Process Costing

1
 Process costing
• Process costing is a form of operation costing
used where production follows a series of
sequential processes.
• Example include oil refinery, food processing,
paper making and glass manufacturing.

2
Direct material
Direct labour
overheads Process 1

Direct material
Direct labour
overheads Process 2

Direct material
Direct labour
overheads Process 3

Finished goods Cost of goods sold

3
Accounting for Process Costing
• Costs are accumulated by each process
• Each process maintains its process account
• The process account is debited with the costs
incurred and credited with goods completed and
transferred to other process account
• When the goods are completed, they will be
transferred to finished goods account
• When the goods are sold, the amount will be
transferred to the cost of goods sold account

4
 Process A Process B
Material 500 Process B 800 Process A800 Process C 1100
Labour 100 Material 50
Overhead200 Labour 150
Overhead100
800 800
1100 1100

Process C Finished Goods

Process B 1100 Finished Gds 1500 Process C 1500 Cost of GDs
Material 80 Sold 1300
Labour 110 Bal c/d 200
Overhead 210
1500 1500 1500 1500

5
 Accounting for losses and scrap
in process account
With many forms of production the quantity, weight or volume
of the process output will be less than the input due to:
a. evaporation, residuals, ash,
b. Unavoidable handling, breakage and spoilage losses
c. Withdrawal for testing and inspection

6
 Accounting for losses in process costing
• Nature of losses
– Normal loss
• Loss are in accordance with normal practice, standard
levels
– Abnormal loss
• Losses are above expectation

7
 Accounting for scrap
• Damaged goods may be sold as scrap
• Revenue arising from the scrap should be
treated as a reduction in cost (credited to the
process account) rather than an increase in
sales revenue

8
Transactions Description Accounting
entries
Normal loss Losses within No entry
expected level
Abnormal loss Excess loss over Dr. Abnormal
the expected level loss
Cr. Process
account
Abnormal gain Gain resulted when Dr. Process
the actual loss is account
less than the Cr. Abnormal
normal or gain
expected loss
9
Transactions Description Accounting
entries
Scrap value of Reducing material Dr. Scrap
normal loss cost Cr. Process
account
Scrap value of Reduce cost of Dr. Scrap
abnormal loss abnormal loss Cr. Abnormal
loss
Loss of scrap The actual units Dr. Abnormal
value due to sold as scrap will gain
abnormal gain be less than the Cr. Scrap
scrap value of
normal loss 10
Transactions Accounting Accounting
treatment entries
Actual cash Reducing material Dr. Cash
received from cost Cr. Scrap
the sale of
scrap

11
Example

12
A food manufacturing process has a normal loss of 5%
which can be sold as animal feedstuff at 5$ tonne.
In a given period the following data were given.

• Cost for Process 1

Input Materials: 160 tones at $23 per tone
Labour and overheads $2896
Losses were at the normal level.
Compute the cost per tone

13
 Tones $
Input materials 160 3680
Labour and Overhead 2896
Less Normal loss 5% ( 8) (40)
Good Production 152 6536

cost per tone of good production = 6536/152

43

14
 Process account
Units $ Units $
Materials 160 3680 Good production 152 6536
Labour and Scrap A/C 8 40
Overhead 2896
160 6576 160 6576

Scrap Sales account

Process A/C 40

15
 Abnormal process losses
• Abnormal losses are those losses above the level deemed to
be normal loss rate for the process and the opposite is the
abnormal gain.
Abnormal loss(gain) = Actual loss- Normal loss
Abnormal conditions should be excluded from routine reporting
and only normal costs charged to production.

