COST ACCOUNTING (PART-7)

PROCESS COSTING

1. INTRODUCTION
Dear Students,

Welcome to the lecture series on Costing accounting. Today in this

lecture we shall cover the topic process costing. We shall learn the

Meaning of process costing

Various factors relating to process costing

Method of computing the cost of each process

Total process cost.

We shall also learn about

Normal loss / Normal gain

Abnormal loss/Abnormal Gain

The objective of this lecture is to have of the process costing that is how
the process costing is being done under cost accounting. We shall learn
each element of process costing, that is computation of total cost,
computation of each product at each level and costing treatment of
abnormal loss and normal loss. We shall learn in detail various
computation aspect of cost under process costing.

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 2. MEANING AND FEATURES OF PROCESS COSTING
Now students first of all let us understand the meaning of process
costing. Let us see its definition.

Process costing is defined as

“ Process costing is a method of costing under which all the costs are
accumulated for each stage of production and the cost per unit of
product is ascertained at each stage of production by dividing the total
cost of each process by the normal output of that process.”

CIMA LONDON defines costing as

That form of operation costing which applies where standardized goods

are produced.

SO students we can understand that process costing is

A. A continuous process

B. products are homogeneous.

Process costing applies where the output of one process becomes input of
next process so it will go on until the finished product is manufactured.

If process A has transformed raw material by applying material, labour

and other expenses to finished product that product form the part of
second process and the output of first process will become the input for
the second process. Then again the second process will apply material
labour over head as per the requirement of that particular process and
transformed that material into the output or the finished product. That
finished product of process to shall become the input of process third and
applying all material labour overhead we can get the final product.

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So this calculation of each output at each process will be done so we have
to ascertain cost and total production and we have to identify if there is
any normal or any abnormal loss in this process.

Now student let see the feature of the process costing.

Process costing is a continuous process. The products so many

manufactured are homogeneous and the products are standardized the
output of process become input of other process. Cost is collected
process wise and the cost per unit will be ascertained for each process.
So these were the features of process costing.

Now let take some example to know where the process costing is being
applied.

Process costing is applied where in the industries where continuous

operations are running so that the particular product is manufactured so
they divide the production processing in such a manner that output of one
process will become the input for another.

Take the example paper industry, textile industry, sugar industry and the
chemical industry and the oil refinery. These are the industry where the
process costing is applied.

For example in the textile industry the production process will be divided
in the three parts first weaving then spinning and dying so they will run
continuously.

Similarly in the case of sugar industry the sugar cane will be cleaned up
first then it will be grained and then refined so these process will go in a
chain one by one and the input of the first product will be transformed
as an output.

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For example the sugar canes are cleaned up and they are going for the
grinding so whatever expenses we have incurred for cleaning up the
sugarcanes so that they can be transformed into output and it can be
used for grinding so whatever expenses we are incurring to transform the
sugarcane for the grinding process will constituted a total cost of the
process for cleaning then will become input for the grinding again
application will be there material will be used and machinery will be used
labor will be used, these all will from the cost of the second process will
be applied on the output for the first process.

Then we will get the output this output will become the input for the
refining process and finally when the refining is done applying so many
cost out there and we will get final sugar. So in any industry where there
is a chain of process in the production cycle we use the process costing.

Now let us see what is the cost involved in process costing.

First of all it will be a cost of direct material. That means whatever of

raw material is being used will form the part of total cost of production.

Labour cost means anyone who has applied his skill and time to transform
the raw material into some product of useable value they will called as
labour and what we are paying in the form of wages or salary they shall
be part of cost of production.

Then the production overheads i.e. rentals, electricity they shall also the
part of cost of process costing. Then other expenses will the part of cost
of production. Sometimes there are common expenses for all the process
so we can apportion those expenses in the appropriate ratios using
appropriate cost pooling. That is we will use a ratio like other expenses
there are in the nature of production expenses. We can use the direct
labour ratio whatever direct labour cost is incurring in all the three
processes we can divide other expenses in that proportion.

This is the way that the common expenses can be apportioned among all
the process when they are not specifically allocated. Then adding up all
the cost we can get the total cost

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Now student let us see the format of process account of on the screen.
Let’s see the specimen of process one on the screen.

On the debit side we have to basic material to Direct Labour, to direct

Wages, to direct expenses to production overhead and to the cost of
rectification of normal effective.

We have two Columns one is the unit’s Column and other is the amount
Column. When material is used in a process first of all we have to write
the number of units and adjacent to it we will write the amount and the
credit side there will be two Column units and Rupees so when we write
the particulars we have to fill both the Column that is of units as well as
rupee.

Credit side is showing the following particulars.

By normal loss we will learn in detail how normal cost will be calculated.

By abnormal loss, by process cost second that is output transferred next

process and

by the P&L account that is output sold.

3. NORMAL LOSS & ABNORMAL LOSS - MEANING TREATMENT

COMPUTATION
We shall learn how the total cost is ascertained and how the normal loss
and abnormal is ascertained. So first of all lets us understand what is
normal loss and abnormal loss.

