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.

Process costing is a type of operation costing which is used to ascertain the cost of
a product at each process or stage of manufacture. CIMA defines process costing as
"The costing method applicable where goods or services result from a sequence of
continuous or repetitive operations or processes. Costs are averaged over the units
produced during the period". Process costing is suitable for industries producing
homogeneous products and where production is a continuous flow. A process can
be referred to as the sub-unit of an organization specifically defined for cost
collection purpose.

The importance of process costing

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. So, a lot of companies prefer to use process-costing system.

[edit] When process costing is 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, and food.

[edit] Reasons for use

Companies need to allocate total product costs to units of product for the following
reasons:

• A company may manufacture thousands or millions of units of product in a

given period of time.
 • Products are manufactured in large quantities, but products may be sold in
small quantities, sometimes one at a time (automobiles, loaves of bread), a
dozen or two at a time (eggs, cookies), etc.

• Product costs must be transferred from Finished Goods to Cost of Goods Sold
as sales are made. This requires a correct and accurate accounting of product
costs per unit, to have a proper matching of product costs against related
sales revenue.

• Managers need to maintain cost control over the manufacturing process.

Process costing provides managers with feedback that can be used to
compare similar product costs from one month to the next, keeping costs in
line with projected manufacturing budgets.

• A fraction-of-a-cent cost change can represent a large dollar change in overall

profitability, when selling millions of units of product a month. Managers must
carefully watch per unit costs on a daily basis through the production
process, while at the same time dealing with materials and output in huge
quantities.

• Materials part way through a process (e.g. chemicals) might need to be given
a value, process costing allows for this. By determining what cost the part
processed material has incurred such as labor or overhead an "equivalent
unit" relative to the value of a finished process can be calculated.

Process cost procedures

There are four basic steps 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.

Job Costing involves the calculation of costs involved in a construction "job" or the
manufacturing of goods done in discrete batches. These costs are recorded in
ledger accounts throughout the life of the job or batch and are then summarized in
the final trial balance before the preparing of the job cost or batch manufacturing
statement.
Job Costing vs Process Costing

Job costing (known by some as job order costing) is fundamental to managerial

accounting. It differs from Process costing in that the flow of costs is tracked by job
or batch instead of by process.

The distinction between job costing and process costing hinges on the nature of the
product and, therefore, on the type of production process:

• Process costing is used when the products are more homogeneous in nature.
[1]
Conversely, job costing systems assign costs to distinct production jobs
that are significantly different. An average cost per unit of product is then
calculated for each job.

• Process costing systems assign costs to one or more production processes.

Because all units are identical or very similar, average costs for each unit of
product are calculated by dividing the process costs by the number of units
produced.

• Many businesses produce products with some unique features and some
common processes. These businesses use costing systems that have both job
and process costing features.[2]

Using Job Costing

In a job costing system, costs may be accumulated either by job or by batch. For a
typical job, direct material, labor, subcontract costs, equipment, and other direct
costs are tracked at their actual values. These are accrued until the job or batch is
completed. Overhead or "burden" may be applied either by using a rate based on
direct labor hours or by using some other Activity Based Costing (ABC) cost driver.
In either case, once overhead/burden is added, the total cost for the job can be
determined. If the accountant is using a general ledger accounting system, which
lacks true job costing functionality, the costs must be manually transferred out of
Work in Process to Finished Goods (Cost of Goods Sold for service industries). Of
course, in the days of computerized job costing software, journaling costs manually
is an obsolete process. Such hand-journaling is mandatory for companies that
continue to use general accounting software to do job costing. Enlightened
accountants are moving forward and using job costing software, thereby improving
cost control, reducing risk, and increasing the chance of profitability.

Using Cost Codes in Budgeting

In a true job cost accounting system, a Budget is set up in advance of the job. As
actual costs are accrued, they are compared to budgeted costs, to determine
variances for each phase of each job. Cost Codes are used for each phase,
allowing "mini-budgets" to be generated and tracked. In the construction industry,
the Construction Specifications Institute (CSI) has established an industry standard
Cost Coding system.job costing system consists of various cost driver that drives job
cost, moreover it