Process Costing

Process cost systems are used to apply costs to similar

products that are mass-produced in a continuous
fashion.

In a process costing environment, finished units are

normally indistinguishable from each other.
Process Costing
 Used by businesses that mass-produce one product or
a small range of almost identical products
 Involves a number of processes that are performed
repetitively
 Used by oil refineries, food processors, manufactures of
tobacco, chemicals and paper
Job Order versus Process Cost
Systems
 In a job order cost system, costs are assigned to each
job.
 In a process cost system, costs are tracked through a
series of connected manufacturing processes or
departments, rather than by individual jobs.
 Thus, process cost systems are used when a large
volume of uniform, or relatively homogeneous,
products are produced.
 Job Order Cost and Process Cost
Flow
Job Order Cost Flow
Work in Process
Direct Materials
Inventory
Direct Labor Finished Goods
Job 101 Cost of Goods Sold
Manufacturing Inventory
Job 102
Overhead
Job 103

Process Cost Flow

Direct
Materials Work in Work in Finished
Direct Labor Cost of Goods
Process - Process - Goods
Manufacturing Sold
Department A Department B Inventory
Overhead
 Process Cost Flow
Manufacturing Work in Process
Finished Goods
Costs Production
Inventory
Department A
Raw Materials
assigned
Factory Labor Costs Cost of
to transferred Goods
Manufacturing out to Sold
Overhead

Work in Process
Production Cost of
Department B Goods Sold

Cost of
complete
d work
 Process Cost Flow
Tyler Company uses a process cost system to account for its
manufacture of automatic can openers.
 Manufacturing consists of two processes: Machining and
Assembly. Materials, labor, and manufacturing overhead can
be added in both departments.
 When the Machining Department finishes its work, the
partially completed units are transferred to the Assembly
Department.
 In the Assembly Department, the goods are finished and are
then transferred to Finished Goods.
 Upon sale, the goods are removed from Finished Goods and
become Cost of Goods Sold.
Assignment of Manufacturing
Costs
 As indicated earlier, the accumulation of the costs of
materials, labor, and manufacturing overhead is the same
in a process cost system as in a job order cost system.
 All raw materials are debited to Raw Materials when
purchased. All factory labor is debited to Factory Labor
when the labor costs are incurred. Overhead costs are
debited to Manufacturing Overhead as they are incurred.
 However, the assignment of the three cost elements to
Work in Process in a process cost system is different from
a job order system.
Problem
 Prepare process accounts and calculate total cost of
production.
Process X Process Y Process Z
Rs. Rs. Rs.

Materials 2250 750 300

Labour 1200 3000 900
Direct Expenses
Fuel 300 200 400
Carriage 200 300 100
Works overheads 1890 2580 1875