Normal loss is that unavoidable loss which will incurs in the process due
to the nature of the process or due to the sequence of the activities for
example the evaporation if the chemical industries there and a certain
dilute is prepares it will be evaporate at any cost we cannot avoided by
applying any control.

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Normal loss is that loss which incurs because the nature of process is such
that it is bound to incur.

Now abnormal are those losses which can be avoided and which have
incurred due to the carelessness or due to machinery breakdown they are
the factors which can be control.

Now let’s see the second important difference between normal loss and
abnormal loss.

Under normal loss we can identify the percentage of the normal loss we
can ascertain this percentage as per the prevailing practices in the
organization or by the pass data’s we can fix up a percentage of normal
loss but abnormal loss cannot be determine in advance.

Next is normal loss is forming the part of the total cost of the production
while abnormal loss is transferred to the costing P&L. When normal loss
incurs the good units absorbs the cost of the lost units in that way the
cost of production get inflated.

We shall learn them in the detail with the example.

While in the abnormal loss the cost of abnormal will be ascertained by

using the formula which will learn in detail.

Now student lets us understand the computation of normal loss.

Normal loss shall be computed by applying the percentage of expected

normal loss to the good units.

If the total output is 2000 units and the expected percentage of normal
loss is 10% so the normal loss units is 200 we will do the subtraction i.e.
2000 -200 = so 1800 will be the normal production.

So they will be the units on which we will do the cost accounting. There
are good units which are absorbing the cost of the normal losses, so 1800
units will be used for further accounting.

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 4. COMPUTATION & PRACTICAL EXAMPLE OF NORMAL LOSS
Now how abnormal loss is calculated. If we have the total production is
2000 units subtracting the normal loss units 200 units we are getting the
normal production is 1800 units.

Now actual production is less than the normal production. If we actually

manufacture 1600 units only so these 200 units which is less than the
normal production will the units of abnormal loss.

Now let’s see how the cost of normal loss and abnormal cost will be
ascertain

First of all we have to find out the total cost then we have to use this
formula: -

= Total cost – scrap of the normal loss

total production – normal loss units.

So what we are using net cost / normal production.

To simplify our calculation we will use these two terms. Normal

production and net cost. So first of all in our working note we will
ascertain net cost and normal production. In simple word we can say
total production-normal loss production - actual production =
abnormal loss or abnormal gain it can be there.

Now let us understand with the help of example the process costing in a
much better way

See this example on the screen input of raw material is 1000 units at Rs 6
per unit direct material 5200 Rs. Direct wages 4000 Rs production
overheads Rs 4000 actual output transferred to process II 950 units and
normal loss is 5% value of scrap per unit is Rs 4 so first of all let us
calculate the normal production. Input of Raw material is 1000 and while
what we are transferring is 950 so there is gap of 50 units.

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So first of all calculate the normal production. 1000 units less normal loss
is 5% of input so will come as 50 units only so 1000 minus 50 is coming as
950 and actual production is also 950 so there is no abnormal loss or gain
in this example.

So first of all we have to write the details on the debit side of the process
account so we will write units introduced at Rs 6 in the units Column we
will write units as 1000 and amount as Rs.6000 then for the direct
material just write the amounts because no adjustment figure of units
will there.

Adding up Rs.6000 then direct material Rs. 5200 direct wages Rs.4000 and
production overhead Rs.4000 we are getting the total cost as Rs.19200.

Writing down the value of by normal loss on the credit side the first entry
will be of normal loss.

So by normal loss in units we will write 50 and that value of scrap is sold
for Rs.200 we will Rs.200 in front of the 50 units in the amount Column.
Now we have to find out the cost per good units. So we know that good
units are 950 net costs is to be ascertain so Rs.19200 is a total cost.

If we subtract the value of normal loss form it i.e. scrap of normal loss we
will get the net cost Rs.19200 minus Rs.200 it will be Rs.19000 divided by
the 950 so the cost per unit will be Rs 20 per unit so will multiply 950
units into 20 so we get the amount Rs.19000 to be transfer to process
second or the balancing figure shall also be Rs.19000 we can cross verify
it by dividing the balancing figure by the units.

Then we have to prepare a normal loss account under normal loss account
we will write on the debit to process account because is coming from the
process account. It is on the credit side of process account so process
account will come on the debit side of the normal loss account and then
we have sold the scrap we would pass the entry bank a/c debit to normal
loss a/c so in the credit side it will show the sale value as 200. In this we
have learn the computation of normal loss by this example.

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 5. COMPUTATION OF ABNORMAL LOSS
Let’s see the computation of the abnormal loss.

If the total units produced are 2000 units and the percentage of
expected loss i.e. normal loss is 10 percent we are getting the good units
as 18200 minus 200 = 1800 units per the actual production is 1700 units so
what is the difference this difference is the abnormal loss units. So you
have to do the cost accounting of abnormal units using the formula that is
net cost is divided by the normal production into the units of abnormal
loss. So it will be imagine that the total cost 18200 units and the sale
value of normal loss is 200 Rs so net cost is 18000 Rs the normal
production we have calculated as 1800 units. so 18000 divided by 1800 is
giving us the cost per unit as Rs 10 while units of the abnormal loss are
100 units so 10 into 100 i.e. 1000 Rs will be the value of abnormal loss.

