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    What Is Process Costing

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    PAUL TIMMY
    The document discusses two costing methods: 1. Process costing assigns costs to individual production processes and calculates a per-unit cost for each process. It is commonly used in industries like manufacturing. 2. Absorption costing treats all production costs, including direct, variable, and fixed overhead costs, as costs of the product. It calculates a full unit cost that includes all costs of production. While it complies with accounting standards, it can overstate costs when fixed overhead is high and production is low.

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    What Is Process Costing

    Uploaded by

    PAUL TIMMY
    57 views12 pages
    The document discusses two costing methods: 1. Process costing assigns costs to individual production processes and calculates a per-unit cost for each process. It is commonly used in industries like manufacturing. 2. Absorption costing treats all production costs, including direct, variable, and fixed overhead costs, as costs of the product. It calculates a full unit cost that includes all costs of production. While it complies with accounting standards, it can overstate costs when fixed overhead is high and production is low.

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    The document discusses two costing methods: 1. Process costing assigns costs to individual production processes and calculates a per-unit cost for each process. It is commonly used in industries like manufacturing. 2. Absorption costing treats all production costs, including direct, variable, and fixed overhead costs, as costs of the product. It calculates a full unit cost that includes all costs of production. While it complies with accounting standards, it can overstate costs when fixed overhead is high and production is low.

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    57 views12 pages

    What Is Process Costing

    Uploaded by

    PAUL TIMMY
    The document discusses two costing methods: 1. Process costing assigns costs to individual production processes and calculates a per-unit cost for each process. It is commonly used in industries like manufacturing. 2. Absorption costing treats all production costs, including direct, variable, and fixed overhead costs, as costs of the product. It calculates a full unit cost that includes all costs of production. While it complies with accounting standards, it can overstate costs when fixed overhead is high and production is low.

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    of 12

    KADUNA STATE UNIVERSITY

    FACULTY OF SOCIAL MANAGEMENT SCIENCES


    DEPARTMENT OF ACCOUNTING

    PGD IN ACCOUNTING

    COURSE CODE: PDA711


    COURSE TITLE:
    COST AND MANAGEMENT ACCOUNTING

    ASSIGNMENT

    BY

    IBRAHIM SULEIMAN TSADU


    KASU/PGD/ACC/20/0018

    QUESTION:

    Discuss process Costing & Absorption costing with clear examples and
    distinctive features of each process and absorption with adequate reference.

    JANUARY, 2021

    0
    What is Process Costing?

    Process costing is method of costing wherein the products go through two


    or more processes and the costs are assigned/charged to individual
    processes or operations which is averaged over the number of units
    produced during the said period. It is used commonly in manufacturing
    units like paper, steel, soaps, medicines, vegetable oils, paints, rubber,
    chemical, etc. use this method widely.

    A product may be manufactured through one process or more than one


    processes. In case two or more processes are involved in manufacturing
    one finished product, the question arises is “which process has consumed
    the expense?” The answer lies within process costing. It helps identify the
    specific cost assigned to each process. It enables the management for
    further decision making.

    Types of Process Costing

    Weighted Average Method of Process Costing

    Here the actual cost is divided by the weighted average of products


    produced during the year. This calculation is simple as compared to any
    other method. A weighted average of units means the summation of the
    product of the rate and quantity of each item.

    Standard Cost

    Here the actual cost of units is not considered; instead, it follows


    a standard costing method. Standard cost assumes the cost of certain
    materials as per management estimate. Any difference in standard &
    actual costs is recorded separately under variance account.

    First-In-First-Out

    This method assigns the expense of first inputs to the processes in the
    order of production. It does not precisely identify as to which a lot of raw
    material is taken for production and its procurement rate.

    1
    Steps of Process Costing

    Step#1 – Record of Inventory

    This step involves the identification of inventory at the end of each


    process. The organisation can identify such inventory either by physically
    counting the units or through a software inbuilt in the manufacturing
    process. The costs of inventory under each process are also identified at
    this change.

