PROCESS COSTING

■ Process costing is a costing method used where it is not possible to identify separate units of
production, or jobs, usually because of the continuous nature of the production processes
involved.

Process costing is used where there is a continuous flow of

identical units and it is common to identify it with
continuous production such as the following.
• Oil refining
• The manufacture of soap
• Paint manufacture
• Food and drink manufacture
■ CIMA Official Terminology
– Process costing is a 'form of costing applicable to continuous processes where process costs are
attributed to the number of units produced.
– This may involve estimating the NUMBER OF EQUIVALENT UNITS in stock at the start
and end of the period under consideration.'
1. Features of process costing
■ The features of process costing which make it different from other methods of costing such
as job or batch costing are as follows.
– (a) The continuous nature of production in many processes means that there will usually
be closing work in progress which must be valued. In process costing it is not
possible to build up cost records of the cost of each individual unit of output because
production in progress is an indistinguishable homogeneous mass.
– (b) There is often a loss in process due to spoilage, wastage, evaporation and so on.
– (c) The output of one process becomes the input to the next until the finished product
is made in the final process.
– (d) Output from production may be a single product, but there may also be a by-product
(or by-products) and/or joint products.
2. The basics of process costing
■ 1. Process accounts: Costs incurred in processes are recorded in what are known as
process accounts.

A process account has two sides, and on each side there are
two columns – one for QUANTITIES (of raw materials, work
in progress and finished goods) and one for COSTS.
(a) On the left hand side of the process account we (b) On the right hand side of the process account we
record the inputs to the process and the cost of these record what happens to the inputs by the end of the
inputs. period.
(i) Some of the input might be converted into
So we might show the quantity of material input to a finished goods, so we show the units of finished
process during the period and its cost, the cost of labour goods and the cost of these units.
and the cost of overheads. (ii) Some of the material input might evaporate or
get spilled or damaged, so there would be losses.
So we record the loss units and the cost of the
loss.
(iii) At the end of a period, some units of input might
be in the process of being turned into finished units
so would be work in progress (WIP). We record
the units of WIP and the cost of these units.
■ The quantity columns on each side of the account should total to the same amount. Why?
Well think about it. If we put 100 kgs of material in to a process (which we record on the left
hand side of the account) we should know what has happened to those 100 kgs. Some
would be losses maybe, some would be WIP, some would be finished units, but the total
should be 100 kgs.
■ Likewise the cost of the inputs to the process during a period (ie the total of the costs
recorded on the left hand side of the account) is the cost of the outputs of the process. If
we have recorded material, labour and overhead costs totalling $1,000 and at the end of
the process we have 100 finished units (and no losses or WIP), then that output cost
$1,000.
PROCESS ACCOUNT
Units Units $ Units $
Material 1,000 11,000 Closing WIP 200 2,000
Labour 4,000 Finished units 800 16,000
Overhead 3,000
1,000 18,000 1,000 18,000
Example: basics of process costing
■ Suppose that Purr and Miaow Co make squeaky toys for cats. Production of the toys involves
two processes, shaping and colouring.
■ During the year to 31 March 20X3, 1,000,000 units of material worth $500,000 were input to
the first process, shaping. Direct labour costs of $200,000 and production overhead costs of
$200,000 were also incurred in connection with the shaping process.
■ There were no opening or closing inventories in the shaping department. The process account
for shaping for the year ended 31 March 20X3 is as follows.

PROCESS 1 (SHAPING) ACCOUNT

Units $ Units $
Direct materials 1,000,000 500,000 Output to Process 2 1,000,000 900,000
Direct labour 200,000
Production overheads 200,000
1,000,000 900,000 1,000,000 900,000
■ When using process costing, if a series of separate processes is needed to manufacture the
finished product, the output of one process becomes the input to the next until the final
output is made in the final process. In our example, all output from shaping was transferred to
the second process, colouring, during the year to 31 March 20X3. An additional 500,000 units
of material, costing $300,000, were input to the colouring process. Direct labour costs of
$150,000 and production overhead costs of $150,000 were also incurred. There were no
opening or closing inventories in the colouring department. The process account for colouring
for the year ended 31 March 20X3 is as follows.
PROCESS 2 (COLOURING) ACCOUNT
Units $ Units $
Materials from process 1 1,000,000 900,000 Output to finished goods 1,500,000 1,500,000

Added materials 500,000 300,000

Direct labour 150,000
Production overhead 150,000
1,500,000 1,500,000 1,500,000 1,500,000
Direct labour and production overhead may be treated together in an assessment question as conversion cost.

