Managerial Accounting - Process Cossting
Primary functions of any product costing system are: (1) accumulating production costs and (ii) assigning those costs to the products being manufactured.Product costs are need for planning, cost-control, decision making and reporting to both internal and external users like regulatory agencies or research associations.
Of the many methods, one is process
costing. It ascertains the cost of a
product at each process or stage of manufacture. It assigns cost equally to homogeneous units within a particular time period.
Process costing is the subject matter of this hub.
PROCESS COSTING - a formal definition
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".
By saying repetitive operations or processes, CIMA has precluded Jobs which are unique and one-time effort.
When is process costing appropriate?
Process costing is suitable where production process is repetitive, products are homogeneous or identical, production flow is continuous and manufacturing time is relative short.
Industries using process costing are oil refineries, paint making plant, soap manufacturing, foods and drinks, paper, petroleum, chemicals, textiles and electronics.
Differences and Similarities with Job Order Costing
JOB ORDER COSTING
Cost by Job
Cost by process
Standard or idential product
Different costs for difference jobs
Same unit cost for all
None with other jobs
Same fiancial and operational data
Same flow of production
Use of Process Cost Information
- Measure costs of production of mass-produced products
- Assign costs to inventory and cost of goods sold for working out profitability and taxes.
- Keep a watch on operations and costs
- Used in budget or future costs for decision making
- Identify potential areas for process improvements
- Analyze the costs and benefits of quality improvements
As in job-costing, materials are withdrawn from stores using a material requisition form. The materials are processed adding labor and overhead. Since there a number of processes, the units would remain partially completed till the final process. In the subsequent processes more material may be added along with labor and overheads. For example, Coca-Cola Company may have three processes or departments: (i) Formulation Department, (ii) Bottling Department and (iii) Distribution Department. To stare with, raw materials (flavors, sugar, water and carbon dioxide) are poured into tanks. Subsequently, bottles and caps are added in the Bottling Department and finally wooden crates are introduced in Distribution Department.
Treatment of labor costs and overheads is the same as in job-costing except these costs are allocated to departments and not to individual jobs. Also, predetermined overheads rate are used.
On completion of a process, the units are moved to next department for further processing. It goes on till the product is completed. The costs of completed units would be transferred to Finished Goods Inventory Account. Finally, when goods are sold, the relevant costs are transferred to Cost of Goods sold for computation of gross profit.
Equivalent Unit of Production
It is not necessary that all semi-finished units are fully treated and passed to next department. In fact, some are left behind as work-in-process of that particular department. For example, in confectionery, the processes are mixing, shaping, baking and packing. Assume that 1,000 of raw cakes were sent to baking department. Due to shortage of working only 600 cakes were backed and the rest remained as received.
Let us say that baking cost was 25% of total cost of a baked cake (not including packing). If total cost of Rs.126,000 was incurred until now, the unit cost would be computed as follows:
- Equivalent Units = 600 + (400 x 75%) = 600+300= 900 equivalent units
- Unit cost = 126,000 divided by 900 units = 140 per cake.
Different Production Processes
A number of processes are used in the industrial plants. The process may be sequential where work-in-process moves in one direction and all units are treated equally. It could be parallel where two or more lines work at the same time and eventually their output is assembled in one complete unit. Finally, in selective process, some units are treated specially and then moved to the main line.
As more processes are involved, the calculation become more cumbersome. It must be remembered that accounting is a service and must be tailor made to satisfy demand of the user. In no case, actual production flow or process flow is changed. In stead, changes are made in cost accounting system to match the requirements.
Process costing is suitable for industries engaged in mass production of near identical products. Both process costing and job costing have the same purpose i.e. to accumulate costs and assign them to products. Product costs are needed for planning and control besides reporting to regulatory authorities.