16
 Example 2
• Assume the same data as in Example 1 except
that actual production was 148 tones.
Compute the abnormal loss and show the
relevant accounts.
• Solution
Abnormal loss= Actual loss – Normal loss
=12-8
= 4 tones
Abnormal losses are valued at the same cost as good
production(43$ per tone)

17
 Process account
Units $ Units $
Materials 160 3680 Good production 148 6334
Labour and Normal loss 8 40
Overhead 2896 Abnormal loss 4 172
160 6576 160 6576

Abnormal losses account

Process A/C 172 Scrap sales 20
P&L 152
172 172
Scrap Sales account
Process A/C 40
Abnormal loss A/C 20

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 Example 3
• Assume the same data as Example 1 except
that actual production was 155 tones .
• Solution
Abnormal gain = Actual loss – Normal loss
= 5-8
= 3 tones
These gains are valued at the same rate as good production

19
 Process account
Units $ Units $
Materials 160 3680 Good production 155 6665
Labour and
Normal loss 8 40
Overhead 2896
Abnormal gains 3 129
163 6705 163 6705
Abnormal Gains account
Scrap sales 15 Process A/C 129
P&L 114
129 129
Scrap Sales account
Process A/C 40 Abnormal gain A/C 15

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Equivalent units and cost elements

21
 Equivalent units of production
• If there is no opening or closing work in
progress (WIP) the unit cost of products can
be obtained as follows

Unit Cost = Sum of production costs

Production quantity

22
• However, If there is opening or closing work in
progress, the partly completed production will have a
lower cost than the fully completed production.
• We have to convert the WIP into finished equivalent
units of production (EUP) have to be completed.

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Example

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Assume that in a given period production was 2200
completed units and 600 partly complete. The partly
Complete units were deemed to be 75% complete.

Equivalent units of production

2200 units completed 2200
600 units were 75% completed 450
2650

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 Equivalent Units and Cost Elements
In a given period production and cost data were as follows.
Costs
Material 5115
Labour 3952
Overheads 3000
12067
Production was 1400 fully complete units and 200 partly
complete. The degree of completion of the 200 units WIP
Was as follows.
Material 75% complete
Labour 60% complete
Overheads 50% complete
Calculate the total equivalent production, the cost per
complete unit and the value of the WIP.
26
Cost Equivalent + Fully completed = Total Total Cost per
Element Units in WIP Units Effective Costs Unit
Production

Material 200x75%=150 + 1400 = 1550 5115 3.3

Labour 200x60%=120 + 1400 = 1520 3952 2.6
OH 200x50%=100 + 1400 = 1500 3000 2.0
12067 7.9

Value of the completed unit =7.9x1400 = 11060

Value of WIP = 12067-11060 = 1007
Cost Equivalent Value of WIP
Element Units in WIP Cost per unit

Material 150 3.3 495

Labour 120 2.6 312
OH 100 2.0 200
1007

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 Exercises
• A firm has two processes 1 and 2
Materials for 12000 items was put into process 1. There were no
opening stock and no process losses and there were transfers of 9000 items
to process 2. The unfinished items were fully complete as to material and
50% complete as to labor and overhead. The cost of process 1 were direct
material Rs. 36000, direct labor Rs. 32000 and overhead Rs. 8000.
Process 2 completed 7600 items and there were 600 scrapped
which was considered normal. The balance was unfinished and deemed to be
25% complete in labor and overheads. The costs for process 2 were; labour
Rs. 28500 and overheads Rs. 14000.
You are required to prepare process accounts for each process.

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 Workings- Process 1
Units Material Labour Overhead Total
Fully complete 9000 9000 9000 9000
WIP- Material (100%) 3000 3000
Labour (50%) 1500
Overheads 1500
Total Equivalent units 12000 10500 10500 12000
Costs Rs 36000 Rs. 32000 Rs. 8000 Rs 76000
Cost per unit Rs. Rs. 3 Rs. 3.048 Rs. 0.762 Rs. 6.81
Cost of complete units:
9000*6.81= Rs. 61290
Cost of WIP
(3000*3)+(1500*3.048)+(1500*0.762) =Rs. 14715

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 Process 1
Units Rs Units Rs
Material Input 12000 36000 Process 2 9000 61290
Labour 32000 WIP 3000 14710
Overheads 8000
12000 76000 12000 76000

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 Workings- Process 2
Units Material Labour Overhead Total
Fully complete 7600 7600 7600 7600
Normal loss 600
WIP- Material (100%) 800 800
Labour (25%) 200
Overheads(25%) 200
Total Equivalent units 8400 7800 7800 9000
Costs Rs 61290 Rs. 28500 Rs. 14000 Rs 103,790
Cost per unit Rs. Rs. 7.3 Rs. 3.654 Rs. 1.795 Rs. 12.749
Cost of complete units:
7600*12.749= Rs. 96892
Cost of WIP
(800*7.3)+(200*3.654)+(200*1.795) =Rs. 6898