•The indirect expenses Rs. 1275 should be apportioned on

the basis of wages.
When there is Process Losses
 When the output of one process is less then the
input of that process, then there is process loss.
 Two types:
 Normal Loss
 Abnormal Loss (actual loss more than
expected normal loss)
 Abnormal gain (actual loss less than
expected normal loss)
Normal Loss
 Determined as % of input
 Sold at scrap value
 Credited to the Process a/c.
 The following information is given in respect of the
process A:
 Material – 1000 kg @ Rs. 6 per Kg.
 Labour – Rs. 5,000
 Direct Expenses – Rs, 1,000
 Indirect Expenses – Rs. 1,000
 Normal wastage – 10 % of input.
 Prepare a Process A a/c when scrap raising out of the
normal loss has a sale value of Re. 1 per unit.
Abnormal Loss
 Arises due to carelessness, accidents, breakdown.
 Transferred to Costing Profit and Loss a/c.
 Steps to calculate:
 Allow the normal loss treatment
 After the normal loss, calculate the cost per unit
 =( Total cost – value of normal loss)/(unit introduced
– normal loss units)
 Multiply cost per unit with abnormal loss units.
 The process a/c is credited with abnormal loss amount
and units
 The balancing fig. is the cost of goods units produced
in the process.
 For abnormal loss a/c
 Debit the abnormal loss units and amount
 Credit the sales proceed of abnormal loss units
 Balancing fig left is net loss transferred to costing profit
and loss a/c.
 50 units introduced into Process A at the cost of Re.1
each. The other expenses incurred is Rs. 30. Of the
units introduced 10 % are normal wastage in the
course of production which has a scrap value of Re.
0.25 each. Owing to an accident, only 40 units are
produced.
 Prepare a Process a/c and abnormal loss a/c.
Abnormal gain
 When actual loss is less than the normal loss, then it is
abnormal gain.
 Abnormal gain a/c is debited to process a/c.
 Abnormal gain a/c is credited with the same and
debited with the normal loss rate (shortfall) and
costing profit and loss a/c.
 50 units introduced into Process A at the cost of Re.1
each. The other expenses incurred is Rs. 30. Of the
units introduced 10 % are normal wastage in the
course of production which has a scrap value of Re.
0.25 each. Owing to an accident, only 47 units are
produced.
 Prepare a Process a/c and abnormal gain a/c.
Equivalent Units of Production
Equivalent units of production measure the work
done during the period, expressed in fully completed
units.

This concept is used to determine the cost per unit of

completed product.
Equivalent Units of Production
There are two methods of computing equivalent units.
 The weighted-average method is the method most
widely used in practice.
 The FIFO method is less frequently used.
Weighted-average Method
The weighted-average method considers the
degree of completion (weighting) of the units
completed and transferred out and the ending work
in process.

The formula to compute equivalent units of

production is:

Units Completed Equivalent Units of

+ = Equivalent Units of
and Transferred Ending Work in
Production
Out Process
 Weighted-average Method:
Examples
To better understand this concept of equivalent units,
consider the following two examples:
Example 1: The Blending Department’s entire output during the
period consists of ending work in process of 4,000 units which
are 60% complete as to materials, labor, and overhead.
The equivalent units of production for the Blending Department
are therefore 2,400 units (4,000 X 60%).

Example 2: The Packaging Department’s output during the

period consists of 10,000 units completed and transferred out,
and 5,000 units in ending work in process which are 70%
completed.
The equivalent units of production for the Packaging
Department are therefore 13,500 [10,000 + (5,000 X 70%)].
Refinements on the Weighted-
average Method
When materials are not added evenly throughout
the processing (such as when all materials are
added at the beginning of a process), Work in
Process at the end of the period will have different
completion percentages for materials and
conversion costs (labor and overhead). Two
equivalent unit computations will then be
needed.
Refinements on the Weighted-
average Method
The earlier formula used to compute equivalent units of
production can be refined to show the computations for
materials and conversion costs, as follows:

Equivalent Units of
Units Completed Equivalent Units of
+ Ending Work in =
and Transferred Production -
Process -
Out - Materials Materials
Materials

Equivalent Units of
Units Completed and Equivalent Units of
+ Ending Work in =
Transferred Out - Production -
Process -
Conversion Costs Conversion Costs
Conversion Costs
Refined Weighted-average
Method: Example
To better understand this refined concept of
equivalent units, consider the following example:
 Kellogg Company makes Eggo® Waffles. Three departments are used
to produce these waffles: Mixing, Baking, and Freezing & Packaging.
The following information relates to the Mixing Department.

