Chapter 7

PROCESS COSTING
1 Record the flow of materials, labor, and overhead through a process

costing system.

2 Compute the equivalent units of production using the weighted average

method.

3 Compute the cost per equivalent unit using the weighted-average method.

4 Assign costs to units using the weighted-average method.

5 Prepare a cost reconciliation report using the weighted-average method.

7.1 PROCESS COSTING
That form of operating costing which applies where standardized goods are

produced. The method of costing under which all costs are accumulated for

each stage of production and the cost/ unit of product is ascertained for each

stage of production by dividing the cost of each process by the normal

output of that process.

7.12 FEATURES OF PROCESS COSTING

 Production is continuous.

 The product is homogeneous.

 The process is standardized.

 Output of one process becomes the raw material of another process.

 The output of the last process will be transferred to the finished stock.

 Costs are collected process-wise.

 Both direct and indirect costs are accumulated in each process.

 If there is a stock of semi-finished goods it is expressed in terms of

equivalent units.

 The total cost of each process is divided by the normal output of that

process to find out the cost/unit of that process.

7.2 Comparison of Job-Order and Process

Costing
In some ways process costing is very similar to job-order costing, and in

some ways, it is very different. In this section, we focus on these similarities

and differences to provide a foundation for the detailed discussion of process

costing that follows.

Similarities between Job-Order and Process Costing

Much of what you learned in previous chapters about costing and cost flows

applies equally well to process costing in this chapter. We are not throwing

out all that we have learned about costing and starting from “scratch” with a

whole new system. The similarities between job-order and process costing

are as follows:

1. Both systems have the same basic purposes—to assign material, labor,

and manufacturing overhead costs to products and to provide a mechanism

for computing unit product costs.

2. Both systems use the same basic manufacturing accounts, including

Manufacturing Overhead, Raw Materials, Work in Process, and Finished

Goods.

3. The flow of costs through the manufacturing accounts is basically the

same in both systems.

As can be seen from this comparison, much of what you have already

learned about costing is applicable to a process costing system. Our task

now is to refine and extend your knowledge to process costing.

Differences between Job-Order and Process Costing

Three differences between job-order and process costing: First, job-order

costing is used when a company produces many different jobs that have

unique production requirements. Process costing is used when a company

produces a continuous flow of units that are indistinguishable from one

another. Second, job-order costing uses job cost sheets to accumulate costs

for individual jobs. Process costing accumulates costs by department (rather

than by job) and assigns these costs uniformly to all identical units that pass

through the department during a period. Third, job-order costing uses job

cost sheets to compute units costs for each job. Process costing systems

compute unit costs by department.

7.11 Cost Flows in Process Costing

Before going through a detailed example of process costing, it will be helpful

to see how, in a general way, manufacturing costs flow through a process

costing system.

Processing Departments

A processing department is an organizational unit where work is

performed on a product and where materials, labor, or overhead costs are

added to the product. For example, a Nalley’s potato chip factory might

have three processing departments—one for preparing potatoes, one for

cooking, and one for inspecting and packaging. First, the activity in the

processing department is performed uniformly on all of the units passing

through it. Second, the output of the processing department is

homogeneous; in other words, all of the units produced are identical.

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The Flow of Materials, Labor, and Overhead Costs

Cost accumulation is simpler in a process costing system than in a job-order

costing system. In a process costing system, instead of having to assign

costs to hundreds of different jobs, costs are assigned to only a few

processing departments. Several key points should be noted from this

exhibit. First, note that a separate Work in Process account is maintained for

each processing department.

Materials, Labor, and Overhead Cost Entries

Materials Costs As in job-order costing, materials is drawn from the

storeroom using a materials requisition form. Materials can be added in any

processing department, although it is not unusual for materials to be added

only in the first processing department, with subsequent departments adding

only labor and overhead costs.

Labor Costs In process costing, labor costs are traced to departments—not

to individual jobs.

Overhead Costs In process costing, as in job-order costing, predetermined

overhead rates are usually used. Manufacturing overhead cost is applied

according to the amount of the allocation base that is incurred in the

department.

Completing the Cost Flows Once processing has been completed in a

department; the units are transferred to the next department for further
processing. After processing has been completed, the costs of the completed

units are transferred to the Finished Goods inventory account. Finally, when

a customer’s order is filled and units are sold, the cost of the units is

transferred to Cost of Goods Sold

PROCESS COST ACCOUNT

Dr. Cr.