31
 Process 2
Units Rs Units Rs
Material Input (Pro 1) 9000 61290 Finished goods 7600 96892
Labour 28500 Normal loss 600
Overheads 14000 WIP 800 6898
9000 103790 9000 103790

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 Three categories in determining the
equivalent units of production
• Opening work in progress
• Scrapped units
• Closing work in progress

33
 Opening work in progress (OWIP)
• If there are closing WIP at the end of one period, there will be
opening WIP at the beginning of the next period. This OWIP is
partly complete and will have a value brought forward from
the previous period. Naturally in most practical situations
there is both opening and closing WIP and in such cases the
problem arises of how to value the closing WIP and
completed units.

34
 Two methods of cost flows in process
costing
• First-in-First out
• Weighted average cost

35
First-in-first-out
method
The opening work in
progress is the first group
of units to be processed and
completed during the
current period
It separates the cost
computations of the opening
work in progress and the
current period production
Weighted average
method
The opening work in
progress is merged with the
production of the current
period to form one batch of
production
The average cost per unit of
the opening work in progress
and the current period
production is the same
36
First-in-first-out
method
The EUP computation ignores
the work performed on the
opening work-in-progress
during the prior period
Cost per unit
= Current cost
EUP
CWIP is valued at current period
cost
Weighted average
method
The EUP computation
includes all work performed
on the opening work-in-
progress during the prior
period
Cost per unit
= Cost of OWIP + Current Cost
EUP
CWIP is valued at both current
cost and OWIP cost
37
 Example 05
Process 2 receives units from process 1 and after carrying out
work on the units transfers them to process 3. For one
accounting period the relevant data were as follows.
OWIP 200 units (25% complete) valued at $2500.
800 units received from process 1 valued at $ 4300
840 units were transferred to process 3
CWIP 160 units (50% complete)
The cost of the period were $ 16580 and no units were scraped.
Prepare process accounts for process 2 using
1. The FIFO method
2. Average cost method

38
 Solution FIFO
640 640
Completed units
200x75% 150

Work contain in CWIP 160x50% 80

870

Period cost per unit = total cost for period

Effective units for period

= 16580+4300
870
= 24
Value of the closing WIP is 160 x 50% x 24 = 1920
39
 Solution Cont.…
The valuation of the number of complete units transferred to process 3 is found
from the balance on the process account as follows.

Process 2 account
Units $ Units $
Opening WIP B/F 200 2500
Receipts from process 1 840 21460
Receipts from process 1 800 4300
Process costs 16580 Opening WIP B/F 160 1920

1000 23380 1000 23380

The transferred value of 21460 is 1300 greater than the period cost per unit
21460-(840x24). This is the amount by which the opening WIP valuation is greater
than the current period cost. 2500-(200x25%x24)= 1300
Thus the closing WIP is valued at 24 per unit.

40
 Solution Using Average Cost Method
Completed units 840

Work contain in CWIP 160x50% 80

920
Period cost per unit = total cost including OWIP
Effective units Produced
= 2500+16580+4300
920
= 25.413
Value of the closing WIP is 160 x 50% x 25.413 = 2033
Transferred to process 3 = 840x25.413= 21347

41
 Solution Using Average Cost Method

Process 2 account
Units $ Units $
Opening WIP B/F 200 2500
Receipts from process 1 840 21347
Receipts from process 1 800 4300
Process costs 16580 Opening WIP B/F 160 2033

1000 23380 1000 23380

According to ACM , the value of the closing stock increase and reduce the value of
transfers to process 3. this is because the previous period cost levels were higher
than the current cost level.

