Process Costing

Process Costing is defined as a branch of operation costing, that determines the cost of a product at each stage, i.e. process of production. It is an accounting method that is adopted by the factories or industries where the standardized identical product is produced, as well as it passes through multiple processes to being transformed into the final product.

Process costing is a cost accounting technique, in which the costs incurred during production are charged to processes and averaged over the total units manufactured. For this purpose, process accounts are opened in the books of accounts, for each process, and all the expenses relating to the process for the period is charged to the respective process account.

Hence, it ascertains the total cost and unit cost of a process, for all the processes carried out in the industry. Further, the average cost represents the cost per unit, wherein the total cost is divided by the total number of outputs produced during the period to arrive at the cost per unit. The cost per unit can be calculated using the First in First Out Method (FIFO), Average Method, and Weighted average Method.

Features of Process Costing

• The plant has various divisions, and each division is a stage of production.
• The production is carried out continuously, by way of a simultaneous, standardized and sequential process.
• The output of a process is the input of another.
• The production from the last process is transferred to finished stock.
• The final product is homogeneous.
• Both direct and indirect costs are charged to the processes.
• The production may result in joint and by-products.
• Losses like normal and abnormal loss occur at different stages of production which are also taken into consideration while calculating the unit cost.
• The output of one process is transferred to another one at a price that includes the profit of the previous process and not at the cost.
• At the end of the period, if there remains the stock of finished goods, then it is also expressed in equivalent completed units. It can be calculated as:
  Equivalent units of semi-finished goods or WIP = Actual number of units in process × Percentage of work completed

Process costing is employed by industries whose production process is continuous and repetitive, as well as the output of one process is the input of another process. So, the chemical industry, oil refineries, cement industries, textile industries, soap manufacturing industries, and paper manufacturing industries use this method.

Process costing is used when there is mass production of similar products, where the costs associated with individual units of output cannot be differentiated from each other. In other words, the cost of each product produced is assumed to be the same as the cost of every other product. Under this concept, costs are accumulated over a fixed period of time, summarized, and then allocated to all of the units produced during that period of time on a consistent basis.

When products are instead being manufactured on an individual basis, job costing is used to accumulate costs and assign the costs to products. When a production process contains some mass manufacturing and some customized elements, then a hybrid costing system is used.

Examples of the industries where this type of production occurs include oil refining, food production, and chemical processing. For example, how would you determine the precise cost required to create one gallon of aviation fuel, when thousands of gallons of the same fuel are gushing out of a refinery every hour? The cost accounting methodology used for this scenario is process costing.

Process costing is the only reasonable approach to determining product costs in many industries.   It uses most of the same journal entries found in a job costing environment, so there is no need to restructure the chart of accounts to any significant degree.  This makes it easy to switch over to a job costing system from a process costing one if the need arises, or to adopt a hybrid approach that uses portions of both systems.

Example of Process Cost Accounting

As a process costing example, ABC International produces purple widgets, which require processing through multiple production departments. The first department in the process is the casting department, where the widgets are initially created. During the month of March, the casting department incurs Rs. 50,000 of direct material costs and Rs. 120,000 of conversion costs (comprised of direct labor and factory overhead).

The department processes 10,000 widgets during March, so this means that the per unit cost of the widgets passing through the casting department during that time period is Rs. 5.00 for direct materials and Rs. 12.00 for conversion costs. The widgets then move to the trimming department for further work, and these per-unit costs will be carried along with the widgets into that department, where additional costs will be added.