    Step #2 – Conversion of Work in Process Inventory

    Apply the percentage of completion to the units which are under any


    process & not yet completed the production. Say 80,000 units of soaps
    are under process & these are 60% completed. Then the equivalent
    completed units are 80,000*60% i.e. 48,000 units.

    Step #3 – Calculation of Inventory Costs

    Here, the organisation calculates the direct cost and indirect


    costs incurred by the plant in the production phase. These costs are
    accumulated from the first process to the last process. The said is then
    bifurcated into an inventory of complete products & inventory of products
    which are under process.

    Step #4 – Calculation of Per-Unit Cost of Inventory

    We calculate this by dividing the total cost by equivalent completed units


    in the production phase. The cost per unit calculated here reflects the cost
    of only completed units. The basis of equivalent units can be the weighted
    average, standard cost or first-in-first-out inventory method.

    Step #5 – Allocation of Costs

    The per-unit costs are then split according to the number of units
    completed & units which are under process.

    2
    Examples of Process Costing

    The entity has provided the following information & wants to calculate the
    cost involved in each manufacturing step. Also, it intends to calculate the
    value of closing inventory.

    Solution:

    3
    Features

     Each plant is divided into several processes/centres. Each such


    division is a stage of production or process. Thus, we first clearly
    identify the cost centres.
     Direct & indirect costs assigned and accumulated to each process in
    the factory.
     The output of one process may become input for another process.
     The finished products are identical & cannot be easily distinguished
    unless batch coding is done.
     The production process is continuous for all days in the year except
    regular breakdown hours required during the year for maintenance
    of the machinery.

    4
     The total cost of production is divided among each process on a
    suitable basis.
     The company requires to keep records for each production process,
    such as units or costs introduced in each process and passed on to
    the next stage of production.
     The production may result in joint-products or by-products.

    Conclusion

    Process cost allows an organisation to assigns the cost to different steps


    in the production phase. It helps management in decision making. The
    organisation can use this method to identify the relevant costs (i.e. direct
    and indirect costs) for each process and no abnormal expenses are
    charged to any process.

    Absorption Costing

    Definition:

    Absorption costing is linking all production costs to the cost unit to


    calculate a full cost per unit of inventories. This costing method treats all
    production costs as costs of the product regardless of fixed cost or
    variance cost. It is sometimes called the full costing method because it
    includes all costs to get a cost unit. Those costs include direct costs,
    variable overhead costs, and fixed overhead costs.

    This article will discuss not only the definition of absorption costing, but
    we will also discuss the formula, calculation, example, advantages, and
    disadvantages.

    To get a better understanding, we start with the normal selling price


    method. To get the selling price, we come up with the formula like:

    Cost + Profit = Selling Price

    And the cost can be determined in many ways such as:

     Production cost + Non Production Cost = Total Cost

    5
     Direct Cost + Indirect Cost = Total Cost

     Prime Cost + Overhead = Total Cost

     Fixed Cost + Variable Cost = Total Cost

     Price ( Rate) * Quantity = Total Cost

    Now, let see the formula of absorption costing,

    Absorption Costing Formula:

    In absorption costing,

    Unit Costs of Product = Direct Cost + Production Overhead Cost

     Direct Cost = Direct Material + Direct Labor

     Production Overhead Cost = Variable Manufacturing Overhead +


    Fixed Manufacturing Overhead.

    Maybe calculating the Production Overhead Cost is the most difficult part
    of the absorption costing method. The following is the step-by-step
    calculation and explanation of absorbed overhead in applying to
    Absorption Costing.

    Advantages:

    Absorption costing is normally used in the production industry here it


    helps the company to calculate the cost of products so that they could
    better calculate the price as well as control the costs of products.

    As long as the company could correctly and accurately calculate the cost,
    there is a high chance that the company could make the correct pricing
    for its products. This is the best competitive advantage for most of the
    company.