42
 Example

Treatment of OWIP and CWIP where

WIP is broken down into its various
elements

43
• At the beginning of period 2 there were 800 units partly completed which had
the following values.
Value % age of completion
Input material (from Process X) 8200 100
Material introduced 5600 55
Labour 3200 60
Overhead 2400 45
During the period 4300 units were transferred from process X at a value of 46500 and the
costs were:
Material Introduced 24000
Labour 19500
Overhead 18200
At the end of the period, the closing WIP was 600 units which were at the following stages
of Completion.
Input material (from Process X) 100
Material introduced 50
Labour 45
Overhead 40
The balance of 4500 units were transferred to finish goods
Calculate the value transferred to Finished goods and the value of WIP

44
Solution Using FIFO
Cost completed Equivalent Equivalent = Total Total Cost per
Element Units + Units in - units in Effective Costs Unit
CWIP OWIP Production

Input Material 4500 + 600 - 800 = 4300 46500 10.814

Materi intro 4500 + 300 - 440 = 4360 24000 5.505
Labour 4500 + 270 - 480 = 4290 19500 4.545
OH 4500 + 240 - 360 = 4380 18200 4.155
25.019

Closing Stock Valuation 600 units

Input Material = 100% complete = 600 x 10.814 = 6488

Material Introduced = 50% complete = 300 x 5.505 = 1651
Labour = 45% complete = 270 x 4.545 = 1227
OH = 40% complete = 240 x 4.155 = 997
10363

45
 Process Y account (FIFO)
Units $ Units $
Opening WIP B/F 800 19400
Transfers to FG 4500 117237
Receipts from process X 4300 46500
Material Introduced 24000 Closing WIP B/F 600 10363
Labour 19500
OH 1 8200
5100 127600 5100 23380

46
Solution Using Average Cost Method
Cost Equivalent units Fully Complete Total
Element in closing WIP + units + Effective
production

Input Material 600 x 100% = 600 + 4500 = 5100

Materi intro 600 x 50% = 300 + 4500 = 4800
Labour 600 x 45%= 270 + 4500 = 4770
OH 600 x 40%=240 + 4500 = 4740

Cost Opening WIP Period Total cost Per Unit

Element + cost = Cost

Input Material 8200 + 46500 = 54700 10.725

Materi intro 5600 + 24000 = 29600 6.167
Labour 3200 + 19500 = 22700 4.759
OH 2400 + 18200 = 20600 4.346
19400 108200 = 127600 25.997

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Value of the completed production
4500 x 25.997 = 116,987

Value of the closing WIP

Total cost – value of the completed production
127600-166987 = 10613

or

Input Material = 100% complete = 600 x 10.725 = 6435

Material Introduced = 50% complete = 300 x 6.167 = 1850.1
Labour = 45% complete = 270 x 4.759 = 1284.93
OH = 40% complete = 240 x 4.346 = 1043.04
10613.07

48
 Process Y account (FIFO)
Units $ Units $
Opening WIP B/F 800 19400
Transfers to FG 4500 116987
Receipts from process X 4300 46500
Material Introduced 24000 Closing WIP B/F 600 10613
Labour 19500
OH 1 8200
5100 5100 127600
127600

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 Example

Treatment of OWIP and CWIP where

WIP is broken down into its various
elements and normal/abnormal
losses

50
• The following data relate to process 2 for one accounting period
Process 2 receives units from process 1 and after Processing transfers them to
process 3.
OWIP 600 units Value % age of completion
Input material (from Process X) 720 100
Material introduced 500 60
Labour 340 50
Overhead 270 40
Transfers from process 1: 4100 units valued at 5200.
Transfers to process 3: 3500 units
Material Introduced 2956
Labour 2200
Overhead 1900
At the end of the period, the closing WIP was 800 units which were at the following stages
of Completion.
Input material 100
Material introduced 60
Labour 50
Overhead 40

51
• 400 units were scraped at following stages of completion
% age of completion
Input material 100
Material introduced 100
Labour 40
Overhead 30
Normal loss is 10% of production and the scrapped units realized 40 cents each.
It is required to prepare the process accounts for process 2 using
The FIFO method
The average cost method

52
 Solution to example using FIFO method

• Production for the period

Opening WIP 600
Transfers in 4100
4700
- CL WIP 800
- Production 3900
- Normal loss 3900x 10% = 390 units
- Ab Loss 400-390 = 10 units

53
Calculation of effective units & cost per unit
Cost Completed + Equiv Equiv Equiv Total Total Cost per
Element Units units + units in - Units in = Effective Costs Unit
in CWIP AB loss OWIP Production

