Process Costing
Process Costing
■ Process costing is a costing method used where it is not possible to identify separate units of
production, or jobs, usually because of the continuous nature of the production processes
involved.
A process account has two sides, and on each side there are
two columns – one for QUANTITIES (of raw materials, work
in progress and finished goods) and one for COSTS.
(a) On the left hand side of the process account we (b) On the right hand side of the process account we
record the inputs to the process and the cost of these record what happens to the inputs by the end of the
inputs. period.
(i) Some of the input might be converted into
So we might show the quantity of material input to a finished goods, so we show the units of finished
process during the period and its cost, the cost of labour goods and the cost of these units.
and the cost of overheads. (ii) Some of the material input might evaporate or
get spilled or damaged, so there would be losses.
So we record the loss units and the cost of the
loss.
(iii) At the end of a period, some units of input might
be in the process of being turned into finished units
so would be work in progress (WIP). We record
the units of WIP and the cost of these units.
■ The quantity columns on each side of the account should total to the same amount. Why?
Well think about it. If we put 100 kgs of material in to a process (which we record on the left
hand side of the account) we should know what has happened to those 100 kgs. Some
would be losses maybe, some would be WIP, some would be finished units, but the total
should be 100 kgs.
■ Likewise the cost of the inputs to the process during a period (ie the total of the costs
recorded on the left hand side of the account) is the cost of the outputs of the process. If
we have recorded material, labour and overhead costs totalling $1,000 and at the end of
the process we have 100 finished units (and no losses or WIP), then that output cost
$1,000.
PROCESS ACCOUNT
Units Units $ Units $
Material 1,000 11,000 Closing WIP 200 2,000
Labour 4,000 Finished units 800 16,000
Overhead 3,000
1,000 18,000 1,000 18,000
Example: basics of process costing
■ Suppose that Purr and Miaow Co make squeaky toys for cats. Production of the toys involves
two processes, shaping and colouring.
■ During the year to 31 March 20X3, 1,000,000 units of material worth $500,000 were input to
the first process, shaping. Direct labour costs of $200,000 and production overhead costs of
$200,000 were also incurred in connection with the shaping process.
■ There were no opening or closing inventories in the shaping department. The process account
for shaping for the year ended 31 March 20X3 is as follows.
Added materials, labour and overhead in Process 2 are usually added gradually throughout the process.
Materials from Process 1, in contrast, will often be introduced in full at the start of the second process.
3. Framework for dealing with process costing
■ Use our suggested four-step approach when dealing with process costing questions.
(a) Revenue from scrap is treated, not as an addition to sales revenue, but as a reduction in costs.
The valuation of normal loss is either at scrap value or nil. It is conventional for the scrap
value of normal loss to be deducted from the cost of materials before a cost per equivalent
unit is calculated.
(b) The scrap value of normal loss is therefore used to reduce the material costs of the process.
DEBIT Scrap account
CREDIT Process account
with the scrap value of the normal loss.
Abnormal losses and gains never affect the cost of good units of
production. The scrap value of abnormal losses is not
credited to the process account, and the abnormal loss and gain
units carry the same full cost as a good unit of
production.
(c) The scrap value of abnormal loss is used to reduce the cost of abnormal loss.
DEBIT Scrap account
CREDIT Abnormal loss account
with the scrap value of abnormal loss, which therefore reduces the write-off of cost to the
income statement.
(d) The scrap value of abnormal gain arises because the actual units sold as scrap will be less than
the scrap value of normal loss. Because there are fewer units of scrap than expected, there will be
less revenue from scrap as a direct consequence of the abnormal gain. The abnormal gain account
should therefore be debited with the scrap value.
DEBIT Abnormal gain account
CREDIT Scrap account
with the scrap value of abnormal gain.
(e) The scrap account is completed by recording the actual cash received from the sale of scrap.
DEBIT Cash received
CREDIT Scrap account
with the cash received from the sale of the actual scrap.
Example: scrap and abnormal loss or gain
A factory has two production processes. Normal loss in each process is 10% and scrapped
units sell for $0.50 each from process 1 and $3 each from process 2. Relevant information for
costing purposes relating to period 5 is as follows.
Direct materials added: Process 1 Process 2
units 2,000 1,250
cost $8,100 $1,900
Direct labour $4,000 $10,000
Production overhead 150% of direct labour cost 120% of direct labour cost
Process 1 Process 2
Units Units
Output 1,750 2,800
Normal loss (10% of input) 200 300
Abnormal loss 50 -
Abnormal gain - (100)
Input 2,000 3,000*
* 1,750 units from Process 1 + 1,250 units input to process.