    Here are the key advantages of absorption costing that you should know:

     Absorption costing is the costing method that allows or compliant


    with most of the accounting standards. These include US GAAP and

    6
    IFRS. As we all know, we need to make sure that the costing
    methods that we are using to calculate or measure the unit cost of
    inventories are per standards. Otherwise, we will have a problem
    with the valuation of inventories and subsequently affect the audit
    report’s opinion on our company’s financial statements.

     Absorption costing recognizes all of the production-related costs


    incurred in the productions costs. As you might note above, the
    fixed overhead costs are also included in calculating absorption
    costing. This helps the company ensure that all of the production-
    related costs incurred during the productions process are included in
    the unit cost of inventories.

     It also disregards the administrative cost when calculating the unit


    cost so that any cost incurred during the period. Still, it does not
    relate to production is not included in the calculation. So the
    company could avoid costing or overpricing its inventories or
    products.

    Disadvantages:

    Besides the advantages that we have discussed above, there is also has a
    certain drawback of absorption costing that we should be aware of. Now,
    let discuss the key disadvantages of absorption costing:

     It might not be the best method when it comes to decision-making


    if the company use absorption costing. As you might see from the
    above formula, let us explain fixed manufacturing overhead to
    calculate the cost per unit of inventories. Certain fixed overhead
    costs like factory rental are still incurred even though there are no
    productions and the highest rental costs. There is no production in
    some cases, but the fixed overhead costs are incurred, then the unit
    cost could be overstated. This leads to over costing of inventories
    and overpricing of the products.

    7
     Following the above point, when fixed overhead costs overstate the
    unit costs of inventory, It might overstate the Inventories amount
    that records in the balance sheet at the end of the period or year.
    Then, the significant adjustment might need to be performed to
    reduce inventories’ value to their net realizable value. The
    company’s profit might also be overstated by the amount of fixed
    overhead costs allocated to inventories, but those inventories are
    still not selling yet.

    Example of Absorption Costing

    Company A is a manufacturer and seller of a single product. In 2016, the


    company reported the following costs:

    Variable costs per unit:

     Direct materials cost: $25

     Direct labor cost: $20

     Variable manufacturing overhead cost: $10

     Variable selling and administrative cost: $5

    Fixed costs:

     Fixed manufacturing overhead of $300,000

     Fixed selling and administrative of $200,000

    Over the year, the company sold 50,000 units and produced 60,000 units,
    with a unit selling price of $100 per unit.

    8
    Using the absorption method of costing, the unit product cost is calculated
    as follows:

    Direct materials + Direct labor + Variable overhead + Fixed


    manufacturing overhead allocated = $25 + $20 + $10 + $300,000 /
    60,000 units = $60 unit product cost under absorption costing

    Recall that selling and administrative costs (fixed and variable) are
    considered period costs and are expensed in the period occurred. Those
    costs are not included in the product costs.

    9
    References

    Dennis C. Zane & Daddy Octa (2009,2000,1992). Modern Cost


    Management and Analysis 3rd Ed. Barron's Education Series, Inc.
    ISBN 978-0-7641-4103-4.
    Bhabatosh Banerjee. Cost Accounting Theory And Practice 12Th Ed.
    Garrison, Ray H; Noreen, Eric W; Brewer, Peter C (2012). Managerial
    Accounting (14th ed.). McGraw-Hill.
    Burgstahler, D., Horngren, C., Schatzberg, J., Stratton, W., & Sundem, G.
    (2008). Introduction to Management Accounting, 14th ed. Upper
    Saddle River: Prentice Hall. Chapters 4 & 13.
    Drury, C. (2008). Management and Cost Accounting, 7th ed. London:
    South‐Western Cengage Learning. Chapters 7 & 10.
    Horngren, C. T., Datar, S. M., Foster, G., Raian, M. & Ittner, C. (2009).
    Cost Accounting: A Managerial Emphasis, 13th ed. Upper Saddle
    River: Prentice Hall. Chapters 5 & 9.
    Lucey, T. (2009). Costing, 7th ed. London: South‐Western Cengage
    Learning. Chapter 19.

    10
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