CHAPTER 3: PROCESS COSTING

• Process costing is one of the two widely used cost accumulation procedures that are used when products are manufactured under
conditions of continuous processing or under mass production methods.
• Process costing is a method for assigning product costs to units of product when all units of product are virtually the same.
• Products are completed in a short time, and costs for a single period can be averaged over the number of units produced. These
conditions exist in industries that produce such products as plastics, textiles, petroleum, steel, sugar, drugs, etc.
• With process costing, costs are not traced to unit of product. Instead, all production costs (unit-level and otherwise) are
assigned or allocated based on total production costs and total units produced.
• Job costing and process costing differ in the way costs are assigned, and they differ because of differences in product
characteristics. With job costing, many costs are traceable to jobs or can be assigned to specific jobs using cost-driver rates.
• For products in a process costing environment, all costs must be assigned using a cost-driver approach. They key difference is
that the only cost-driver is the actual number of units produced.
In general, process costing is used;
• In homogeneous products
• In continuous processing
• In mass production techniques
• Process costing is most commonly used in industries that produce essentially homogeneous (e.g. uniform) products on a
continuous basis.
• Firms producing distinct and unique products use job order costing where as firms producing similar or identical units
use process-costing system.
• Process costing system accumulate costs by department for a period of time, just as a job order costing system
accumulate costs by job, and the total cost then will be assigned to the units produced during that period.
Definition
According to I.C.M.A., London, “Process Costing is that form of operation costing, where standardized goods are produced.”
Characteristic/Features of Process Costing
• Production is continuous, in a series of stages called processes.
• Each process is deemed as a cost centre and costs are accumulated for each process separately along with output
finished and in progress.
• Products and processes are standardized.
• The output of one process becomes the raw material to the next process, usually till the final product is completed.
• The cost of the previous process is transferred to the next process along with the output. Sometimes, the transfer may
be at a transfer price inclusive of profit.
• There may be process losses of the input. They may be normal or abnormal or both.
• Completed and semi finished outputs have to be expressed in common terms for cost determination.
• Since production is of identical units, the total cost of a process is divided with the units of output to obtain average cost
per unit.
• Two or more products may be produced unavoidably in the same process. They may be of equal importance or of
disproportionate values.
• It is not possible or necessary to trace or identify specific lots of material inputs with products or output.
Advantages of Process Costing:
• Cost of each process and that of the finished product can be computed at short intervals, weekly or daily.
• Cost control and control over production are more effective because of uniform output and usage of predetermined costs as
budgeted or standard costs.
• Cost ascertainment is simple and less expensive.
• Average cost per unit can easily be obtained.
• Indirect expenses can be apportioned and allocated more accurately and reliable data can be obtained.
• Valuation of inventories is easier and accurate.
• Quotations become easier due to standardized processes.
Disadvantages:
• Costs obtained at the end of processes are historical costs and their utility for cost control and managerial decision-making
is not significant.
• Inefficiencies in processes can be concealed.
• Later processes may be adversely affected due to the inefficiency of earlier processes.
• Evaluating the efficiency of individual workers or supervisors is difficult.
• Apportionment of joint costs to common products may lead to irrational pricing decisions.
Similarities between Job Order & Process Costing
• The same basic purposes exit in both systems, which are to assign material, labor, and overhead cost to products and to
provide a mechanism for computing unit costs.
• Both systems maintain and use the same basic manufacturing accounts, including MO, Raw Materials, Work-in-Process,
and Finished Goods.
• The flow of costs through the manufacturing accounts is basically the same in both systems.
Differences between Job-Order & Process costing
S.no Job-Order Costing Process Costing
1 Many different jobs are worked on during each period, A single product is produced either on a continuous basis for
with each job having different production requirements. long periods of time. All units of product are identical.
2 Costs are accumulated by identical job. Costs are accumulated by department.
3 The job cost sheet is the key document controlling the The department production report is the key document showing
accumulation of costs by a job. the accumulation and disposition of costs by a department.
4 Unit costs are computed by job on the job cost sheet. Unit costs are computed by department on the department
production report.
• In manufacturing process costing setting, each unit is assumed to receive the same amount of direct materials cost,
direct manufacturing labor costs, and indirect manufacturing costs. Units are computed by dividing total costs by
the number of units.
• The principal difference between process costing and job costing is the extent of averaging used to compute unit
costs of products or services. In job-costing system, individual jobs use different quantities of production
resources. Thus, it would be incorrect to cost each job at the same average production cost.
• In contrast, when identical or similar units of products or services are mass produced, and not processed as
individual jobs, process costing averages production costs over all units produced.
The difference between job order and process costing system is, thus, the extent of the averaging used to compute unit
cost. In job order costing each job differs in terms of material used, labor incurred, and manufacturing overhead.
Hence, it is impossible to assign the same cost for different jobs. On the contrary, identical units produced in mass took
equal amount of direct material, direct labor, and manufacturing overhead. Thus, the unit cost can be found by dividing
total cot by the number of units produced.
There are three cases in process costing that will be considered in section.
Case 1: Process costing with zero beginning and zero ending work-in-process inventories that is all units are
started and fully completed by the end of the accounting period.
Illustrating Process Costing
Haron Chemical Company makes different chemicals and uses process costing system to account for its operation. One
of its products, namely product A is produced in two processing departments: the Mixing Department and the Bottling
Department. Product A is marketed in one-liter bottles.
Part I: Mixing Department
In the mixing department, various ingredients are added at the start of the process and costs are accumulated in two
pools, one for direct material and another for the conversion costs. Direct material is added at the beginning of the
process and conversion costs are applied evenly throughout the process. Data for the first month of operation
(September of the mixing department is given below:
Physical Units, Costs and Stages of Completion
Beginning work in process 0 units
Started during the month 1,000 units
Completed during the month 1,000 units
Direct material costs Br. 80,000
Conversion costs Br. 40,000
Ending work in process 0 units
Total cost of production for the month is computed as follows:
Direct Material costs -------------------- 80,000
Conversion costs -------------------------- 40,000
Total cost ----------------------------------- 120,000
Unit cost
Direct material --------------------------- 80 (80,000/1000)
Conversion cost ------------------------- 40 (40,000/1000)
Total --------------------------------------- 120 (120,000/1000)
Case 2: Process Costing with zero beginning but some ending work in process inventory
Data for the second month of operation (October) of the Mixing Department is given below:
Physical Units, Costs and Stages of Completion
Beginning work in process 0 units
Started during the month 2,000 units
Completed during the month 800 units
Ending work in process (60% completed as to conversion cost) 1200 units
Direct material costs Br. 160,000
Conversion costs Br. 91,200
How should the Co. Calculate the cost of fully assembled units in and the cost of partially assembled units still in
process at the end of September?
Steps:
• Summarize the flow of physical units of output.
• Compute output in terms of equivalent units.
• Compute equivalent unit costs.
• Summarize total costs to account for.
• Assign total costs to unit’s completed and to units in ending work in process.
Step 1: summarize the flow of physical units of output (quantity schedule)
This schedule shows the physical flow of units into and out of departments. The total units to account for most equal to
the total units accounted for.
Step 2: Equivalent Units (EUs) Schedule:
Equivalent units are the number of units for which periodic manufacturing cost is incurred. Equivalent units equal the
total units completed plus incomplete unit restated in terms of completed units.
Step 3: Equivalent unit costs
This is computed by dividing costs incurred by the related equivalent units.
Step 4: Cost to Account for Schedule:
This schedule shows which costs are charged to or accumulated by the department. Unit costs broken down by the cost
elements are also presented in this section.
Step 5: Assign total costs to unit are completed and to units in ending work in process
This schedule shows the distribution of accumulated costs to units completed & transferred and to units still in process.
The total cost to account for must equal to the total cost accounted for. Usually process costing system is illustrated
under three cases. These cases are:

Physical units & Equivalent units (Step 1 & 2)

Step – 1 Step – 2 equivalent units
Flow of production Physical units Direct Material Conversion costs
Beginning work in process 0 - -
Started during the month 2,000 units - -
Total units to account for 2,000 units - -
Completed during the month 800 800 800
Work in process ending 1,200 1,200 720
Total units accounted for 2,000 - -
Work done current period 2,000 1,520

Production cost report Total production cost Direct material cost Conversion cost
Costs added this period 251,200 Br. 160,000 Br. 91,200
Equivalent units 2,000 1,520
Equivalent unit cost (step -3) 80 60
Total cost to account for (st -4) 251,200 - -
Assignment of cost (step 5) - - -
Competed & transferred out 112,000 800*80 800*60
W/P ending: Direct material 96,000 1,200*80 -
Conversion cost 43,200 - 720*60
Total W/P ending 139,200 - -
Total cost accounted for 251,200 - -
Journal entries
W/P mixing department -------160,000
A/P ---------------------------------------- 160,000
W/P mixing department ------- 91,200
Various accounts -----------------------91,200
Case 3: Process costing with some beginning and some ending work in process inventory.
Data for the third month of operation (November) of the mixing department is given below:
 Beginning work in process 1,200 units
Started during the month 1,000 units
Completed during the month 1,600 units
Ending work in process (50% competed as to conversion costs) 600 units
Direct material costs Br.69,000
Conversion costs Br.70,800