PARTICULAR UNITS AMOUNT PARTICULAR UNITS AMOUNT

S S

Direct ××× ××× Normal Loss ××× ×××

Material

Direct Wages ××× ××× Transfer to ××× ×××

next Process

Direct ××× ××× Abnormal ××× ×××

Expenses Loss

Production ××× ×××

Overheads

Cost of ××× ×××

Rectification

Abnormal ××× ×××

gain

Process Losses: Losses incurred during production. Some may be visible

while some are inevitable. These losses are classified into two categories.
 a) Normal Loss: an unavoidable loss which occurs due to the inherent
nature of the materials and production process under normal
conditions. It is normally estimated on the bases of past experience, it
may be in the form of:

i. Normal wastage

ii. Normal spoilage

iii. Normal scrap

iv. Normal defectiveness

It may occur at any time of the process

# of units of normal loss = Input * expected % of normal

loss

Cost of god unit = (Total cost increased – sale value of scrap)/(input –

normal loss units)

b) Abnormal Loss: Any loss caused by unexpected abnormal conditions

such as plant breakdown, carelessness accident etc. e.g. substandard
material.

Abnormal loss = Actual loss – normal loss

Value of abnormal loss = [(Total cost increase – scrap value of

normal loss) * Units of abnormal loss] / (Input units – normal loss units)

PROCEDURE FOR CALCULATING ABNORMAL LOSS ACCOUNT

Abnormal Loss Account

Dr. Cr.

Particulars Units Amount Particulars Units Amount

 To process ××× ××× Bank ××× ×××
A/c

Profit and ××× ×××

Loss A/c

Abnormal Gain Account

Dr. Cr.

Particulars Units Amount Particulars Units Amount

Normal × ××× Process × ×××

Loss

Profit and × ×××

Loss A/c

The product of a company passes through 3 distinct processes. The following

information is obtained from the account for the month of January 31, 2013.

PARTICULARS PROCESS A PROCESS B PROCESS C

Direct Material 7800 5940 8886
Direct Wages 6000 9000 12000
Production 6000 9000 12000
Overheads

3000 units at M3 each were introduced to process A. There was no stock of

raw materials or work-in-progress. The output of each process passes
directly to the next process and final to the finished goods account.

The following additional information is obtained:

PROCESS OUTPUT % of Normal VALUE OF

loss to output SCRAP/UNIT

(M)

A 2850 5% 2

B 2520 10% 4

C 2250 15% 5

Prepare:
1. Process Cost A/C’s

2. Normal Loss A/C

3. Abnormal Gain or Loss A/C

SOLUTION:
PROCESS A A/C
Dr. Cr.
Particulars Units Amount Particulars Units Amount
Basic 3000 9000 Normal 150 300
Material Loss
Direct 7800 Transfer to 2850 28,500
Material Process B
Direct 6000
Wages
Production 6000
Overheads
3,000 28, 800 3,000 28, 800

PROCESS B A/C
Dr. Cr.
Particular Units Amount Particular Units Amount
s s
Process A 2850 28, 500 Normal 285 1140
Loss
Direct 5,940 Transfer to 2520 50,400
Material Process C
Direct 9,000 Abnormal 45 900
Wages Loss
Production 9,000
Overheads
2, 850 52, 440 2,850 52, 440

PROCESS C A/C
Dr. Cr.
Particular Units Amount Particular Units Amount
s s
Process B 2520 50, 400 Normal 378 1,890
Loss
Direct 8,886 Transfer to 2250 85,500
Material Finished
Goods
Direct 12,000
Wages
Production 12,000
Overheads
Abnormal 108 4,104
Gain
2, 628 87, 390 2, 628 87, 390

NORMAL LOSS A/C

Dr. Cr.
Particular Units Amount Particular Units Amount
s s
Process A 150 300 Profit and 150 300
Loss A/C
Process A
Process B 285 1,140 Profit and 285 1,140
Loss A/C
Process B
Process C 378 1,890 Profit and 270 1,350
Loss A/C
Process C
Abnormal 108 540
Gain
Abnormal 108 4,104
Gain
813 3, 330 813 3, 330

Abnormal Gain Account

 Dr. Cr.

Particula Units Amount Particula Units Amount

rs rs

Normal 108 540 Process C 108 4,104

Loss

Profit & 3,564

Loss

108 4,104 108 4,104

Abnormal Loss Account

Dr. Cr.

Particulars Units Amount Particulars Units Amount

Process B 45 900 Profit and 45 900

Loss A/c

ADVANTAGES OF PROCESS COSTING ACCOUNT

 Costs are calculated periodically at the end of a particular period.

 It is simple and involves less clerical work.

  It is easy to allocate the expenses to processes in order to have
accurate costs.

 Use of standardized costing systems is very effective in process

costing situations.

 It helps in the preparation of tenders and quotations.

 Since cost data is available for process, operations and department,

good managerial control is possible.

LIMITATIONS OF PROCESS COSTING ACCOUNT

 Cost obtained at each process is only historical cost and are not very
useful for effective control.

 Based on average cost method which is not that suitable for

performance analysis, evaluation and managerial control.

 Work-in-progress is generally done on estimated basis which leads to

in accuracy in total cost calculations.

 The calculation 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.

 Where different products arise in the same process and common costs
are pro-rated to various cost units; such individual process costs may
be taken as only approximations and hence not reliable.