Added materials, labour and overhead in Process 2 are usually added gradually throughout the process.
Materials from Process 1, in contrast, will often be introduced in full at the start of the second process.
3. Framework for dealing with process costing
■ Use our suggested four-step approach when dealing with process costing questions.

Step 1 Determine output and losses

Step 2 Calculate cost per unit of output, losses and WIP

Step 3 Calculate total cost of output, losses and WIP

Step 4 Complete accounts

Process costing is centred around four key steps. The exact

work done at each step will depend on the circumstances of
the question, but the approach can always be used.
Step 1 Determine output and losses
• Determine expected output.
• Calculate normal loss and abnormal loss and gain.
• Calculate equivalent units if there is closing work in progress.
Step 2 Calculate cost per unit of output, losses and WIP
Calculate cost per unit or cost per equivalent unit.
Step 3 Calculate total cost of output, losses and WIP
In some examples this will be straightforward. In cases where there is work in progress, a
statement of evaluation will have to be prepared.
Step 4 Complete accounts
• Complete the process account.
• Write up the other accounts required by the question.
It always saves time in an assessment if you don't have to think too long
about how to approach a question before you begin. This four-step
approach can be applied to any process costing question so it would be
a good idea to memorise it now. It will be useful as a framework for
any workings that you may need to do.
DEALING WITH LOSSES IN PROCESS
■ Losses may occur in process. If a certain level of loss is expected, this is known as normal
loss.
■ If losses are greater than expected, the extra loss is abnormal loss.
■ If losses are less than expected, the difference is known as abnormal gain.
Losses/Gains
■ During a production process, a loss may occur.
– Normal loss is 'expected loss, allowed for in the budget, and normally calculated as a
percentage of the good output, from a process during a period of time. Normal losses are
generally either valued at zero or at their disposal values.'
– Abnormal loss is 'any loss in excess of the normal loss allowance'.
– Abnormal gain is 'improvement on the accepted or normal loss associated with a production
activity'.
■ CIMA Official Terminology

Losses may occur due to wastage, spoilage, evaporation, and so on.

Since normal loss is not given a cost, the cost of producing these units is borne by the 'good' units of output.
Abnormal loss and gain units are valued at the same unit rate as 'good' units. Abnormal events do not therefore affect
the cost of good production.Their costs are analysed separately in an abnormal loss or abnormal gain account.
■ The bookkeeping
– (a) In an abnormal loss account, the debit entry shows the units (and their value) from
the process account.The credit entry shows the impact on the income statement.
– (b) In an abnormal gain account, the debit entry shows the effect on the income
statement, while the credit entry shows the units (and their value) from the process
account.

