PROCESS COSTING

Process costing is probably the most widely used method of cost ascertainment. It
is used in mass production industries producing standard products, like steel,
sugar and chemicals.
ESSENTIAL CHARACTERISTICS OF
PROCESS COSTING
1. The production is continuous and the final product is the result of a sequence
of processes.

2. Costs are accumulated process-wise.

3. The products are standardized and homogeneous.

4. The cost per unit produced is the average cost which is calculated by dividing the
total process cost by the number of units produced.
5. The finished product of each but last process becomes the raw material for the
next process in sequence and that of the last process is transferred to the finished
goods stock.

6. The sequence of operations or processes is specific and predetermined.

7. Some loss of materials in processes (due to chemical action, evaporation,

etc.) is unavoidable.
8. Processing of a raw materials may give rise to the production of several products.
These several products produced from the same raw material may be termed as
joint products or by-products.
PROCESS COSTING AND JOB
COSTING— A COMPARISON
PROCESS COSTING PROCEDURE

The factory is divided into a The finished output of the last

number of processes and an process (i.e., the final product) is
account is maintained for each transferred to the Finished Goods
process. Account.

The output of a process is

Each process account is debited
transferred to the next process in
with material cost, labour cost,
the sequence. In other words,
direct expenses and overheads
finished output of one process
allocated or apportioned to the
becomes input of the next
process.
process.
PROCESS COSTING PROCEDURE
 PROCESS LOSSES AND WASTAGES
In industries which employ process costing, a certain amount of loss occurs at
various stages of production. It is, therefore, necessary to keep accurate records
of both input and output.

Process losses may by classified into (a) normal, and (b) abnormal.

Normal Process Loss

• That amount of loss which cannot be avoided because of the nature of

material or process is normal process loss. Such a loss is quite expected under
normal conditions. It is caused by factors, like chemical change,
evaporation, withdrawals for tests or sampling and unavoidable spoiled
quantities

Abnormal Process Loss

• This type of loss consists of loss due to carelessness, machine breakdown,

accident, use of defective materials, etc. Thus, it arises due to abnormal
factors and represents a loss which is over and above the normal loss.
 ACCOUNTING TREATMENT OF
NORMAL AND ABNORMAL LOSS
Accounting Treatment of Normal Loss
Normal loss is generally determined as a percentage of input. Such a wastage is not
physically present, obviously it cannot have any value. However, when normal loss is
physically present in the form of scrap, it may have some value, which is credited to the
Process Account.

Accounting Treatment of Abnormal Process Loss

(a) Allow for normal loss in the manner described earlier.
(b) After considering normal loss, find out the cost per unit in that process.
Cost per unit=(Total cost-Value of normal loss)/Units introduced-Normal loss
units
(c) Multiply the cost per unit by the number of units of abnormal loss. This gives the total
value of abnormal loss.
(d) Credit relevant Process Account with quantity(value) of abnormal loss.
(e) The balance figure in the Process Account is the cost of good units produced in the
process. This can also be found by multiplying cost per unit with the number of good
units produced.
(f) Open ‘Abnormal Loss Account’ and debit it with the quantity and value of abnormal
loss shown in the Process Account. Sale proceeds from abnormal loss are credited to
Abnormal Loss Account. Any balance left in this account is net loss and transferred to
Costing P&L Account.
ABNORMAL GAIN OR EFFECTIVENESS
The normal process loss represents the loss that would be expected under normal
conditions. It is an estimated figure.

The actual loss may be greater or less than the normal loss. If the actual loss is greater
than normal loss, it is known as abnormal loss.

But if actual loss is less than normal loss, a gain is obtained which is termed as
abnormal gain or effectiveness.

The value of abnormal gain is calculated in a manner similar to abnormal loss.

It is shown on the debit side of the Process Account and credit side of the Abnormal Gain
Account. Like abnormal loss, it is ultimately transferred to Costing Profit and Loss
Account.
WHEN OUTPUT OF IS PARTLY SOLD AND
PARTLY TRANSFERRED TO THE NEXT
PROCESS
Sometimes the output of a process may be partly sold and partly transferred to
the next process for further processing.

For example, in a textile mill, part of the output of a spinning process may be
sold and the remaining output is passed on to the weaving process for further
processing.

A part of the output so sold will contain an element of profit or loss which will
be revealed in the Process Account. But when a part of the output is sent to
warehouse for sale, it is at cost and does not contain an element of profit or loss.
 WORK-IN-PROGRESS
(EQUIVALENT PRODUCTION )
Process costing mainly deals with continuous type of production. At the end
of the accounting period, there may be some work-in-progress, i.e., semi-
finished goods may be in the pipeline. The valuation of such work-in-progress is
done in terms of equivalent or effective production.

