3 1: Introduction to Process Costing Business LibreTexts

The total cost added in the process needs to be computed for different items of the material and the conversion cost. The cost is allocated based on the completion of the activity for particular products. It helps to measure the value of work in process at the year-end as the cost can be traced with the completion of the stage of production.

Losses and Gains at different stages in the Process

The journal entries to reflect the above process costing transactions are as follows. For example, a customer might place an order for an item of furniture to be manufactured to their specifications. All the costs relating to the manufacture are identified and allocated to the job and later used to invoice the customer. Manufacturing overheads are allocated to each department at $500 per direct labor hour worked. Process costing is not required a complicated accounting or IT system to collect data and calculate it. When we obtain enough information, only a simple spreadsheet is enough to complete the work.

Direct or Indirect Material

Process costing is the only reasonable approach to determining product costs in many industries. It uses most of the same journal entries found in a job costing environment, so there is no need to restructure the chart of accounts to any significant degree. This makes it easy to switch over to a job costing system from a process costing one if the need arises, or to adopt a hybrid approach that uses portions of both systems. While both systems produce a cost of goods sold for a given period, Process Costing focuses on the product’s progression through various stages of production.

Similarities between Process Costing and Job Order Costing

• It’s not suitable for the companies that have different products to be produced at each time.
• Manufacturing departments are often organized by the various stages of the production process.
• Examples of products that would use process costing are Cheerios brand cereal, iPhones, or Toyota Camrys.
• The completion of the percentage is assigned to create ease in the process of cost allocation for the processed units.
• Direct costs accumulate and indirect costs are applied to the batches as they move through the production processes.

We are going to discuss how these methods are used in a process costing system but first let’s have an understanding of what a process costing system is. While the costing systems are different from each other, management uses the information provided to make similar managerial decisions, such as setting the sales price. For example, in a job order cost system, each job is unique, which allows management to establish individual prices for individual projects. Process costing follows a simple and easy calculation method; even non-accountant can understand it easily. Although it goes through many assembly lines as it incurs costs such as direct material, direct labor, and overhead, we can just sum up all costs and divide them by the total output of each process line.

• If the product unit losses are greater than the normal expected unit losses they are referred to as abnormal losses.
• Process costing is generally used in industries that deal with chemicals, distilled products, canned products, food products, oil refineries, edible oils, soap, paper, textiles, and others.
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• Therefore, the costs are maintained by each department, rather than by job, as they are in job order costing.
• Inherent in the process are expected (normal) losses calculated as follows.

It should be noted that process costing and job costing are different methods of costing. The main difference between process costing and job costing is that job costing is used when the costs can be allocated to a specific job, often identified with a particular customer. Examples of the industries where this type of production occurs include oil refining, food production, process costing and chemical processing. For example, how would you determine the precise cost required to create one gallon of aviation fuel, when thousands of gallons of the same fuel are gushing out of a refinery every hour? The cost accounting methodology used for this scenario is process costing. This problem is handled through the concept of equivalent units of production.

Calculating Unit Cost Under Process Costing

It is much easy for management to spot the weakness of each process by comparing their cost and output. You cannot calculate the total output of the period by just taking the sum of completed units and work in process (ending inventory) because units in the work-in-process inventory are not 100% complete. Further, the basis for the allocation of the costing on a batch is arbitrary and not transparent as in the case of the job order costing.

The units that have been complete during the period have been completed in the above stage of the process costing. However, there are units that remain incomplete during the period that need to be considered as well. Process A is the first process and the inputs are raw materials, labor, other costs and overheads. https://www.bookstime.com/articles/credit-memo During the period the costs total 45,000 and these are considered sufficient to make 1,200 units of the product. If the product unit losses are less than the normal expected losses they are referred to as an abnormal gain. The costs attributed to abnormal gains are added back to the process account.

Just-In-Time: History, Objective, Productions, and Purchasing

Under process costing, the procedure used to manufacture a product is divided into well-defined processes. A separate account is opened for each process to which all incurred costs are charged. There are situations whereby companies manufacture a broad mix of products and find it difficult to accurately assign actual costs to each type of product; in such instances, using standard costs can be very useful.

• The advantages of process costing include but are not limited to straightforward computation of the product cost, basic inputs in the process like direct material, direct labor, and overhead cost.
• A batch is defined as each time a quantity of materials is added to the first point of production to keep the work flow going.
• The carbonated drinks that the company produces pass through several production departments.
• Then, when the products are eventually sold, the cost is shifted to the cost of goods sold account on the income statement.
• The cost for the direct material, direct labor, and overheads is assigned to the process which is then allocated for the batch of production.

For instance, further material required to complete the process is 20%. The business expects to lose 105 units during Process B and will eventually sell these for a scrap value calculated as follows. The business expects to lose 60 units during Process A and will eventually sell these for a scrap value calculated as follows. Inherent in the process are expected (normal) losses calculated as follows. There are a number of terms which need to be understood when discussing process accounting.