Weighted-Average process costing method

This method calculates the equivalent unit cost of the work done to date (regardless of the period in which it was done)
and assigns this cost to equivalent units completed and transferred out of the process and to equivalent units in ending
work in process inventory.
The weighted average cost is the total of all costs entering in the work in process account (regardless of whether it is
from the beginning work in process or from work started during the period) divided by total equivalent units of work
done to date.
Using the weighted average method, the cost of partially and fully computed units can be computed as follows:
Step – 1 Step – 2 Equivalent units
Flow of production Physical units Direct material Conversion costs
Beginning work in process 1,200 - -
Started during the month 1,000 - -
Total units to account for 2,200 - -
Completed during the month 1,600 1,600 1,600
Work in process ending 600 600 300
Total units accounted for 2,200 - -
Work done to date - 2,200 1,900

Production cost report Total production cost Direct material cost Conversion cost
Beginning W/P Br. 139,200 Br. 96,000 Br. 43,200
Current period cost 139,800 69,000 70,800
Cost incurred to date - 165,000 114,000
Equivalent units - 2,200 1,900
Equivalent unit cost ( step – 3) - 75 60
Total cost to account for (st-4) 279,000 - -
Assignment of cost - - -
Competed & transferred out 216,000 1600*75 1600*60
W/P ending: direct material 45,000 600*75 -
Conversion 18,000 - 300*60
Total W/P ending 63,0000 - -

Journal entries
• W/p mixing department -------- 69,000
A/P --------------------------------------- 69,000
• W/P mixing department -------- 70,800
Various accounts --------------------- 70,800
• W/P mixing department ----------------- 216,000
W/P bottling department ---------------------- 216,000
First-in, First-out Method
• The FIFO process costing method assigns the cost of the previous periods equivalent units in beginning work-in
process inventory to the first units completed and transferred out of the process, and assigns the cost of equivalent
units worked on during the current period first to complete beginning inventory, then to start and complete new
units in ending work in process inventory.
• This method assumes that the earliest equivalent units in the work in process account are completed first.
• A distinct feature of the FIFO process-costing method is that work done on beginning inventory before the current
period is kept separate from work done in the current period.
• Costs incurred in the current period ad units produced in the current period are used to calculate costs per
equivalent unit of work done in the current period.
• In contrast equivalent unit and cost per equivalent unit calculations in the weighted average method mere the units
and costs in beginning inventory with units and costs of work done in the current period.

Using the FIFO method, the cost of partially and fully computed unit can be computed as follows:

Step – 1 Step – 2 Equivalent units

Flow of production Physical units Direct material Conversion costs
Beginning work in process 1,200 - -
Started during the month 1,000 - -
Total units to account for 2,200 - -
Completed during the month
From beginning 1,200 0 480
Started and completed 400 400 400
Work in process ending 600 600 300
Total units accounted for 2,200 - -
Work done only current period 1,000 1180

Production cost report Total production cost Direct material cost Conversion cost
Beginning W/P Br. 139,200 Br. 96,000 Br. 43,200*
Current period cost 139,800 69,000 70,800*
Work done only current period 1,000 1180
Equivalent unit cost (step – 3) - 69 60
Total cost to account for (st-4) 279,000 - -
Assignment of cost (step -5)
Completed:
From the beginning WIP
Cost in the beginning WIP 139,200
Cost to complete these units : - - -
Direct materials 0 0*69
Conversion costs 28,800 - 480*60
Total cost from beginning 168,000 - 400*60
Started and completed 51,600 400*69 300*60
Total completed & transferred out 219,600 - -
W/P ending: direct material 41,400 600*69
Conversion cost 18,000 - -
Total W/P ending 59,400 - -
Total cost account for 279,000 - -

Journal entries
• W/P mixing department --------------69,000
A/P --------------------------------------------- 69,000

