Process Costing

Process costing refers to a method of

ascertaining the cost of a product at
each stage or process of manufacture
in the industries where a product
passes through a sequence of
different processes each of which is
different / distinct & well defined.
 Continuation..
• The finished output of one process is used as a raw
material/ input of next process & the output of the
last process will be the finished stock.
• A separate account is opened for each process & all
cost incurred in it are debited to this account.
Therefore the cost is ascertained process wise.
• The average cost per unit in a process is calculated by
dividing the total cost of the process with the
number of units produced in that process & the cost
per unit of the last process is the average unit cost of
the final product.
 Features of process costing
• Process costing is applicable in industries where
production is continuous & passes through a
sequence of processes each distinct & well
defined.
• All cost of material , labour, expenses &
overheads are ascertained process wise.
• A separate account is maintained for each
process to which all direct & indirect cost are
apportioned.
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• The production is standardised & homogeneous
& is generally for stock.
• The output of each process is transferred as input
to the next process and the output of last process
is transferred to finished stock account.
• The example of industries where it is suitable
are:- chemical works, steel mills, textile, sugar
works, paper mills, soap making, food processing,
milk dairy, paint manufacturing & oil refineries.
 Format of process ‘A’ account
Particulars Units Amount Particulars Units Amount
To units introduced By normal loss
To materials By abnormal loss
To labour By next process
(output)
To direct expenses
To overheads
To abnormal gain
 Procedure of process costing
• Debit the cost of basic raw material introduced in the
first process account and record both quantity as well
as amount.
• Debit the cost of other material , direct labour &
direct expenses relating to each process in their
process account .
• Debit each process account with the production
overheads assigned on some equitable basis.
• Credit the process account with realisable value of
normal scrap
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• Ascertain the total cost of the process &
calculate normal cost per unit of normal
output by dividing the total normal cost with
the normal output.
• Credit the process concerned with total cost of
the output transferred to the next process,
which will be shown on the debit side of next
process as cost of input.
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• If any portion of output has been sold then credit it’s
cost as a transfer to process stock account & the
balance should transfer to next process.
• If any container is used for packaging the finished
goods then it’s cost should be debited to the last
process account.
• The cost of closing work in progress in each process
should be ascertained & shown on the credit side of
the process. Opening stock of work in progress is
debited to the process concerned in the beginning
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• Cost of abnormal wastage & the value of
abnormal gain should be calculated & write
these on credit side & debit side of the
process.
• The total cost of last process shall be transfer
to finished stock account. Finished stock
account is like trading account. Therefore sales
will be credited to this account which will help
in ascertaining gross profit.
 Process loss
• In most of the manufacturing industries where
process costing is employed, some loss or
wastage of materials always occurs when
production passes through different stages or
processes.
• Consequently the output from a process is
generally less than the input.
• This difference is termed as process loss
 Types of process loss
• Normal process loss:- which are either because
of very nature of materials used or nature of
manufacturing process. These are expected
losses under normal course of production.
• Example :- losses due to evaporation, spoilage,
scrap, chemical reaction
• Normal loss should be borne by the cost of
production. For ascertaining the cost per unit of
output , the total cost should be divided by
number of good units
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• If wastage has some realisable value, the same
should be credited to process account &
deducted from the total cost of process.
• Normal cost of normal output=(total process
cost – realisable value of normal loss) / ( total
units- normal loss)
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• Abnormal loss :- process loss over & above the
normal loss is treated as abnormal loss, which may
occur due to un-expected operating conditions such
as carelessness, inefficiency , accidents, faulty
planning, poor maintenance of machinery, lack of
proper supervision.
• Accounting treatment:- since these losses are not
part of cost of production, so cannot be included in
cost of production. Hence such costs are excluded
from process costs by transferring it to the costing
profit & loss account
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• Value of abnormal loss= (total cost- value of
normal loss)/ units introduced- normal loss of
units X units of abnormal loss
 Abnormal gain
• The normal process loss represents the loss that
would be expected under normal conditions &
it is calculated in advance.
• If the actual normal loss is less than the
estimated normal loss, this difference is known
as abnormal gain or effectives.
• Accounting treatment:- the value of abnormal
gain is calculated in the same manner as the
abnormal loss.
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• Value of abnormal gain= normal cost of
normal output X abnormal gain(units)
• The value of abnormal gain is shown on the
debit side of the process account & on the
credit side of the abnormal gain account. Like
the abnormal loss , it is also transferred to
costing profit & loss account.
 Work in progress & it’s valuation
• Process costing is employed in industries where
the flow of production is continuous & is carried
generally for stock & sale.
• Process accounts are prepared on time basis.
When process accounts are prepared at the end
of period there is possibility that some work in
progress will be there in a process.
• This closing work in progress will become opening
work in progress in the starting of the next period.
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• Problem of valuation of work in progress will arises in
process costing. This is because the production is
split between completed units & incomplete or semi
– finished units.
• Cost of production cannot be assigned on two basis
i.e one for completed units & another for incomplete
units. Therefore for the purpose of valuation of
closing work in progress the incomplete units have to
be converted into equivalent completed units.
• This will make the correct valuation of WIP.
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• The term equivalent units is defined as notional
whole units representing uncompleted work. Used
to apportion cost between work in progress &
finished output.
• The following statements are prepared for
computation of equivalent production & it’s
valuation:-
a) Statement of equivalent production
b) Statement of cost
c) Statement of evaluation
 Valuation of work in progress
• Case 1:- when there is no opening stock of work in
progress, there is only closing work in progress & no
process losses
• Case 2:- when there is no opening stock of work in progress
but there is closing work in progress with process losses
• Case 3:- when there is opening as well as closing stock of
work in progress:- in such as case there are two methods of
calculating equivalent production
1. FIFO method
2. Average cost method
 FIFO method
• 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 work in progress is completed first,
before work on any new unit is taken up.
• Thus no units from opening work in progress
will be left incomplete & none of these will find
place in closing work in progress
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• Closing stock will be calculated out of the material
introduced during the current period & will be
valued at the current cost.
• The cost incurred during the current period will be
distributed over opening stock of work in progress,
units introduced & completed during the period &
closing stock of work in progress. This is done by
dividing the cost incurred by the relevant equivalent
production so as to arrive at the per unit cost of
equivalent production.
 2. Average method
• In this method, the cost of opening work in
progress is not kept separately but is averages
with the additional cost incurred during the
period.
• this method thus combines the cost of
opening work in progress & new production.
Information relating to degree of completed
work not required
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• In order to calculate the cost per unit of
equivalent production, the cost of each element
(material, labour, overhead) applicable to the
opening work in progress is added to the cost
incurred in the current period for that element.
• A single cumulative total & unit cost is
obtained. Unit completed & transferred as well
as closing work in progress will be valued at this
average unit cost.