Equivalent Production
Equivalent production represents the production of a process in terms of
completed units. Work-in-progress at the end of an accounting period are
converted into equivalent completed units.
 EVALUATION OF EQUIVALENT
PRODUCTION
Ascertain the cost per
Find out the total cost unit of equivalent
(net) for each element production separately
At this rate of cost per
of cost, i.e., material, for each element of cost.
unit, ascertain the value
labour and overheads. This is done by dividing
of finished production
Scrap value of normal the total cost of each
and work-in-progress.
loss is deducted from element by the
the material cost. respective number of
equivalent units.

For the purpose of computation of equivalent production and its evaluation, the
following three statements are generally prepared:
(a) Statement of equivalent production
(b) Statement of cost (per unit)
(c) Statement of evaluation
These three statements may also be combined in one comprehensive statement called
‘Statement of Production, Cost and Evaluation.’
EQUIVALENT PRODUCTION
When there is no opening stock and no process loss

Normal Loss-Equivalent units of normal loss are taken as nil. In

other words, normal loss is not added in the equivalent production.
However, realizable value of normal scrap is deducted from the cost of
material so as to calculate the net material cost. This net material
cost becomes the basis of calculating the material cost per unit in the
statement of cost.

Abnormal Loss-This is treated as if this were good production lost.

Abnormal loss, thus, is added to equivalent production with due
consideration to its degree of completion. Unless the degree of
completion is specified, it may be assumed that abnormal loss units are
100% complete in respect of all elements of cost.

Abnormal Gain-Units of abnormal gain are represented by good

finished production. It is therefore, always taken as 100% complete in
respect of all elements of cost, i.e., material, labour and overheads.
Abnormal gain is deducted to obtain equivalent production.
EQUIVALENT PRODUCTION(CONTD.)
When there is opening as well as closing stock of work-in-progress
In such a case there are two methods of calculating equivalent production:
1. FIFO: This method is based on the assumption that work-in-progress moves on a first-
in-first out basis. This means that unfinished work on the opening stock is completed first,
before work on any new units is taken up.

Computation of Equivalent Production under FIFO Method.

• State the opening stock of work-in-progress in equivalent completed units. This is done by
applying the percentage of work needed to complete the unfinished work of the previous
1 period.

• Ascertain the number of units introduced into the process and deduct the number of units of
closing work-in-progress. This gives the number of units started and completed during the
2 period. Add these units to the opening stock of work-in-progress calculated in (i) above.

• Add to the above the equivalent completed unit of closing work-in-progress. This can be
determined by applying the percentage of work done on the finished units at the end of the
3 period.
 EQUIVALENT
PRODUCTION(CONTD.)
2. Average Cost Method
 In this method, the cost of opening work-in-progress is not kept separately but is averaged
with the additional costs incurred during the period. This method thus combines the cost of
opening work-in-progress and new production. Information relating to degree of
completion of opening WIP is not required.
 In order to find out the cost per unit of equivalent production, the cost of each element
(material, labour and overheads) applicable to the opening work-in-progress is added to the
cost incurred in the current period for that element.
 A single cumulative total and unit cost is obtained. Units completed and transferred as
well as closing work-in-progress will be valued at this average unit cost.
HOW TO CHOOSE BETWEEN FIFO
AND AVERAGE METHOD
Use Average - If the cost
Use FIFO - If the cost of
of opening work-in-
the opening work-in-
progress is given in terms
progress in one lump sum
of materials, labour and
figure and the stage of
overhead but the stage of
completion is given.
completion is not given.

FIFO or Average-Your
Choice - If the degree of
completion and the cost in Where the question
terms of materials, labour specifies a method to be
and overheads of the followed, then that
opening work-in-progress method must be
are given, then one has a followed.
choice between FIFO and
Average methods.
 INTERNAL PROCESS PROFITS
(INTER-PROCESS PROFITS)
In some businesses, it is a practice to charge the output of each process to the next process
not at cost but at a price showing profit to the transferor process. The transfer price may be
either the current market price or cost plus a fixed percentage.

In brief, the objects of such internal process profit are:

(c) To assist in making decisions,

(a) To show whether the such as to buy a partly-processed
(b) To make each
cost in each process material rather than to process
process stand on its own
competes with the work internally or to sell a partly-
efficiency and economy.
market prices. processed product or to process it
further.