Process Costing

Definition of process costing:

Process costing is that form of operation costing which is used to ascertain the cost of the product at each process or stage of manufacture.

Application of process costing

The industries in which process costs may be used are many. In fact a process costing system can usually be devised in all industries except where job, batch or unit operation costing is necessary.

Examples of industries, where process costing is applied are:-

1. Chemical works – Textile, weaving, spinning, etc.

2. Paper mills – Paint, Ink and varnishing, etc.

Advantages of process costing

The following are the main advantages of process costing:

1. It is possible to determine process costs periodically at short intervals. Unit cost can be computed weekly or even daily if overhead rates are used on predetermined basis.

2. It is simple and less expensive to find out the process cost.

3. It is possible to have managerial control by evaluating the performance of each process.

4. It is easy to allocate the expenses to processes in order to have accurate cost.

5. It is easy to quote the prices with standardization of process. Standard costing can be established easily in process type of manufacture

Fundamental principles of process costing:

The following are the fundamental principles of process costing:-

1. Cost of materials, wages and overhead expenses are collected for each process or operation in a period.

2. Adequate records in respect of output and scrap of each processor operation during the period are kept.

3. The cost per finished output of each process is obtained by deviating the total cost incurred during a period by the number of units produced during the period after taking into consideration the losses and amount realized from sale of scrap.

4. The finished product along with its cost is transferred from one process to the next process just like raw materials of that process.

Elements of production costing

The following are the main elements of production cost in process costing:-

1. Materials:

Generally in process costing, all the material required for production is issued to the first process, where after processing it is passed to the next process and soon. Some operation on the material is performed in each process which has been passed from the first process.

2. Labour:

Generally, the cost of direct labour is very small part of the cost of production in industries adopting process costing. The direct labour element becomes smaller and smaller while the overhead element increases with the introduction of more and more automatic machinery.

3. Production overhead:

The overhead element of total cost is generally very high in process costing great care is required to ensure that each process is charged with a reasonable share of production overhead. The actual overheads are debited to each process account.

In process costing, the four main aspects which are to be discussed are;

1. Process losses

2. Inter process profits

3. work-in-progress and effective or equivalent production.

4. Joint and by-products.

Normal process loss:-

If the loss is unavoidable on account of inherent nature of production processes. Such loss can be estimated in advance on the basis of past experience or data. The normal process loss is recorded only in items of quantity and the cost per unit of usable production is increased accordingly, where scrap possesses some value as a waste product or a raw material for an earlier process, the value thereof is credited to the process account. This reduces the cost of normal output; process loss is shared by usable units.

Abnormal process loss:-

Any loss caused by unexpected or abnormal conditions such as plant break down, sub-standard materials, careless, accident etc. or loss in excess of the margin anticipated for normal process loss should be regarded as abnormal process loss. The unit of abnormal loss is calculated as under.

Abnormal loss = actual loss – normal loss.

The valuation of abnormal process loss should be done with the help of the following formula.

Value of abnormal loss

Normal cost of normal output

= ------------------------------------ x units of abnormal loss

Normal output

All cases of abnormal process loss should be thoroughly investigated and steps taken to prevent these recurrence in future. Abnormal process loss should not be allowed to affect the cost of production as it is caused by abnormal or unexpected conditions. Such loss representing the cost of materials, labour and overhead incurred on the wastage should be transferred to an abnormal loss account. If this abnormal loss has got any scrap value, it should be credited to abnormal loss account and the balance is ultimately written off to costing profit and loss account.

COST CONCEPTS

Cost:

The Institute of Cost and Management Accountants (ICMA) has defined cost as “the amount of expenditure, actual or notional, incurred on or attributable to a specified thing or activity”. It is the amount of resources sacrificed to achieve a specific objective. A cost must be with reference to the purpose for which it is used and the conditions under which it is computed. To take decisions, managers wish to know the cost of something. This something is called a “cost unit”.

2. Cost unit:

A cost unit is any thing for which a separate measurement of costs if desired. A product, service, department, project or an educational course can all be cost units. Cost units are chosen not for their own sake but to aid decision making. Thus a cost unit is a “quantitative unit or product or service in relation to which costs are ascertained”. The cost unit to be used at any given situation is that which is most relevant to the purpose of cost ascertainment.

3. Cost centre:

According to ICMA London, cost center is “a location, person or items of equipment in respect of which costs may be ascertained and related to cost units for cooses”. It is simply a method by which costs are gathered together, according to their incidence, usually by means of cost center codes. It is the smallest element of an organization in respect of which costs are charged and ascertained.

Maintenance department, a public relation office, a printing machine are all examples of cost centers.

The establishment of cost centers serves two important purposes. Firstly cost ascertainment is made possible by collecting and charging cost to each cost center. Secondly, cost control is ensured as costs can be more closely looked at and more easily monitored by a responsible official. The setting up of a cost centers depends on numerous factors such as organization of factory, requirement of the costing system and management policy.