BM2404

PROCESS COSTING
INTRODUCTION OF CONCEPTS AND APPLICATION OF PROCESS COSTING
The basic purpose of cost accounting is to accumulate data designed to provide management with
accurate information on the cost of manufacturing a product. The appropriate cost accounting system for
a particular entity depends on the nature of its manufacturing operations.
When a manufacturing process involves the continuous production of identical units rather than
distinguishable job loss, there can be no job orientation. When there is no obvious start or finish (because
the manufacturing process is endlessly repetitive), we use a process-costing system to accumulate and
allocate manufacturing costs. In using process costing, all manufacturing costs are allocated first to
departments or processes.
Departmental or process costs are then allocated to units of the product as units are completed. Instead
of using job cost sheets, the costs associated with each department are summarized in a cost-of-
productions report, with one report per department for a period. At the end of each period, the costs
accumulated on each such report will be allocated between end-of-period work in process and units
transferred to the next process or, in the case of the final process, to finished goods.
A process cost system determines how manufacturing costs incurred during each period will be allocated.
Allocating costs within a department is only an information step; the goal is to compute the total cost per
unit for income determination. During a period, some units will start but will not be completed by the end
of the period. Consequently, each department must determine how much of the total costs incurred by
the department are distributed to units still in process and how much is attributable to completed units.
Process costing methods are used by the following:
1. Industries produce chemicals, petroleum, textiles, steel, rubber, cement, flour, pharmaceuticals,
shoes, plastics, sugar, and coal.
2. Firms manufacture items such as rivets, screws, bolts, and small electrical parts.
3. Assembly-type industry, which manufactures typewriters, automobiles, airplanes, and household
electric appliances.
4. Service industries such as gas, water, and heat.
Characteristics of a Process Cost System
1. Costs are accumulated by department or cost center.
2. Each department has its general ledger Work in Process Inventory account.
This account is debited by the department's processing costs and credited with the cost of completed
units transferred to another department or the finished goods inventory.
3. Equivalent units are used to restate work-in-process inventory in terms of completed units at the end
of a period.
4. Completed units and their corresponding costs are transferred to the last department or the finished
goods inventory. By the time units leave the last processing department, total costs for the period
have been accumulated and can be used to determine the unit cost of each and the total finished
goods.
5. Total and unit costs for each department are periodically calculated and analyzed using the
department cost of production report.

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THE COST OF PRODUCTION REPORT

The cost of production report analyzes the activity in the department or cost center for the period. All
costs chargeable to a department or cost center are presented according to cost elements.

Total and unit costs are determined and summarized in a production report. Either each cost center
or department makes such a report, or the individual reports of several departments are outlined.
There are several useful formats for preparing the cost of production report. However, only one
format is illustrated in this book. Regardless of the format used, the important thing to emphasize is
that process costing requires an orderly approach to assigning costs to products. The following steps
provide a uniform approach to preparing the cost of production report.
Step 1 - The Quantity Schedule
This schedule accounts for the physical flow of units into and out of departments. All units started in
the department must be accounted for, and the disposition of these units, that is, whether they are
transferred to the next department, lost, or remain in the department (complete or incomplete). This
schedule is concerned only with whole units, regardless of their stages of completion.
Step 2 - Calculate Equivalent Units and Unit Costs
The concept of equivalent production is basic to process costing. In most cases, not all units are
completed during the period. Thus, there are units still in process at varying stages of completion at
the end of the period. All units must be expressed in terms of completed units to determine unit costs.
Equivalent production equals total units completed plus incomplete units restated in terms of
completed units. Completed units do not create a problem when equivalent production is computed
because they are always 100% complete as to direct materials, direct labor, and factory overhead.
The problem lies in the restatement of incomplete units in terms of completed units. Incomplete units
are accounted for in the work-in-process inventory until they are completed and transferred to
the finished goods inventory. Therefore, to compute equivalent production, an analysis must be made
of the stage of completion of work in process inventory, subdivided into direct materials, direct labor,
and factory overhead. For example, direct materials may be added at one specific point in production,
such as at the beginning or the end of the process. If direct materials are added at the beginning, all
work-in-process units will have complete direct material costs. When direct materials are added at
the end of the process, the work-in-process inventory will not have any direct materials from that
department. Direct materials may also be added continuously; in this case, the work-in-process
inventory will have direct materials equal to the stage of completion of the work-in-process. The unit
cost in the department is computed by dividing the cost incurred in the department for each element
by the equivalent production.
• FIRST-IN FIRST-OUT METHOD
Equivalent unit cost = Costs added during the period/Equivalent Units (Work done this period)
• WEIGHTED AVERAGE METHOD
Equivalent Unit Cost = (Cost last period plus cost added this period)/Equivalent Units (Work
done last period plus work done this period)
Step 3 - Determine the costs to be accounted for (costs charged to the department)
The cost that a department is responsible for may come from several sources. For one thing, there
may be some units at the beginning of inventory that may be partially complete, and the costs of
direct materials, direct labor, and factory overhead that were assigned to these units last period will
become the cost of. the beginning inventory and must be accounted for. Also, suppose the