Example: abnormal losses and gains

Suppose that input to a process is 1,000 units at a cost of $4,500. Normal loss is 10% and there are
no opening or closing inventories. Determine the accounting entries for the cost of output and the
cost of the loss if actual output were as follows.
(a) 860 units (so that actual loss is 140 units)
(b) 920 units (so that actual loss is 80 units)
■ Solution:
– Before we demonstrate the use of the 'four-step framework' we will summarise the way that the
losses are dealt with.
– (a) Normal loss is given no share of cost.
– (b) The cost of output is therefore based on the expected units of output, which in our example
amount to 90% of 1,000 = 900 units.
– (c) Abnormal loss is given a cost, which is written off to the income statement via an abnormal
loss/gain account.
– (d) Abnormal gain is treated in the same way, except that being a gain rather than a loss, it
appears as a debit entry in the process account (as it is a sort of input, being additional
unexpected units), whereas a loss appears as a credit entry in this account (as it is a sort of
output).
 ■ (a) Output is 860 units
Step 1 Determine output and losses Step 4 Complete accounts
If actual output is 860 units and the actual loss is 140 units:
Units PROCESS ACCOUNT
Actual loss 140
Normal loss (10% of 1,000) 100 Units $ Units $
Step 2 Calculate
Abnormal loss cost per unit of output and losses 40 Cost incurred 1,000 4,500 Normal loss 100 0
The cost per unit of output and the cost per unit of abnormal loss Output (finishedgoods a/c)
are based on expected output. 860 x (× $5) 860 4,300
=Costs incurred / Expected output Abnormal loss 40 x ($5) 40 200
= $4,500/900 units 1,000 4,500 1,000 4,500
= $5 per unit
Step 3 Calculate total cost of output and losses
Normal loss is not assigned any cost.
$ ABNORMAL LOSS ACCOUNT
Cost of output (860 × $5) 4,300
Units $ Units $
Normal loss 0
Abnormal loss (40 × $5) 200 Process a/c 40 200 Income statement 40 200
4,500
 ■ (b) Output is 920 units Step 4 Complete accounts

Step 1 Determine output and losses

If actual output is 920 units and the actual loss is 80 units: PROCESS ACCOUNT
Units Units $ Units $
Actual loss 80
Cost incurred 1,000 4,500 Normal loss 100 0
Normal loss (10% of 1,000) 100
Abnormal gain 20 Abnormal gain a/c 20 Output (finished goods a/c)
x (× $5) 20 100 920x (× $5) 920 4,600
Step 2 Calculate cost per unit of output and losses
The cost per unit of output and the cost per unit of abnormal gain are
based on expected output. 1,020 4,600 1,020 4,600
=Costs incurred /Expected output
= $4,500 / 900
= $5 per unit ABNORMAL GAIN
(Whether there is abnormal loss or gain does not affect the valuation of
units of output. The figure of $5 per unit is exactly the same as in the Units $ Units $
previous paragraph, when there were 40 units of abnormal loss.) Income statement 20 100 Process a/c 20 100
Step 3 Calculate total cost of output and losses
$
Cost of output (920 × $5) 4,600
Normal loss 0
Abnormal gain (20 × $5) (100)
4,500
Example: Abnormal losses and gains
■ During a four-week period, period 3, costs of input to a process were $29,070. Input was 1,000
units, output was 850 units and normal loss is 10%.
■ During the next period, period 4, costs of input were again $29,070. Input was again 1,000 units,
but output was 950 units.There were no units of opening or closing inventory.
■ Required Prepare the process account and abnormal loss or gain account for each period.
Step 1 Determine output and losses Step 4 Complete accounts
Period 3 PROCESS ACCOUNT
Units
Units $ Units $
Actual output 850
Period 3
Normal loss (10% × 1,000) 100
Abnormal loss 50 Cost of input 1,000 29,070 Normal loss 100 0
Input 1,000 Finished goods
Period 4 a/c 850 27,455
Units (× $32.30)
Actual output 950 Abnormal loss
Normal loss (10% × 1,000) 100 a/c 50 1,615
Abnormal gain (50) (× $32.30)
Input 1,000
1,000 29,070 1,000 29,070
Step 2 Calculate cost per unit of output and losses
Period 4
For each period the cost per unit is based on expected output.
=Cost of input / Expected units of output Cost of input 1,000 29,070 Normal loss 100 0
= $29,070/ 900 Finished goods
= $32.30 per unit Abnormal gain a/c 50 1,615 a/c 950 30,685
Step 3 Calculate total cost of output and losses (× $32.30) (× $32.30)
Period 3 $
1,050 30,685 1,050 30,685
Cost of output (850 × $32.30) 27,455
Normal loss 0 ABNORMAL LOSS OR GAIN ACCOUNT
Abnormal loss (50 × $32.30) 1,615
29,070 $ $
Period 4 $ Period 3 Period 4
Cost of output (950 × $32.30) 30,685 Abnormal loss in process a/c 1,615 Abnormal gain in process a/c 1,615
Normal loss 0
Abnormal loss in process a/c 1,615 Abnormal gain in process a/c 1,615
Abnormal gain (50 × $32.30) 1,615
There is a zero balance on this account at the end of period 4.
29,070
Example :Cost of output
■ Charlton Co manufactures a product in a single process operation. Normal loss is 10% of
input. Loss occurs at the end of the process. Data for June are as follows.
■ Opening and closing inventories of work in progress Nil
■ Cost of input materials (3,300 units) $59,100
■ Direct labour and production overhead $30,000
■ Output to finished goods 2,750 units
– The full cost of finished output in June was
– A $74,250
– B $81,000
The correct answer is C.
– C $82,500
– D $89,100
Step 1 Determine output and losses
Units
Actual output 2,750
Normal loss (10% × 3,300) 330
Abnormal loss 220
3,300
Step 2 Calculate cost per unit of output and losses

