As a result, the costs of the last units produced are given to the units remaining in inventory. The advantages of process costing include but are not limited to straightforward computation of the product cost, basic inputs in the process like direct material, direct labor, and overhead cost. This loss increases the cost of production of the product produced in the process. If the scrap is sold then the sale value of scrap is also shown on the credit of process account which results into decreasing the cost of production.

• Furthermore, This analysis also allows companies to identify areas to reduce production and costs.
• Discover the importance of production planning in manufacturing & its role in supply chain management.
• In these industries, the production process is continuous and standardized, making it difficult to determine the exact cost of producing each product unit.
• While a process costing system is designed to be accurate, there can be instances where the system may not provide an accurate cost calculation.
• Hence, the degree of completion of abnormal loss units is first identified and then they are converted into equivalent production units to arrive at the element wise cost.
• As the cost of production of the previous process is considered the cost per unit of opening as well as closing stock of the next process.

Under this method, weighted average is computed and used in valuation of the incomplete units. We know that, there will be Work in progress during the opening and closing of a period and thus an organization needs to decide on the cost flow assumptions. For computing costs under process costing the organization can use either the FIFO or weighted average cost flow assumption. Process costing provides a more accurate estimate of each unit’s production cost since the costs are allocated based on a predetermined rate. Job costing is less accurate since the actual prices may vary based on the specific requirements of each job. Process costing generally requires a large scale of production to be effective.

Direct Expenses

Sometimes overheads are recorded at pre-determined rate based on direct wages, prime cost, etc. Sometimes, owing to abnormal conditions advantages of process costing even abnormal loss is also observed. See, when you stack up the process costing against other methods, like job costing, it’s like comparing a high-speed train to a bicycle. Because it just makes the whole deal of figuring out costs a whole lot simpler and cheaper. You won’t have to break your head over complex calculations and the extra costs that come with them.

Service Industry

All those expenses which are specially incurred for a process like corks, bottles, bags or primary packing material is the direct expenses incurred for that product or process. (iii) To distribute the joint expenses on the various products produced. In certain industries, there arise by-products or joint-products, which require further processing. The factory is divided into a number of process cost centers or departments and in each cost center an account is maintained—setting up progress cost centers. Simultaneous Production – Different products, with or without by-product, are simultaneously produced in one or more processes. If the product is processed in more than one process, the output of the first process is transferred to the second process.

• The textile industry uses process costing to calculate the cost of producing fabrics.
• Process costing is streamlined and straightforward, making it easier to apply in industries where production processes are highly standardized and continuous.
• Completing opening work-in-process, i.e., opening W.I.P. which was completed during process.
• Average method is used when opening WIP is given in terms of materials, labour and overhead but the degree of completion is not mentioned.

Process Costing – 4 Main Elements of Production Cost

In a case like this losses up to 5% of input will be categorised as normal loss of the process. The cost of normal loss in process is absorbed as additional cost by good production in the process. By past experience and data available relating to industry, a rate of normal loss is always mentioned with specification of produc­tion techniques. If the loss is within the specified limit, it is referred to as normal loss.

Advantages & Disadvantages of Process Costing Under Accounting

At its core, process costing is about dividing the total production cost of a manufacturing process into smaller parts to determine the cost per unit. This approach is particularly useful in industries where products are more or less indistinguishable from one another. Process costing follows a simple and easy calculation method; even non-accountant can understand it easily. For the total product cost, we will sum all costs from all processes. Under this method, all products pass through a series of processes in sequence. Under this method of process costing, output and cost of production is transferred from process to process until finished products are obtained.

Assume that there was no work-in-progress either at the beginning or at the end. Show the process costs for each process and the total cost of the finished product. A separate account is prepared for each process on the basis of double entry book keeping with quantity column alongside the amount (total cost) column.

The products produced in the process costing are standard and do not differentiate from each other. The units that remain incomplete are analyzes to have been completed with different inputs of the process. For instance, it needs to be considered the percentage of the process with respect to material, labor, and overheads.

Products in these industries often require multiple stages of processing, each with its own costs and resources allocated. The cost flows are tracked using a cost of production report, which tracks the costs incurred in each process and the number of units produced. The prices are then accumulated and allocated to the units produced based on a predetermined allocation method. An unfortunate issue with process costing is the penchant for inaccuracy when costing products. Production processes may include indirect costs or items not related to producing products.

By using process costing, manufacturers can track the cost of production per unit and ensure that inventory is managed effectively, reducing waste and increasing efficiency. For example, the cost of raw materials for the entire production process is $30,000. Therefore, the total applicable cost for the production of Widget A is $51,000. The actual cost of production is then compared to the standard cost, allowing manufacturers to identify any variances and make necessary adjustments. This method is helpful for manufacturers with a well-established production process and can accurately predict the cost of production. Process costing is an essential tool for businesses that operate in the manufacturing industry.

There is often a loss in process due to spoilage, wastage, evaporation and so on. The loss may be normal or abnormal.

This idea to find out units, which would have been completed, if the work done on unfinished units had been done for finished units only. The concept of “equivalent production” is used for assigning cost of process to both finished units and unfinished units. There can be abnormal gain also when the actual production is more than the expected production. The quantity as well as the values of these losses can be known through the process costing. Apart from this, there occur abnormal wastages and abnormal gains. Assigning overhead costs to products in a process costing system can be complex and may lead to imprecise cost allocations.

Equivalent production is obtained by multiplying the actual number of units in process by their stage of completion in terms of cost. Suppose, 6,000 units are completed and transferred to the subsequent process, and 3,000 units remain incomplete (at the stage of 40% completion) at the end of the period. In some cases, the entire output of a process may not be transferred to the subsequent process and a part of it may be held in the processing department in its finished form. Such stock of finished goods (opening as well as closing) is valued on the basis of the cost per unit as shown by the concerned process account (in which stock is held) for the relevant periods. Normal production is represented by input minus normal loss relating the performance.

If actual production of process A happen to be 95 units, will 5 units represent abnormal gain in process A? Abnormal gain represents good units, which should not have been produced if the production in the process had been strictly according to accepted norms. This situation arises when output of the process is more than normal production of that process. Therefore,the cost of normal loss should be borne by good production during the process. For scrap value relating to normal loss is credited to the process account so that only the actual cost of normal loss is shared by good production in the process. “Equivalent production” is a technique by which work done on unfinished units is expressed in terms of “completed units” only.

Suppose, input in process A is 100 units, normal loss of process A should be 10 units and normal production of process A should be 90 units. When work done in process includes work done on unfinished units also, it is advisable to prepare a statement of equivalent production. This statement shows element wise details of work done in terms of completed units only. This difficulty will always be experienced, when work done is represented both by finished and unfinished units. To avoid this difficulty, work done on unfinished units is expressed in terms of equivalent completed units, 100 units, which are half finished with regard to material, labour and overhead.

It does take into account the normal losses of production depending on the process and allocated to the costing of a product. On the contrary, the abnormal losses are taken in the cost of sales. The process costing system follows certain stages that are discussed below. This method is used when degree of completion of opening WIP is not given. The opening WIP units are not shown separately in the equivalent production statement, but are included in the total units completed and transferred to the subsequent process/finished stock.