Percentage Complete

Physical Units Materials Conversion Costs

Work in process, June 1 100,000 100% 70%
Started into production 800,000
Total units 900,000
Units transferred out 700,000
Work in process, June 30 200,000 100% 60%
Total units 900,000
Refined Weighted-average
Method: Example
 The previous slide indicates that the beginning work in
process is 100% complete as to material cost and 70%
complete as to conversion costs. In other words, all of the
materials are added at the beginning of the process, while the
conversion costs are incurred uniformly throughout the
process and are 70% complete at the end of the period.
 The units transferred out to the Mixing Department are
fully complete as to both materials and conversion costs.
 The ending work in process is fully complete as to materials,
but only 60% complete as to conversion costs.
Refined Weighted-average
Method: Example
Two equivalent unit computations are therefore
necessary: one for materials and the other for conversion
costs. These computations are shown below:

Equivalent Units
Materials Conversion Costs
Units transferred out 700,000 700,000
Work in process, June 30
200,000 X 100% 200,000
200,000 X 60% 120,000
Total equivalent units 900,000 820,000

Notice that in computing equivalent units, the

beginning work in process is not part of the formula.
Production Cost Report
A production cost report is the key document used by
management to understand the activities in a
department because it shows the production quantity
and cost data related to that department.

For example, in producing Eggo® Waffles, Kellogg

Company would have three production cost reports:
Mixing, Baking, and Freezing & Packaging.
Production Cost Report
In order to be ready to complete a production cost
report, the company must perform four steps:
1 Compute the physical unit flow.
2 Compute the equivalent units of production.
3 Compute unit production costs.
4 Prepare a cost reconciliation schedule.
As a whole, these four steps make up the process costing
system.
Comprehensive Example of
Process Costing: Data
Mixing Department
Units:
Work in process, June 1 100,000
Direct materials: 100% complete
Conversion costs: 70% complete
Units started into production during June 800,000
Units completed and transferred out to Baking 700,000
Work in process, June 30 200,000
Direct materials: 100% complete
Conversion costs: 60% complete

Costs:
Work in process, June 1 Rs.
Direct materials: 100% complete 50,000
Conversion costs: 70% complete 35,000
Cost of work in process, June 1 85,000
Costs incurred during production in June
Direct materials 400,000
Conversion costs 170,000
Costs incurred in June 570,000
Compute the Physical Unit Flow
(Step 1)
 Physical units are the actual units to be accounted for
during a period, irrespective of any work performed.
Add the units started into production during the period
to the units in process at the beginning of the period.
This amount is referred to as the total units to be
accounted for.
 These units are then accounted for by the output of the
period, which consists of units transferred out during
the period, and any units in process at the end of the
period. This amount is referred to as the total units
accounted for.
Compute the Physical Unit Flow
(Step 1)
The flow of physical units for Kellogg Company
for the month of June in the Mixing Department
are shown below:
Mixing Department
Physical Units
Units to be accounted for
Work in process, June 1 100,000
Started (transferred) into production 800,000
Total units 900,000
Units accounted for
Completed and transferred out 700,000
Work in process, June 30 200,000
Total units 900,000
Compute Equivalent Units (Step 2)
 Once the physical flow of the units is established, it is
necessary to measure the Mixing Department’s
productivity in terms of equivalent units of
production.
 In the Mixing Department, materials are added at the
beginning of the process. Thus, two computations of
equivalent units are required: one for materials and
one for conversion costs.
Compute Equivalent Units (Step 2)
The equivalent unit computation is as follows:
(Remember that beginning work in process is ignored
in this computation.)

Equivalent Units

Materials Conversion Costs

700,000 700,000
Units transferred out
Work in process, June 30
200,000
200,000 X 100%
120,000
200,000 X 60%
Total equivalent units 900,000 820,000
Compute Unit Production Costs
(Step 3)
 Armed with the knowledge of the equivalent units of
production, now compute the unit production costs.
Unit production costs are costs expressed in terms of
equivalent units of production.
 When equivalent units of production are different for
materials and conversion costs, three unit costs are
computed: (1) materials, (2) conversion, and (3) total
manufacturing.
Compute Unit Production Costs
(Step 3)
The computation of total materials cost related to
Eggo® Waffles is as follows:
Work in process, June 1
Direct materials costs Rs 50,000
Costs added to production during June
Direct materials costs 400,000
Total materials costs 450,000

