Process costing is an accounting methodology that traces and accumulates direct costs, and allocates indirect costs of a manufacturing process. Costs are assigned to products, usually in a large batch, which might include an entire month’s production. Eventually, costs have to be allocated to individual units of product. It assigns average costs to each unit, and is the opposite extreme of Job costing which attempts to measure individual costs of production of each unit. Process costing is usually a significant chapter. It is a method of assigning costs to units of production in companies producing large quantities of homogeneous products.
Process costing is a type of operation costing which is used to ascertain the cost of a product at each process or stage of manufacture. CIMA defines process costing as “The costing method applicable where goods or services result from a sequence of continuous or repetitive operations or processes. Costs are averaged over the units produced during the period”. Process costing is suitable for industries producing homogeneous products and where production is a continuous flow. A process can be referred to as the sub-unit of an organization specifically defined for cost collection purpose.
Weighted Average Method of Process Costing
Here the actual cost is divided by the weighted average of products produced. This calculation is simple as compared to any other method. A weighted average of units means the summation of the product of the rate and quantity of each item.
Here the actual cost of units is not considered; instead, it follows a standard costing method. Standard cost assumes the cost of certain materials as per management estimate. Any difference in standard & actual costs is recorded separately under the variance account
This method assigns the expense of first inputs to the processes in the order of production. However, it does not precisely identify which a lot of raw material is taken for production and its procurement rate.
Steps of Process Costing
Step 1 Record of Inventory
This step involves the identification of inventory at the end of each process. The organization can identify such inventory by physically counting the units or through software inbuilt into the manufacturing process. In addition, the costs of inventory under each process are also identified at this change.
Step 2 Conversion of Work in Process Inventory
Apply the percentage of completion to the units which are under any process & not yet completed the production. Say 80,000 units of soaps are under process & these are 60% completed. Then the equivalent completed units are 80,000*60% i.e. 48,000 units.
Step 3 Calculation of Inventory Costs
Here, the organisation calculates the direct cost and indirect costs in the production phase. These costs are accumulated from the first process to the last process. The said is then bifurcated into an inventory of complete products & inventory of products that are under process.
Step 4 Calculation of Per-Unit Cost of Inventory
We calculate this by dividing the total cost by equivalent completed units in the production phase. The cost per unit calculated here reflects the cost of only completed units. The basis of equivalent units can be the weighted average, standard cost, or first-in-first-out inventory method.
Step 5 Allocation of Costs
The per-unit costs are then split according to the number of units completed & units that are under process.
- Direct & indirect costs are assigned and accumulated to each process in the factory.
- Each plant is divided into several processes/centers. Each such division is a stage of production or process. Thus, we first clearly identify the cost centers.
- The output of one process may become input for another process.
- The finished products are identical & cannot be easily distinguished unless batch coding is done.
- The total cost of production is divided among each process on a suitable basis.
- The production process is continuous for all days in the year except for regular breakdown hours required to maintain the machinery.
- The company is required to keep records for each production process, such as units or costs introduced in each process and passed on to the next stage of production.
- The production may result in joint products or by-products.
Cost Flow in Process Costing
The typical manner in which costs flow in process costing is that direct material costs are added at the beginning of the process, while all other costs (both direct labor and overhead) are gradually added over the course of the production process. For example, in a food processing operation, the direct material (such as a cow) is added at the beginning of the operation, and then various rendering operations gradually convert the direct material into finished products (such as steaks).