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Managerial Process Cost Accounting: The Estimation System used by Management to Account for Costing Processes

Updated on September 18, 2012

What is Process Costing? Process Manufacturers Use Process Cost Systems For Accounting

Process manufacturers are those that utilize a continuous production process to make products that are homogeneous – like ice cream, soda, and gasoline. Since these manufacturers do not produce discrete batches of products, they cannot utilize the job order costing accounting system to account for the costs of manufacturing. So what is process costing? Read on to find out!

Similarities Between Job Order and Process Cost Systems

While the job order and process cost systems are different, there are a few similarities. For example, both:

· Use a cost estimation process to allocate overhead costs of the factory and administration

· Can be used for setting product prices

· Break costs down into direct materials, direct labor, and overhead

· Use a perpetual (sequential) inventory system


The Differences Between Job Order and Process Costing: Process Manufacturers Use Accounting Cost Flows

Process costing is a little more complicated than job order costing, because it requires careful tracking of when in the overall business process which costs occur. Nevertheless, following the set of steps below will allow you to make an accurate estimation of process costs:

· Record materials purchased in the materials ledger

· Direct materials used are recorded in the step of the process that uses them

· Direct labor used is also recorded for each process step in the WIP (work in process) account

· Factory and administrative overhead (depreciation expense, utilities, etc) is recorded for each department and applied to the work in process account

· Cost of units completed in one department is transferred to the next department

· The cost transferred out of the final process is the Cost of Goods Sold


Quiz: Process or Job Order Costing?

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Cost of Production Report: A Valuable Tool in Process Cost Accounting Systems

The cost of production report is the process costing counterpart to the job order cost sheet. It provides a summary of costs incurred by each department as well as a summary of costs transferred between departments.

When preparing a cost of production report, it is important to determine whether the FIFO or LIFO method will be used. The FIFO (first in first out) method is most commonly used for several reasons: it is GAAP-compliant, and it matches the physical flow of units. The LIFO (last in first out) method is not as common, but still sees occasional use.

Preparing the cost of production report for a process manufacturer requires managers to take the following four steps:

1. Compute equivalent units of production

2. Determine cost per equivalent unit

3. Allocate costs to units transferred out

4. Allocate costs to partially completed units (WIP)


Determining Equivalent Cost Units For Production

Units are variable items used to assign costs. The units used could be pounds, tons, gallons, pallets, etc – whichever is most appropriate for the specific business process. The units will be subdivided into beginning inventory, ending inventory, and new finished products (those started and completed during the month, quarter, etc). However, we have to account for one more group – WIP. Work in process is accounted for using equivalent units of production. Basically, to calculate equivalent units, the number of units in WIP is multiplied by the “percent finished” statistic. This can be accomplished in several ways.

Conversion Equivalent Units

This metric measures equivalent units based on the direct labor hours and factory overhead costs that are assigned and allocated through each process. The sum of these costs is referred to as conversion costs. For example, if 30% of the labor hours + overhead are used in a specific process, then the WIP will be viewed as 30% complete – so an “equivalent unit of production” will be equal to 0.3 times the number of WIP units in this process.

Materials Equivalent Units

This metric measures equivalent units based on the amount of direct materials they have consumed. If the process as a whole uses 100 units of direct materials per finished product, and the specific process step uses 20 units of direct materials, then the WIP through this process will be treated as 20% complete.


Determining Cost Per Equivalent Unit

Calculating unit costs in process manufacturing accounting is quite easy. You simply take the total costs (either materials or conversion) and divide by the appropriate number of equivalent units. So if total direct materials cost was $20,000, and total materials equivalent units were 1,000, then the direct materials cost per unit is $20,000 / 1,000 = $20. If the total conversion costs were $30,000 and total equivalent conversion units = 500, then the unit conversion cost per equivalent unit would be $60. (30,000 / 50)

Process Cost Accounting: Allocating Costs

Now that the unit costs have been calculated, we can allocate costs for each step of the process. This is broken down into the groups described above: beginning inventory, ending inventory, inventory started and completed during the period, and WIP.


Just In Time (JIT) Processing: A New Management Method

Just In Time (JIT) processing is a new managerial approach to process production that aims to improve quality and decrease time spent and costs incurred. In traditional process manufacturers, each department is responsible for individual steps (mixing, bottling, etc). In a manufacturer using JIT processing, individual functions are often combined into manufacturing cells. Individual workers are now responsible for more than one function, which improves their efficiency for several reasons: they’re freed from boring days of doing the exact same task over and over (now they have multiple tasks to switch between) and they get more of a chance to see the effects of their work on the final product. Furthermore, they gain a deeper understanding of the production process as a whole, learning how to work and repair multiple machines.

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