Material 3500 + 800 + 10 - 600 = 3710 5100 1.402

Materi Intro 3500 + 480 + 10 - 360 = 3630 2800* 0.771
Labour 3500 + 400 + 4 - 300 = 3604 2200 0.610
OH 3500 + 320 + 3 - 240 = 3583 1900 0.530

* This is the cost of the material introduced, 2956, less

the resale value of the normal loss, 156 (390@40)

54
 Closing WIP Valuation 800units

Input Material = 100% complete = 800 x 1.402 = 1121.29

Material Introduced = 60% complete = 480 x 0.771 = 370.25
Labour = 50% complete = 400 x 0.610 = 244.17
OH = 40% complete = 320 x 0.530 = 169.69
1905.40

Abnormal Loss Valuation 10units

Input Material = 100% complete = 10x 1.402 = 14.02

Material Introduced = 100% complete = 10 x 0.771 = 7.71
Labour = 40% complete = 4 x 0.612 = 2.44
OH = 30% complete = 3 x 0.530 = 1.59
25.75

55
 Process Y account (FIFO)
Units $ Units $
Opening WIP B/F 600 1830 Normal loss 390 156
Receipts from process 1 4100 5200 Abnormal loss 10 26
Material Introduced 2956 Transfers to FG 3500 11999
Labour 2200 Closing WIP B/F 800 1905
OH 1 900
4700 4700 14086
14086

56
Solution Using Average Cost Method
Cost Equivalent units Equivalent units Fully Complete Total
Element in closing WIP + in AB loss + units = Effective
production

Input Material 800 x 100% = 800 + 10 + 3500 = 4310

Materi intro 800 x 60% = 480 + 10 + 3500 = 3990
Labour 800 x 50% = 400 + 04 + 3500 = 3904
OH 800 x 40% = 320 + 03 + 3500 = 3823

Cost Opening WIP Period Total cost Per Unit

Element + cost = Cost

Input Material 720 + 5200 = 5920 1.35

Materi intro 500 + 2800 = 3300 0.827
Labour 340 + 2200 = 2540 0.651
OH 270 + 1900 = 2170 0.568

57
 Closing WIP Valuation 800 units

Input Material = 100% complete = 800 x 1.35 = 1098.83

Material Introduced = 60% complete = 480 x 0.827 = 396.99
Labour = 50% complete = 400 x 0.651 = 260.24
OH = 40% complete = 320 x 0.568 = 181.64
1937.70

Abnormal Loss Valuation 10 units

Input Material = 100% complete = 10x 1.35 = 13.73

Material Introduced = 100% complete = 10 x 0.827 = 8.27
Labour = 40% complete = 4 x 0.651 = 2.60
OH = 30% complete = 3 x 0.568 = 1.704
26.30

58
 Completed production 3500 units

Input Material = 3500 x 1.35 = 4807.42

Material Introduced = 3500 x 0.827 = 2894.74
Labour = 3500 x 0.651 = 2277.15
OH = 3500 x 0.568 = 1986.66
11965.97

59
 Process Y account (FIFO)
Units $ Units $
Opening WIP B/F 600 1830 Normal loss 390 156
Receipts from process 1 4100 5200 Abnormal loss 10 26
Material Introduced 2956 Transfers to FG 3500 11966
Labour 2200 Closing WIP B/F 800 1937
OH 1 900
4700 4700 14086
14086

If instead of the abnormal loss there had been an abnormal gain the treatment
Would be to find the EUP less the AG units. These units would be calculated at the
Cost per unit calculated and the process account debited with the abnormal gain.

60
• A firm has two processes 1 and 2
Material for 12000 items was put into process 1. there were no opening stocks and no
process losses and there were transfers of 9000 items to process 2. the unfinished
items were complete as to material and 50% complete as to labour and overhead. The
costs of process 1 were direct material Rs.36000, direct labour Rs. 32000 and OH Rs.
8000.
Process 2 completed 7600 units and there were 600 units scrapped which
was considered normal. The balance was unfinished and deemed to be 25% complete
in labour and OH. The costs for process 2 were; labour Rs. 28500 and OH Rs. 14000.
You are required prepare process accounts for each process.

61
END

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