PROCESS COSTING

PROCESS COSTING

• The process costing refers to the procedure of determining the average

unit cost in situations in which the product passes through more than
one stage of manufacturing process .

• In other words , it is used when identical units are produced through an on

going series of uniform production steps .

This system can be applied when :

• The output is homogeneous

• Production is continuous

• There is a feasibility of segmentation of the manufacturing

operations into clearly identifiable processes or
departments.
 The process costing is appropriate for industries
such as:
• Chemicals
• Food processing
• Breweries
• Petroleum refining
• Glass
• Metal manufacturing e.g. steel , aluminum etc
• Paper
• Sugar
 DIFFERENCE BETWEEN JOB COSTING & PROCESS COSTING

SN JOB COSTING PROCESS COSTING

1 Jobs receive varying degree of Units of output produced
skill and attention from each receive identical attention
production department or from each production
operation. department or operation.

2 Job- order cost system identifies The process cost system

costs essentially with a specific identifies cost with units
job . of work performed during
a period of time .

3 Unit costs are determined Unit costs are determined

continuously as each job is completed . periodically

4 Production is for a specific order to meet Production is for building

an individual customers specification up inventories for future sales
.Therefore sales always precede and therefore production
production . precedes sales.
 DIFFERENCE BETWEEN JOB COSTING & PROCESS COSTING

5 Further , the materials needed for jobs would The material needed for out put
depend on the receipt of specific job – order , are known and hence the
and therefore the material inventory/stock held material inventory kept on hand
is small /minimum . tends to be higher.

6 In job costing most of the costs are directly In process costing automation /
traceable to the jobs and therefore a major part mechanization is feasible to a
of the total costs normally consist of direct greater extent entailing higher
costs , overheads form a relatively low overhead costs .
proportion of these costs.

7 Production runs are short , since the number of Production being on a mass
units produced each time depends on specific scale , production runs are long
order received. and often continuous .
• The foregoing differences notwithstanding , job and process
costing systems are not mutually exclusive ,i.e. , a firm
need not limit itself to the adoption of either of the two systems.

• For , the same firm can use both the methods to serve cost
information needs .
 For instance Automobile Manufacturing Firms may employ :
* job costing in their engineering departments
and
* process costing in their main assembly lines .

• Similarly , Heavy Equipment Manufacturing Firms often use:

* job costing to determine the total cost of a large machine
but
* the costs of mass produced machine components like
switches , valves and so on are first determined by the
process cost method.
 COST ACCUMULATION IN PROCESS COSTING

• The process cost system accumulates the production costs

according to department or processes .

• Each department / process constitutes a responsibility

centre from the point of view of cost control and performance
evaluation through techniques such as standard costing ,
responsibility accounting , budgeting and so on .

• It provides unit cost measures that are helpful in establishing

selling price particularly when the firm employs `cost plus` or
some other type of cost based product pricing .
 INCOMPLETE UNITS
• Given the nature of the production process , some units may
remain incomplete at the time for the total cost of
production.
• In such a situation , some units are complete while the others
are incomplete / partially complete.
• For the purpose of cost accumulation , the units of production
are to be converted into complete comparable units. They are
referred to as Equivalent Units .
For e.g. 100 units of inventory estimated to be 40 % complete.
What will be the cost of these incomplete units?
Equivalent Units :
Actual number of partially completed units * Stage of
Completion
= 100 * 40 % = 40 units
Therefore , for cost determination purposes , 100 partially
completed units will be considered equal to 40 units of
completed units.
 SPOILAGE

In the case of firms whose output passes through

several stages , some wastage / spoilage of units
takes place for a variety of reasons such as:
• breakdown of machines ,
• use of substandard material ,
• poor workmanship ,
• evaporation ,
• shrinkage and so on.

