Process costing: definition; specific objectives; types of process costing; principles; characteristics; element of process costing;
1.1 Introduction
Definition; Process costing is an operation costing approach used to assign cost on standardized homogenous goods which are being produced. It is a costing method applicable in industries such as chemical, textiles, steel, rubber, sugar, shoes, petrol etc.
NB: That process costing is an output costing method whose main objective of accumulating costs is to determine the average cost or cost per unit at the end of a certain period. So, the basic activities that the producer or manufacturer undertakes is to do cost ascertainment per unit of a single product in a continuous manufacturing activity. The per unit cost is computed by dividing total production cost by the number of units manufactured.
1.2 Objectives of Process Costing Method
The specific objectives of process costing method which is the universe of output/unit costing, is as follows;
1). To establish the total cost pertaining a particular product within a specific time horizon and then further determine the cost per unit thereof. Also referred to as Average Cost (AC)
2). To ascertain profitability level of every unit of a product produced or manufactured at the end of the period.
3). To assess the total cost of a production process by analyzing and classifying the cost elements as explained in Cost Accounting discipline.
4). To undertake the management role of cost control by comparing the cost of one period with the cost of another period to know the operational efficiency or otherwise of the production activities.
Types of process costing
Under process costing, there are three ways in which valuation of produced units are done or assigned cost.
2.1 Process costing for (a) A single product
Process costing for a single product is a method of costing one main product at the end of the process of production. In this case, there are no cases of co-products or by-products.
2.2 Process costing for two Products
Process costing for two products is a method of costing where by two categories of products emerges at the end of the production process. The two products that arise may either be both main products or one main product accompanied by a by-product.
2.2.1 Joint Products
Joint products are two goods produced under the same production process with the same class or category/class of being main products as far as economic value (i.e., monetary value) is concerned. Such that, before the split off point is reached, the input for the two products is the same. But after split off point, the additional cost may vary although in the overall, the economic value is equal for the two products.
The point here is that, the two products produced at the end are both main products as far as the aforementioned economic aspect is concerned. For example, diesel, petrol and jet fuel. They are all produced using oil refinery process.
2.2.2 By-Products
By-products are two goods of different class or category/class where by one is a main product while the second product is of minor category/class as far as economic value (i.e., monetary value) is concerned. Such that, before the split off point is reached, the input for the two products is the same. But after split off point, the additional cost may vary resulting to one product having more economic value as compared to the other product.
The point here is that, the two products produced at the end are not of the same economic (i.e., monetary value) for one is a main product and the second product is a minor one as far as the aforementioned economic aspect is concerned. For example, manufacture of timber products such as chairs and tables which is a main product while saw dust is a by-product.
NB: That, the by-product can be saleable or a truly a waste. Hence, the manufacturing firm cannot realize any economic value/price from it. It is a waste product.
Principles of process costing method
3.1 Introduction
Process costing is guided by some specific rules and regulations which make it functional. These are as discussed below;
3.2 Principles
1). Most of the cost items ordinarily are identified with specific processes and in return collected and accumulated separately for each period.
2). Records are kept to portray the activities that earmark the specific process every period production is taking place.
3). Cost per unit in every stage or process entails summation of the total cost for that particular process level and divided with the total production.
4). Normal loss is always absorbed in actual cost of production if and only is the units associated with normal loss are not sold or disposed.
Characteristics of process costing method
4.1 Introduction
The following are some of the characteristics that dominate process costing method. They include;
1). Production process is a continuous one such that before a product is finalized, it passes through two or more stages.
2). Uniformity in product design. That is all the products are the same in most of the features
3). Standardized process is what dominates the process costing.
4). The output on one process is the input of the next process. For example, the output or end results of process one becomes the input of process two. This trend continues until the final stage when the complete product is taken to the stores.
5). The final product at the last processing stage translates to goods being taken to stores.
6). Each process stage is dominated by the direct material cost, direct labor
Elements of process costing method and accounting treatment
5.1 Introduction
The following are the various elements used in process costing and how they are treated in the books of accounting under process costing.
5.2 Materials
Definition: Materials are inputs that are used to create a final product after conversion process has taken place. The materials may assume two forms. One, initial materials and second the additional materials.
5.2.1 Initial material
Initial materials are the starting materials that are inserted in process one. They are the materials which take the biggest percentage of the product being created or produced. Initial materials are always introduced in level one of the processes and are said to be 100% complete when it comes to the level of completion as far as work in progress is concerned.
5.2.2 Additional Materials
Additional materials are the second round or third round or the nth round type of materials that are added to an already existing material (initial material).
They are introduced in the second or third or nth level of the production process. These materials can be assuming either 100 or less than 100% level of completion when it comes to inventory of work in progress.
5.2.3 Accounting Entries for Material Cost:
5.3 Labor
Definition: Labor is the production input which converts the raw materials in to finished or semi-finished product. In fact, labor is a conversion cost. It can either take the form of skilled, semi-skilled or unskilled labor force. If the process of production or conversion process of the raw materials is dominated more by labor force as compared to capital goods (automated process), then this kind of technology is said to be labor intensive. Similarly, if the production process is more of capital goods used in production (automated) then we say the technology is less labor intensive.
5.3.1 Accounting Entries for Labor cost
5.4 Direct Expenses
Definition: Direct expense is economic resources which are direct inputs on the materials being used to produce the final product. Such as packaging materials etc.
5.4.1 Accounting Entries for Direct Expense:
5.5 Production Overhead (O/H)
Definition: Production overhead is indirect expenses which is incurred in the factory but it is not directly part of the physical product. When it is paid, it is charged to the correct ledger account. For example, factory repair and maintenance and depreciation of factory plants and equipment.