Now see the practical guide lines to do the cost accounting of abnormal
loss on your serene.

1. Debit abnormal loss a/c and credit process a/c with the units of
cost of abnormal loss.
2. Credit abnormal loss a/c with the realized value of abnormal loss
units.
3. Close this account by transferring the balance to the costing P&L.

So we can see this specimen of the abnormal loss a/c on the debit side
we will write to process a/c. it will be cost of abnormal loss.

On the credit side we will write by bank i.e. the sale value of abnormal
loss. And the balancing figure shall be the profit or loss which will be
shown as by costing P&L or to costing P&L.

So take for example

The cost has come as 1000 Rs as we has calculated so to process a/c we

will write 1000 if we have sold this abnormal loss at 800 so the balancing
figure will be transferred to costing P&L as Rs 200 and we will close up
this account.
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 6. COMPUTATION OF ABNORMAL GAIN
Now lest see what the computation of abnormal gain.

What is abnormal gain?

Abnormal gain is that the actual production is about the expected

production. So we will compute like this.

Total production minus the normal loss we will get the normal production
expected production.

So if actual production subtracted from the normal production i.e. actual

production minus input minus normal loss is equal to abnormal gain. This
abnormal gain cost will not be a recovery from the total cost of
production nor will it be credited to the process account. Now see the
practical guidelines for doing the cost accounting of abnormal gain. It’s
on your screen.

1. Debit process account credit abnormal gain account with the units and
cost of abnormal gain.

2. Debit abnormal gain account and credit normal loss account with the
units and the realized value of the abnormal gain and

3. Close this account by costing P&L. It will be on the debit side i.e. to
costing P&L.

Now let’s see difference between the abnormal gain and abnormal loss.

Abnormal loss arises when actual loss is more than the accepted loss and
abnormal gain aeries when actual loss is less than the accepted loss. Then
units will be calculated as input minus normal loss minus actual
production under abnormal loss while in the abnormal gain it will be
first actual units will come and the we will subtracts from actual units
input and normal loss.

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Then the accounting of the realizable value should be analyzed for both
the abnormal gain and abnormal loss. Under abnormal loss it will be
credited to the abnormal loss a/c while in the case of abnormal gain
debit to the abnormal gain and credited to the abnormal loss a/c and the
accounting treatment of cost for both will be also different.

Abnormal loss will be debited to the costing P&L and abnormal gain will
be credited to costing P&L. so with this learn the treatment of abnormal
gain.

7. COMPUTATION OF NUMBER OF UNITS INITIALLY INTRODUCED IN

PROCESS I

Now we will understand a very conceptual problem which comes when

the output of the finished goods is given and we have to find out the
output value of the previous process i.e. we have to move in a reverse
manner.

So this type of questions is very important so need to need to understand

the computation aspect of such example.

So let’s see these examples on the screen.

Here we have to find out the number of units initially introduce in

process 1.

COMPUTE UNITS INITIALLY INTRODUCED

When normal wastage is 10% 5% and 8% inputs respectively. There were

3933 units of insides stock and there was no abnormal loss or
effectiveness in any of the process, so what we have to do we have to use
the rates of normal losses to find out the production outputs so we will go
in this way.

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We have to imagine the inputs as 100 units we will apply the rate of loss
on it and we will ascertain a output of the final product and we will
equate the units with this figure. So we can get the input value at the
beginning of the process, so let’s see how this working is going on.

Suppose the initial input is 100 unit so for the process 1 input is 100 loss
figure is given less 10% so output is coming as 90 then this output will
become the input for process second so input for the process 2nd will be
90 and the loss percentage is 5% under process 2, so 5% of 90 is 4.5 the
output will come as 85.5 this output will again become input for process
3rd so input for process 3rd will be 85.5 when will apply the normal loss
rate and it is 8% for the process 3rd so 8% of 85.5 is 6.84 so the final
output is coming as 78.66. If output of process 3rd is 78.66 we have input
as 100 Rs if the output of process 3rd is 1 we can write that input will be
100/78.66 and given that the output of process 3rd is 3933 we can find out
the input of process 1 as 100/78.66X3933 it will be 5000 units.

With this we have learn all the difficult calculations aspect of process
costing.

8. SUMMARY
Now let us summaries what we have learn in today’s lecture.

We have learn the elements of cost using the process costing the features
of process costing the way the process costing is carrying on i.e. is the
costing treatment how output of the first process become the input of
second process and finally finished product comes out and the treatment
of normal loss and abnormal loss and abnormal gain with theirs meaning
and computation.

We have learned in detail the computation of reverse units to be known

as i.e. we have learned the computation of finding out the input in the
beginning of the process by applying the reverse calculations

Thank you!

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