The effect of wastage is that the actual units

produced are less than the units introduced
initially.
 The treatment of the spoiled units depends on the nature of
the spoilage / wastage / loss.
• Normal Loss :
The loss of units which is an inherent part of the
production process caused by natural and unavoidable
causes such as milling , drying, breaking , weighing ,
evaporating , processing , loading , unloading and so on .
• Abnormal Loss :
Any loss in excess of normal spoilage is called abnormal
loss. It is controllable loss.
• Abnormal Gain :
If the number of units actually lost are less than the
number of units normally expected to be lost , the
difference would represent an abnormal gain /
effectiveness .
 A/C Treatment for NORMAL LOSS
• Normal spoilage forms a part of the product cost.
• It is inherent in the production process.
• It occurs even under efficient operating conditions.
• Therefore , the cost of production of spoiled units is
recovered from good units .

A/C Treatment for ABNORMAL LOSS

• Abnormal loss is treated as a period cost .
• It is written off as a loss of the period in which it occurs
• It is relevant for determining the process cost .
Abnormal Loss is transferred to the profit and loss account
of the period.

Likewise , Abnormal Gain is transferred to the profit and

loss account of the period.
• It is likely that the wasted units ( normal as well as abnormal)
may have salvage value.

A/c Treatment for Salvage Value

In case of Normal Loss
• The sales proceeds of the units in normal waste would reduce
the cost of production .

Total Normal Loss

(-) Salvage Value of Scrap
______________________
Actual Normal Loss
______________________

Actual Normal Loss will become a part of the Cost of Production.

 In case of Abnormal Loss
• The loss on abnormal wastage charged against the costing
profit and loss account will be lower to the extent of the revenue
received from their sale .

Total Abnormal Loss

(-) Salvage Value of Scrap
______________________
Actual Abnormal Loss
______________________

Actual Abnormal Loss will be transferred to the Profit and Loss

Account.
• Cost per unit = [total process cost (-) salvage
value of normal spoilage ] / ( total units
introduced (-) normal loss in units)

• Abnormal Loss = [ Abnormal loss in units * unit

production cost] – salvage value of abnormal
spoilage
 PROCESS COSTING
ILLUSTRATION 1 :

A product passes through two processes : A and B .During the month ended
June 30 , 1,500 units were produced . The details of the costs break – up is as
follows :

Process A Process B

Direct Materials Rs. 90,000 Rs.75,000

Direct Labour 75,000 1,50,000
Direct Expenses 15,000 18,000

Indirect overheads costs during the period were Rs. 60,000 apportioned to the
processes on the basis direct labour cost .No work in progress existed at the
beginning and end of the period .Prepare the relevant Process Accounts .
 Solution:
Process A Account
Rs. By Cost of Output Rs.2,00,000
To Direct Materials 90,000 Transferred to
Process B
To Direct Labour 75,000

To Direct Expenses 15,000

To Indirect 20,000
Overheads (1/3 of
60,000 )
2,00,000 2,00,000
 Process B Account
To Process A ( cost Rs. By Cost of Output Rs.
transferred ) 2,00,000 Transferred to 4,83,000
Finished Goods
inventory
To Direct Materials 75,000
To Direct Labour 1,50,000
To Direct Expenses 18,000

To Indirect Overheads 40,000

(2/3 of 60,000 )

4,83,000 4,83,000
ILLUSTRATION 2 :

600 kgs of material was charged to Process I at the rate of Rs.

4 per kg. The direct labour accounted for Rs.200 and the other
departmental expenses amounted to Rs. 760.The normal loss
is 10 percent input . During the period , the actual production
was 500 kgs .
Assuming that the scrap is saleable at Rs. 2 per kg .
Prepare a ledger account of Process I , showing the values
of normal and abnormal losses.
Working Note 1 : Calculation of Abnormal loss

Units introduced 600

(-) Normal loss (10%) 60
Normal out put Expected 540
(-)Actual output achieved 500
Abnormal loss (units) 40
Working Notes 2: Calculation of Cost per unit

= [Total Cost – Sales Proceeds of the Scrap] / Normal

Expected Output

=[ 3,360 (-) 120 ] / 540 units

= Rs. 6 p. u.
 Solution:
Process I Account

Units Amount Units Amount

Particulars Kg s Rs. Particulars Kg s Rs.