5.5.1 Accounting Entries for Direct Expense:
Process accounts-a case of single product
6.1 Introduction
How do we prepare process accounts for a single product case? This task is always tricky to most learners and it is not easy to successfully prepare the respective accounts. The following procedures will aid you on how to prepare such accounts where by the process involves production of one main product. We will undertake a step-by-step approach to demonstrate how to prepare such accounts starting with simple to complex illustrations. In this article, the focus is on the process costing cases without loss and gains; process costing with normal loss only; process costing with abnormal loss and lastly a case of process costing with abnormal gain. To achieve this goal, each aspect is discussed in a summative manner.
6.2 Process costing account for single product with no loss or gain
A process account where there are no cases of normal loss, abnormal loss and abnormal gain is easy to prepare. This is because there are no technical computations to be undertaken. Again, this scenario is not easy to get or experience for most of the times there must occur some losses due to unavoidable circumstances.
6.3 Process costing account for a single product with normal loss
Introduction: What do you understand by this term, normal loss?
Sometimes process costing for a single product is dominated by a situation whereby the normal loss equals the actual loss incurred at the end of the production process. In this case, no abnormal loss or abnormal gain at the end of the production process.
Again, this scenario is a rare one for there is no much coincidence where by the normal loss computed at the beginning of production process will ever automatically equal the actual loss. The details on the terms used and the accounting treatment of normal loss and other concepts are found in our article on “process costing account for a single product with normal loss”.
6.4 Process costing account for a single product with abnormal loss
Introduction: What do you understand by this term, Abnormal loss?
The concept of abnormal loss is very common in production processes. Most of the times, the actual loss exceeds the normal or computed loss at the beginning of the production process. The details of process costing account for a single product with abnormal loss is explained in the respective article.
6.4.1 Accounting Treatment of Abnormal Loss
There are twofold ways of treating abnormal loss
i). Case one, you maintain a corresponding Abnormal loss account in the books of account of the business which later is closed to profit and loss account
ii). Case two, involves off-setting of the scrap value of the abnormal loss units against the Scrap-Debtor Account to reduce the scrap income.
6.5 Process costing account for a single product with abnormal gain
Introduction: What do you understand by this term, Abnormal gain?
The concept of abnormal gain is very common in production processes. Most of the times, the actual loss is less than the normal or computed loss at the beginning of the production process. The details of process costing account for a single product with abnormal gain is explained in the respective article.
Difference between abnormal loss and abnormal gain
7.1 Introduction
As a learner, how can you differentiate between abnormal loss and abnormal gain cases? There is always confusion on how to identify the differences between the two concepts which almost look the same in every way. These are the differences;
Difference between normal loss and abnormal loss
8.1 Introduction
As a learner, how can you differentiate between normal loss and abnormal loss cases? There is always confusion on how to identify the differences between the two concepts which almost look the same in every way. This is the differences
Process accounts for a single product -with work in progress (wip)
9.1 Introduction
It is only in an ideal situation where all materials are fully used to produce complete units of a product. But in reality, when production process starts, there are many cases where the producer will experience availability of some unused raw materials either in the beginning or at the end of the year or both. On the same breath, output can either be complete or partially finished.
So, as a result of this technicalities, the aspect of WIP is pivotal in this discussion. The summarized terms are commonly used in WIP concept. The list is as indicated in 9.2
9.2. Terms used in Work in Progress (WIP)
The following terms are commonly used in this thematic matter.
9.2.1 Equivalent Units
9.2.2 Logic behind Equivalent Units
9.2.3 Total Equivalent Production
9.2.4 Cost per Unit
9.2.5 Input Materials
9.2.6 Additional Input Materials
The details on the terms used and the accounting treatment of WIP and other concepts are found in our article on “process accounts for a single product-with work in progress (WIP)”. Click the corresponding sub-title above to access the details.
Process accounts for a single product with work in progress (wip)
10.1 Introduction
This refers to the physical assigning of the monetary value of the closing WIP inventory. This objective can be achieved by use of different valuation methods which may include and not limited to;
a). First in First Out method.
b). Average cost method.
10.2 Statement of Cost
This is a statement that is used in cost accounting to express the cumulative cost as per inputs used, equivalent units and cost per unit. The format is as shown below.
Required
Calculate
i). The total equivalent units
ii). The cost per complete unit
iii). The total cost for the 1,600 units
iv). The total cost of Work in Progress (WIP).
Solution
Workings
Computation of equivalent units
11.1 Introduction
There are various methods of computing EQ units. The common ones are Fist in First Out (FIFO) and average method.
Process costing-a case of joint products
12.1 Introduction
Under process costing, there are three ways in which valuation of produced units are valued or assigned cost as indicated in our process costing article. In this article, the focus is on joint products
12.2 Joint Products
Definition: Joint products are two or more services or goods which are produced together as defined in our process costing-case of joint product article.
12.3 Joint Product Cost Apportionment Methods
There are THREE main methods which can be used to apportion the costs as explained in our articles. Namely;
i). Physical unit Basis
ii). Sales Value Basis
iii). Sales Value Less Post Separation Cost Basis
Process costing-a case of by-products
13.1 Introduction
By-product process costing involves a case of a main and minor products being realized at the end of a production process. The reliable definition and examples of this type of production process are found in “process costing-a case of by-product article.”
13.2 Accounting Treatment of By-Products
How to account for transactions involving a by-product is pegged on four key bases. Namely;
i). By-product has a small saleable value.
ii). Sales proceeds from a by-product is reasonably more.
iii). Sales value of the by-product is almost equivalent to the main product sales value
iv). Sales value of the by-product is the same or relative more than the main product.