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department is not the first department in the production process. In that case, it will receive costs
from other departments when the units from these departments are accepted into its operations. In
addition, each department will incur direct materials, direct labor, and factory overhead in its
processing. The total cost must be determined so that they can be accounted for.
Step 4 - Account for all costs
After the department's costs are determined, accounting for their disposition must be made. Some of
the costs are assigned to cost centers receiving units transferred out of the department. The
remaining costs are assigned to the units remaining in the department and, in some cases, to any unit
lost.
Production by Department
In a process cost system, when units are completed in one department, they are transferred to the next
processing department, accompanied by their corresponding costs. A complete unit of one department
becomes the raw materials of the next department until the units reach finished goods. Thus, the output
of Department 1 becomes the input of Department 2. Department 2 receives both the units produced by
Department 1 and the costs carried out by such units. When Department 2 completes its processing, it
transfers out the units and the costs it received from Department 1 plus any cost it incurred while working
on the units. The costs of a unit grow larger as they progress along the assembly line from one department
to the next.
EXAMPLE: Sunbloc manufactures chairs and uses three (3) departments to produce one (1) chair.
Department 1 cuts and cleans the wood at an average cost of P 45.00 per unit. The woods are then moved
to Department 2, where they are assembled and put together at an average cost of P 15.00. The next stop
is Department 3, where they are painted at an average cost of P 25.00 per unit. The complete chairs are
transferred from Department 3 to finish goods inventory. The total unit cost of one finished chair is P
85.00, computed as follows:
Department 1 ₱ 45.00
Department 2 15.00
Department 3 25.00
Total unit cost added ₱ 85.00
The cost per unit increases as units flow through each department. However, if volume is added to the
product, the cost can decrease when units pass through a department.
Methods of Application of Elements of Cost to Production
1. Even application - It is considered at any stage during the production process. The introduction of the
three (3) elements of cost is equal. Only one (1) computation of equivalent production should be
made.
2. Uneven application - The introduction of the elements of cost to production varies at any stage of the
process. Hence, there should be as many computations of equivalent as the elements of cost that are
unevenly applied.
PRODUCT FLOW
A product can flow through a factory in three (3) different ways. These product flow formats associated
with process costing are:

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1. Sequential product flow - The initial raw materials are placed into a process in the
first department and flow through every department in the factory. Additional
materials may or may not be added in the subsequent departments. All items
purchased go through the same processes in the same sequence. A flowchart
presentation of sequential product flow is presented below.

2. Parallel product flow—Certain portions of the work are done simultaneously, then
brought together for the final process and, upon completion, transferred to
the finished goods inventory.

3. Selective—Depending on the desired final product, the product moves to different departments
within the factory. Several products are produced from the same initial raw materials.

System Flow
Units and costs flow together through a process cost system. The following equation summarizes the
physical flow units in a department.

UNITS TO ACCOUNT FOR

Beginning units in process UNITS ACCOUNTED FOR
+ Units completed & transferred.
Units started in process or = +
Received from previous dept. Units completed and on hand.
+ +
Increase in units due, addition of Units in process end
Materials

Procedures - Direct Materials, Direct Labor, and Factory Overhead

The use of a process cost system does not alter the manner of accumulating direct materials, direct labor,
and factory overhead costs. The normal procedures of cost accounting are used to accumulate the three
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product cost elements. Process costing is concerned, however, with assigning these costs to the
appropriate departmental Work in Process Inventory account.
DIRECT MATERIALS
The entry to record the issuance of direct materials to Department 1 during the period is as follows.

Work in Process – Department 1 xxx

Materials xxx

Direct materials are always added in the first processing department, but they are also usually added in
other departments. The journal entry would be the same for adding direct material costs in later
processing departments. The accumulation of direct material cost is much simpler in a process cost system
than in a job order cost system.
Fewer journal entries are required under the process cost system. The number of departments using
direct materials is usually less than the number of jobs requiring direct materials in a job order cost
accumulation system.

DIRECT LABOR
The entry to distribute direct labor costs is as follows:
Work in Process – Department 1 xxx
Work in Process – Department 2 xxx
Work in Process – Department 3 xxx
Payroll xxx

The amounts to be charged to each department are determined by the gross earnings of the employees
assigned to each department. Assuming Maxine Garcia works in Department C, her gross salary is charged
to Department B. Under a job order cost system Maxine Garcia's salary would have to be distributed
among all the jobs she worked in. Process costing reduces the amount of paperwork needed to assign
labor costs.

FACTORY OVERHEAD
In a process cost system, factory overhead costs may be applied using either of the following methods.
The first method, which is used in job order costing, applies factory overhead to work-in-process inventory
at a predetermined application rate. A predetermined factory overhead application rate based on normal
capacity is appropriate when production volume or factory overhead costs fluctuate from month to
month, as it eliminates distortion in monthly unit costs caused by such fluctuations.
Work in Process – Department 1 xxx
Work in Process – Department 2 xxx
Work in Process – Department 3 xxx
Factory overhead applied xxx

The second method charges actual factory costs incurred to work in process inventory. If production
volume and factory overhead costs remain constant from month to month, expected capacity is
appropriate as the denominator activity level. In a process cost system, where there is continuous
production, either method may be used.

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References
Cabrera, E. (2021). Cost Accounting and Control. EESM Bookstore.
DeLeon, N. (2022). Cost Accounting and Control. Readers Knowledge Bookstore.
Piper, M. (2022). Cost Accounting Made Simple. Simple Subjects LLC.
Raiborn, C. (2021). Cost Accounting and Control. Cengage Learning.

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