Process costing is a form of operations costing used where standardized homogeneous goods are produced. This costing method is used in industries like chemicals, textiles, steel, rubber, sugar, shoes, petrol, etc. Process costing is also used in assembly types of industries. It is assumed in process costing that the average cost presents the cost per unit.
The cost of production during a particular period is divided by the- number of units produced during that period to arrive at the cost per unit.
CIMA London defines process costing as “operation costing, which applies where standardized goods are produced.”
Features of Process Costing
- The production is continuous
- The product is homogeneous
- The process is standardized
- The output of one process becomes the raw material of another process
- The output of the last process is transferred to the finished stock.
- Costs are collected process-wise
- Both direct and indirect costs are accumulated in each process
- If there is a stock of semi-finished goods, it is expressed in terms of equivalent units
- The total cost of each process is divided by the normal output of that process to find out the cost per unit of that process.
In what types of industries is process costing adopted?
So many industries use process costing except those industries where job, batch, or unit operation costing is necessary. The following are examples of industries where process costing is practiced-
- Industries involved in chemical works, textile, weaving, spinning, etc.
- Industries are producing gas, electricity, water, ice, steel, paper, cement, rubber, bread, etc.
- Industries are producing bakeries, confectionery, flour mills, canners, manufacturers of medicine, fabricators, etc.
- Industries involved in foundries, laundries, dyers, cleaners, etc.
- Industries produce spare parts, fittings, equipment, fertilizer, etc.
- Industries involved in box making, paper mills, biscuit factories, oil refining, milk dairy, and meat product factory.
Advantages of Process Costing
The advantages of process costing are;
- Costs are computed periodically at the end of a particular period.
- It is simple and involves less clerical work than job costing.
- It is easy to allocate the expenses to processes to have accurate costs.
- The use of standard costing systems is very effective in process costing situations.
- Process costing helps in the preparation of tender quotations.
- Since cost data is available for each process, operation, and department, good managerial control is possible.
Distinguish between job costing and process costing
Job order costing and process costing are two different systems. Both systems are used for cost calculation and cost attachment to each unit completed, but both systems are suitable in different situations.
The basic difference between job costing and process costing are;
| Basis of Distinction | Job order costing | Process costing |
|---|---|---|
| Specific order | Performed against specific orders | Production is contentious |
| Nature | Each job may be different. | The product is homogeneous and Standardized. |
| Cost determination | Cost is determined for each job separately. | Costs are complied with for each process for the department on a time basis, i.e., for a given accounting period. |
| Cost calculations | Cost complies when a job is completed. | Cost is calculated at the end of the cost period. |
| Control | Proper control is comparatively difficult as each product unit is different, and the production is not continuous. | Proper control is comparatively easier as the production is standardized and is more suitable. |
| Transfer | There is usually not transfer from one job to another unless there is some surplus work. | The output of one process is transferred to another process as input. |
| Work-in-progress | There may or may not be work-in-progress. | There is usually no transfer from one job to another unless there is some surplus work. |
| Suitability | Suitable to industries where production is intermittent, and customer orders can be identified in the value of production. | Suitable where goods are made for stock and production is continuous. |
Normal Loss
The good units produced bear the cost of the units representing normal loss. If the normal loss has any realizable scrap value, such value is credited to the process accounting.
Thus normal loss is treated by neglect. Suppose there is neither any scrap value nor any abnormal gain. However, a separate account for normal loss must be opened if there is abnormal gain.
Abnormal Loss
The cost of the process is to be apportioned between the units lost abnormally and good units in the ratio of such units. The cost of units representing abnormal loss is debited to the abnormal loss account and credited to the process account.
Thus, good units are not bear abnormal losses.
If there is the scrap value of the units lost, such value is credited to an abnormal loss account, and the balance remaining after that in that account is written off to the costing profit and loss account.
How does a manufacturing company experience Abnormal Loss and Abnormal
There may also be loss of a different nature, i.e., loss arising out of unexpected or abnormal conditions. This type of loss is termed abnormal loss.
Substandard materials, breakdowns, accidents, wrong plant design, carelessness, etc., are abnormal losses. Normal loss and abnormal loss are relative terms. They widely vary from industry to industry, depending upon the nature of the materials used.
Production technique, preventive measures against incidents, etc. Loss of the same nature may be treated as normal in some industries and abnormal in others.
Abnormal Gain
Abnormal gain is not allowed to affect the process cost. The value of units representing abnormal gain is debited to process accounts and credited to an abnormal gain account.
At the same time, the scrap value of the units representing normal loss is debited to the normal loss account’ and credited to the process account.
To the extent of loss of income, the abnormal gain is transferred to a normal loss account, and the balance of abnormal gain is transferred to the costing profit and loss account.
Inter-Process Profit
Some process industries transfer the finished goods from one process to the next process at a price above cost. The excess of the transfer price over cost represents inter-process profit.
The last process also transfers the finished goods to the finished stock account at a price higher than the cost.