The computation of unit materials cost is as follows:


Total Materials Equivalent Units of = Unit Materials Cost
Cost Materials

Rs.450,000  900,000 = Rs0.50

Compute Unit Production Costs
(Step 3)
The computation of total conversion costs is as
follows:
Work in process, June 1
Conversion costs Rs 35,000
Costs added to production during June
Conversion costs 170,000
Total conversion costs Rs.205,000

The computation of unit conversion cost is as follows:


Total Conversion Equivalent Units of = Unit Conversion
Cost Conversion Costs Cost

Rs.205,000  820,000 = Rs0.25

Compute Unit Production Costs
(Step 3)
Total manufacturing cost per unit is therefore
computed as follows:

Total
Unit Conversion =
Unit Materials Cost
+ Costs
Manufacturing
Cost per Unit

Rs0.50 + Rs.0.25 = Rs0.75

Prepare a Cost Reconciliation Schedule
(Step 4)
We are now ready to determine the cost of goods
transferred out of the Mixing Department to the Baking
Department and the costs in ending work in process.
The total costs that were charged to the Mixing
Department in June are as follows:

Rs.
Costs to be accounted for
Work in process, June 1 85,000
Started into production 570,000
Total costs 655,000
Prepare a Cost Reconciliation Schedule
(Step 4)
The total costs charged to the Mixing Department in June are
therefore 655,000.
A cost reconciliation schedule is then prepared to assign these
costs to (1) units transferred out to the Baking Department and (2)
ending work in process.
Mixing Department
Cost Reconciliation Schedule( in Rs.)

Costs accounted for

Transferred out (700,000 x 0.75) 525,000
Work in process, June 30
Materials (200,000 x 0.50) 100,000
Conversion costs (120,000 x0.25) 30,000
130,000
Total costs 655,000
Prepare a Cost Reconciliation Schedule
(Step 4)
 The total manufacturing cost per unit of 0.75 is
used in costing the units completed and transferred
to the Baking Department.
 In contrast, the unit cost of materials and the
unit cost of conversion are needed in costing
units in process.

The cost reconciliation schedule shows that the total costs

accounted for equal the total costs to be accounted for.
Preparing the Production Cost
Report
 Preparation of the production cost report for the
Mixing Department.
 As indicated earlier, this report is an internal
document for management that shows production
quantity and cost data for a production
department.
 The production cost report for the Mixing
Department is shown on the next two slides. The
four steps in preparing the report are highlighted.
Production
Cost Report
Mixing Department
Production Cost Report
For the Month Ended June 30

Physical Units Equivalent Units

Step 1 Step 2
QUANTITIES
Units to be accounted for Materials Conversion Costs
Work in process, June 1 100,000
Started into production 800,000
Total units 900,000
Units accounted for
Transferred out 700,000 700,000 700,000
Work in process, June 30 200,000 200,000 120,000
Total Units 900,000 900,000 820,000
Mixing Department
Production Cost Report
For the Month Ended June 30,
COSTS(in Rs.) Conversion
Units costs Step 3 Materials Costs Total
Costs in June (a) 450,000 205,000 655,000
Equivalent units (b) 900,000 820,000
Unit costs (a)  (b) 0.50 0.25 0.75
Costs to be accounted for
Work in process, June 1 85,000
Started into production 570,000
Total costs 655,000
Cost Reconciliation Schedule Step 4
Costs accounted for
525,000
Transferred out (700,000 x 0.75)
Work in process, June 30
100,000
Materials (200,000 x 0.50)
30,000
Conversion costs (120,000 x 0.25)
130,000
Total costs
655,000
Production Cost Report
 Production cost reports provide a basis for
evaluating the productivity of a department.
 In addition, the cost data can be used to assess
whether unit costs and total costs are reasonable.
 When the quantity and cost data are compared with
predetermined goals, top management can also
ascertain whether current performance is meeting
planned objectives.