• W/P mixing department -------------- 70,800

Various accounts --------------------------- 70,800
• W/P bottling department ------------ 219,600
W/P mixing department ---------------- 219,600
Transferred-in costs in Process Costing
• Transferred-in costs also called previous department costs are the costs incurred in a previous department that are
carried forward as the product’s cost when it moves to a subsequent process in the production cycle. That is as
the units from one department to the next, their costs are transferred with them.
• Transferred in costs are treated as if they are a separate type of direct material added at the beginning of the
process. In other words, when successive departments are involved, transferred units from one department
 became all or a part of the direct materials of the next department; however they are called transferred-in costs, not
direct material costs.
Assume the following data for Haron Chemicals during the month of November in the Bottling department
In the bottling department, where the product is bottled, labelled, and placed in cartons, costs are accumulated in the
two cost pools (material and conversion) as that of the mixing department plus a transferred –in cost poor. However,
direct material is added at the end of the process and conversion costs are incurred evenly through –out the process.
Physical units Transferred in costs Direct material costs Conversion costs
Beginning work in process 1,200 units 100% complete 0% complete 75% complete
Transferred-in during the month 1,600 units
Completed during the month 2,000 units
Completed during the month 800 units 100% complete 0% complete 50% complete

Cost incurred
Beginning work in process:
Transferred in costs (1,200 x Br.170) Br. 204,000
Direct materials costs 0
Conversion costs 90,000
Transferred in during the month: weighted average 216,000
Firs-in first-out 219,600
Direct material costs incurred during the month 60,000
Conversion costs incurred during the month 150,000

Transferred-in Costs and Weighted average method

Step-1 Step-2 Equivalent Units
Flow of production Physical units Transferred-in costs Direct material Conversion costs
Beginning work in process 1,200
Transferred in during the
1,600
month
Total units to account for 2,800
Completed during the month 2,000 2,000 2,000 2,000
Work in process ending 800 800 0 400
Total units accounted for 2,800
Work done to date 2,800 2,000 2,400

Production cost report Total production costs Transferred-in costs Direct material Conversion costs
cost
Beginning w/p Br. 294,000 204,000 0 Br.90,000
Current period cost 426,000 216,000 60,000 150,000
Cost incurred to date 420,000 60,000 240,000
Equivalent units 2,800 2,000 2,400
Equivalent units costs (step -3) 150 30 100
Total cost to account for (st-4) 720,000
Assignment of cost (step -5)
Completed & transferred out 560,000 2000*150 2000*30 2000*100
w/p ending: transferred –in 120,000 800*150
Direct material 0 0*30
Conversion cost 40,000 400*100
Total w/p ending 160,000
Total cost accounted for 720,000
Journal entries
• w/p bottling department ---------- 60,000
A/p ---------------------------------------- 60,000
• w/p bottling department --------150,000
Various accounts ---------------------- 150,000
 • finished goods -------------------- 560,000
W/p bottling department ------------- 560,000
Transferred-in Costs and FIFO method
Step-1 Step-2 Equivalent Units
Flow of production Physical units Transferred-in costs Direct material Conversion costs
Beginning work in process 1,200
Transferred in during the month 1,600
Total units to account for 2,800
Competed during the month
From beginning 1,200 0 1,200 300
Transferred-in & completed 800 800 800 800
Work in process ending 800 800 0 400
Total units accounted for 2,200
Work done only current period 1,600 2,000 1,500

Production cost report Total production costs Transferred-in costs Direct material cost Conversion costs
Beginning w/p Br. 294,000 204,000 0 Br.90,000
Current period cost 429,600 219,600 60,000 150,000
Work done only current period 1,600 2,000 1,500
Equivalent unit cost (step -3) 137.25 30 100
Total cost to account for (st-4) 723,600 - - -
Assignment of cost (step -5)
Completed:
From the beginning WIP:
Cost in the beginning WIP 294,000
Cost to complete these units: - - - -
Transferred-in costs 0 0*137.25
Direct materials 36,000 1,200*30
Conversion costs 30,000 300*100
Total cost from beginning 360,000
Started and completed 213,800 800*137.25 800*30 800*100
Total completed & transferred
573,800
out
w/p ending: transferred-in 109,800 800*137.25
Direct materials 0 0*30
Conversion cost 40,000 400*100
Total w/p ending 149,800
Total cost accounted for 723,600
Journal Entries
• W/p bottling department ----------60,000
A/p --------------------------------------- 60,000
• W/p bottling department ---------- 150,000
Various accounts -------------------------- 150,000
• finished goods ---------------------- 573,800
W/p bottling department ----------------- 573,800