To Material 600 2,400 By Normal 60 120

Loss
( 60* 2)
To Wages 200 By Abnormal 40 240
Loss(40*6p.u)
To Departmental 760 By Process II 500 3,000
Expenses ( 500 units
transferred
at Rs. 6 p.u.)
600 3,360 600 3,360
ILLUSTRATION 3 :

The product of ABC Ltd. Passes through three distinct processes for
completion .From the past experience , it is ascertained that normal
wastage in each process is as under :

Process Wastage (%) Sale value of

wastage per unit

A 2 Rs. 0.25
B 4 0.50
C 2.5 0.60
 The expenses were as follows :

Process Process Process

A B C
Material Rs. 12,000 Rs. 10,000 Rs. 9,000

Direct Labour 16,000 5,000 4,900

Manufacturing Expenses 2,000 3,400 3,590
Other Factory Expenses 3,500 2,005 2004

4,000 units were initially introduced in process at a cost of Rs. 13,560. The
output of each process was as under : A , 3,850 ; B, 3,600 ; C,3,500 units.

Prepare process accounts and also work out the sale price per unit of
finished stock so as to realize 20 % profit on selling price .
W/N 1 : Calculation of Normal Loss
2 % of the units introduced i.e.
2 % 4,000 units = 80 units

W/N 2 : Calculation of Abnormal Loss

Total Units Introduced 4,000
(-) Normal Loss (2%) 80
Expected Normal Output 3,920
(-) Actual output of Process A 3,850
Abnormal Loss 70 units
W/N 3 :Calculation of Cost per unit

Total Process Cost / Expected Normal Output

= 47,060 (-) 20 / 3,920
= 47,040 / 3,920
=Rs. 12 per unit
 Solution: Process A Account
Particulars Units Amount Particulars Units Amount
(Rs.) (Rs.)
To Units 4,000 13,560 By Normal 80 20
Introduced Wastage
To Material 12,000 By Abnormal 70 840
Wastage @ Rs.12
per unit
To Direct Labour 16,000 By Process B 3,850 46,200
(output transferred
@ Rs. 12 per unit ,
Rs. 47,040 / 3,920,
normal out put)
To Manufacturing 2,000
Expense
To Other Factory 3,500
Expenses
4,000 47,060 4,000 47,060
W/N 4 : Calculation of Normal Loss
4 % of the units introduced in process B
i.e.
4 % 3,850 units = 154 units

W/N 5 : Calculation of Abnormal Loss in process B

Total Units Introduced 3,850
(-) Normal Loss (4%) 154
Expected Normal Output 3,696
(-) Actual output of Process A 3,600
Abnormal Loss 96 units
 Process B Account
Particulars Units Amount Particulars Units Amount
(Rs.) (Rs.)
To Process A 3,850 46,200 By Normal 154 77
Wastage
To Material 10,000 By Abnormal 96 1,728
Wastage @ Rs.18
per unit
To Direct Labour 5,000 By Process C 3,600 64,800
(output transferred
@ Rs. 18 per unit ,
Rs. 66,528 / 3,696,
normal out put)

To Manufacturing 3,400
Expense
To Other Factory
Expenses 2,005
3,850 66,605 3,850 66,605
 Process C Account

Particulars Units Amount Particulars Units Amount

(Rs.) (Rs.)
To Process B 3,600 64,800 By Normal Wastage 90 54
To Material 9,000 By Abnormal 10 240
Wastage @ Rs.24
per unit
To Direct Labour 4,900 By Finished Stock 3,500 84,000
(output transferred
@ Rs. 24 per unit ,
Rs. 84,240 / 3,510,
normal out put)
To Manufacturing 3,590
Expense
To Other Factory
Expenses 2,004
3,600 84,294 3,600 84,294

Selling price per unit is Rs.30 (24 + 6)

THANK YOU