Step 2 Calculate cost per unit of output and losses
Process 1 Process 2
$ $
Cost of input
– material 8,100 1,900
– from Process 1 – (1,750 × $10) 17,500
– labour 4,000 10,000
– overhead (150% × $4,000) 6,000 (120% × $10,000) 12,000
18,100 41,400
Less: scrap value of
Normal loss (200 × $0.50) (100) (300 × $3) (900)
18,000 40,500
Expected output
90% of 2,000 1,800
90% of 3,000 2,700
Cost per unit
$18,000 ÷ 1,800 $10
$40,500 ÷ 2,700 $15
Step 3 Calculate total cost of output and losses
Process 1 Process 2
$ $
Output (1,750 × $10) 17,500 (2,800 × $15) 42,000
Normal loss (200 × $0.50)* 100 (300 × $3)* 900
Abnormal loss (50 × $10) 500 –
18,100 42,900
Abnormal gain – (100 × $15) (1,500)
18,100 41,400
* Remember that normal loss is valued at scrap value only.
Step 4 Complete accounts PROCESS 1 ACCOUNT
Units $ Units $
Direct material 2,000 8,100 Scrap a/c (normal loss) 200 100
Direct labour 4,000 Process 2 a/c 1,750 17,500
Production overhead a/c 6,000 Abnormal loss a/c 50 500
2,000 18,100 2,000 18,100
PROCESS 2 ACCOUNT
Units $ Units $
Direct materials: From process 1 1,750 17,500 Scrap a/c (normal loss) 300 900
Added materials 1,250 1,900 Finished goods a/c 2,800 42,000
Direct labour 10,000
Production o'hd 12,000
3,000 41,400
Abnormal gain 100 1,500
3,100 42,900 3,100 42,900
ABNORMAL LOSS ACCOUNT
$ $
Process 1 (50 units) 500 Scrap a/c: sale of scrap of extra loss (50 units) 25
Income statement 475
500 500
SCRAP ACCOUNT
$ $
Scrap value of normal loss Cash a/c - cash received
Process 1 (200 units) 100 Loss in process 1 (250 units) 125
Process 2 (300 units) 900 Loss in process 2 (200 units) 600
Abnormal loss a/c (process 1) 25 Abnormal gain a/c (process 2) 300
1025 1025
VALUING CLOSING WORK IN PROGRESS
■ When units are partly completed at the end of a period (i.e. when there is closing work in
progress) it is necessary to calculate THE EQUIVALENT UNITS OF PRODUCTION in order to
determine the cost of a completed unit.
In the earlier process costing we have looked at so far we have assumed that opening
and closing inventories of work in process have been nil.
We must now look at more realistic issue and consider how to allocate the costs
incurred in a period between completed output (i.e. finished units) and partly completed
closing inventory.
Example: valuation of closing inventory
■ Trotter Co is a manufacturer of processed goods. In March 20X3, in one process, there was
no opening inventory, but 5,000 units of input were introduced to the process during the
month, at the following cost.
$
– Direct materials 16,560
– Direct labour 7,360
– Production overhead 5,520
29,440
■ Of the 5,000 units introduced, 4,000 were completely finished during the month and
transferred to the next process.
■ Closing inventory of 1,000 units was only 60% complete with respect to materials and
conversion costs.
■ Solution:
■ (a) The problem in this example is to divide the costs of production ($29,440) between the
finished output of 4,000 units and the closing inventory of 1,000 units. It is argued, with
good reason, that a division of costs in proportion to the number of units of each
(4,000:1,000) would not be 'fair' because closing inventory has not been completed, and
has not yet 'received' its full amount of materials and conversion costs, but only 60% of the
full amount. The 1,000 units of closing inventory, being only 60% complete, are the
equivalent of 600 fully worked units.
■ (b) To apportion costs fairly and proportionately, units of production must be converted into
the equivalent of completed units, i.e. into equivalent units of production.
Step 3 Calculate total cost of output and WIP Step 4 Complete accounts
For this step in our framework a statement of evaluation may now be The process account would be shown as follows.
prepared, to show how the costs should be apportioned between finished
output and closing inventory. PROCESS ACCOUNT
STATEMENT OF EVALUATION Units $ Units $
Equivalent Cost per equivalent Direct materials 5,000 16,560 Output to next process 4,000 25,600
Item units unit Valuation $
Direct labour 7,360 Closing inventory c/f (WIP) 1,000 3,840
Fully worked units 4,000 $6.40 25,600
Production o'hd 5,520
Closing inventory 600 $6.40 3,840
4,600 29,440 5,000 29,440 5,000 29,440
Step 3 Calculate total cost of output, losses and WIP Step 4 Complete accounts
STATEMENT OF EVALUATION PROCESS ACCOUNT
Equivalent Units $ Units $
units $ Opening inventory – – Normal loss 280 0
Completely worked units 2,000 14,000 Input costs 2,800 16,695 Finished goods a/c 2,000 14,000
Closing inventory 315 2,205 Abnormal loss a/c 70 490
Abnormal loss 70 490 Closing inventory c/d 450 2,205
2,385 16,695 2,800 16,695 2,800 16,695