could be counted as an equivalent unit for the company.

Taking all this into account, the company should then determine the total number of equivalent
units produced during that period by taking the total number of Work in Process units and
multiplying it with the units that are complete. (Ex. 5000 Work in Process units x 0.75 {75%} =
3750 completed units).

If you are looking to know more about process costing, here is a video that talks about it in a
simpler way.

3.Identify the total costs

The third step is to account for all the costs that are incurred during the whole production
process.

This is done by adding costs to each process to get an average individual cost per unit.

Compared to the other costing methods available, this method uses quite a basic method to
calculate these costs.

These costs are divided into direct costs and indirect costs.

The direct costs are usually noted down as:

 Direct Labor – This is the cost of employing people to work on producing the product during that
particular process. Ex: Factory worker on the bottling line.

 Direct Materials – These are the costs of the raw materials that were used to produce the units during
the process.

 Overheads  Manufacturing– This includes all the other costs that will be incurred during this time that
are not accounted for in Direct Costs such as depreciation, rent, property tax, and electricity.
Other examples of indirect costs would include facility maintenance, worker salaries, quality
assurance, and other factory supplies which are not directly related to manufacturing.

4.Calculate the average cost per equivalent unit

Once all the costs have been identified for each process, then it’s a simple process to calculate
the average cost per unit.

All of these costs from each process are added together to get one total cost, and this value is
then divided by the total equivalent unit number to get the average equivalent cost per unit.
What are the characteristics of process costing?
Process costing has certain characteristics of its own. The chief characteristics of
process costing are: (1) The production of goods is continuous, except where the plant
is shut-down for repairs, until the final product. (2) The finished product is the result of
two or more processes.