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.
Advantages of Process Costing:
- 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.
- It is simple and less expensive to find out the process cost.
- It is possible to have managerial control by evaluating the performance of each process.
- It is easy to allocate the expenses to processes in order to have accurate costs.
- It is easy to quote the prices with standardisation of process. Standard costing can be established easily in process type of manufacture.
Disadvantages of Process Costing:
- Costs obtained at the end of the accounting period are only of historical value and are not very useful for effective control.
- Work in progress is required to be ascertained at the end of an accounting period for calculating the cost of continuous process. Valuation of work in progress is generally done on estimated basis which introduces further inaccuracies in total cost.
- Where different products arise in the same process and common costs are prorated to various cost units. Such individual products’ costs may be taken as only approximation and hence not reliable but may be taken as the best.
- There is a wide scope of errors while calculating average costs. An error in one average cost will be carried through all processes to the valuation of work in process and finished goods.
- The computation of average cost is more difficult in those cases where more than one type of products are manufactured and a division of the cost elements is necessary.
Fundamental Principles of Process Costing:
- Cost of materials, wages and overhead expenses are collected for each process or operation in a period.
- Adequate records in respect of output and scrap of each process or operation during the period are kept.
- The cost per finished output of each process is obtained by dividing the total cost incurred during a period by the number of units produced during the period after taking into consideration the losses and amount realised from sale of scrap.
- 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 Cost:
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 so on. Some operation on the material is performed in each process which has been passed from the first process. In some other cases, material may pass from the first process to the second process, where extra or new materials are added, then more material is added in the next processes, this may continue until completion.
Sufficient supplies of raw materials must be available to meet the production needs. Material may be requisitioned in prescribed way or bulk requisitions may be issued. When bulk requisitions are used, materials are issued from the stores to the departments in large quantities, where they are held in departmental stock until such time as they are needed.
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. The recording and allocating of time spent on production is relatively easy as compared with job costing.
Generally employees are engaged continuously on one process and time spent by them is posted to the debit of the Process Account. But, if employees are engaged on more than one process, it will be necessary to record the time spent on each one or an approximate apportionment of the total time will be allocated to each process concerned.
(iii) 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.
For the purpose of cost accounting, process industries are divided into departments, each department representing a particular process. A process may consist of a separate operation or series of operations. A foreman or supervisor is appointed for each department. He is responsible for the efficient functioning of his department.
In process costing, a separate account is kept for each process. The account is debited with the value of materials, labour, direct expenses and overheads relating to the process. The value of by-products and scrap, if any, is credited to this account. The balance of this account, representing the cost of partially worked out product, is passed on to the next process and so on until the product is completed. Thus the finished product of one process becomes the raw material of the next process.
In some industries, depending upon the plant arrangement, the partially worked out product of a process may be transferred to a Process Stock Account from which it may be issued to the next process as and when required.