=Cost of input / Expected units of output

= $89,100 / 3,300 -330
= $30 per unit
Step 3 Calculate total cost of output and losses
$
Cost of output (2,750 × $30) 82,500
Normal loss 0
Abnormal loss (220 × $30) 6,600
89,100
Example: Abnormal gain
■ Zed Co makes a product Emm which goes through several processes. The following
information is available for the month of June.
Kg
■ Opening WIP 5,200
■ Closing WIP 3,500
■ Input 58,300
■ Normal loss 400
■ Transferred to finished goods 59,900
– What was the abnormal gain in June?
– A 260 kg
– B 300 kg The correct answer is B.
– C 400 kg The abnormal gain is the balancing figure. 63,800 – 5,200
– D 560 kg – 58,300 = 300
ACCOUNTING FOR SCRAP
■ Scrap is 'discarded material having some value'. CIMA Official Terminology

(a) Revenue from scrap is treated, not as an addition to sales revenue, but as a reduction in costs.
The valuation of normal loss is either at scrap value or nil. It is conventional for the scrap
value of normal loss to be deducted from the cost of materials before a cost per equivalent
unit is calculated.
(b) The scrap value of normal loss is therefore used to reduce the material costs of the process.
DEBIT Scrap account
CREDIT Process account
with the scrap value of the normal loss.

Abnormal losses and gains never affect the cost of good units of
production. The scrap value of abnormal losses is not
credited to the process account, and the abnormal loss and gain
units carry the same full cost as a good unit of
production.
(c) The scrap value of abnormal loss is used to reduce the cost of abnormal loss.
DEBIT Scrap account
CREDIT Abnormal loss account
with the scrap value of abnormal loss, which therefore reduces the write-off of cost to the
income statement.
(d) The scrap value of abnormal gain arises because the actual units sold as scrap will be less than
the scrap value of normal loss. Because there are fewer units of scrap than expected, there will be
less revenue from scrap as a direct consequence of the abnormal gain. The abnormal gain account
should therefore be debited with the scrap value.
DEBIT Abnormal gain account
CREDIT Scrap account
with the scrap value of abnormal gain.
(e) The scrap account is completed by recording the actual cash received from the sale of scrap.
DEBIT Cash received
CREDIT Scrap account
with the cash received from the sale of the actual scrap.
Example: scrap and abnormal loss or gain
A factory has two production processes. Normal loss in each process is 10% and scrapped
units sell for $0.50 each from process 1 and $3 each from process 2. Relevant information for
costing purposes relating to period 5 is as follows.
Direct materials added: Process 1 Process 2
units 2,000 1,250
cost $8,100 $1,900
Direct labour $4,000 $10,000
Production overhead 150% of direct labour cost 120% of direct labour cost

Output to process 2/finished goods 1,750 units 2,800 units

Actual production overhead $17,800
Required:
Prepare the accounts for process 1, process 2, scrap, abnormal loss or gain.
Step 1 Determine output and losses

Process 1 Process 2
Units Units
Output 1,750 2,800
Normal loss (10% of input) 200 300
Abnormal loss 50 -
Abnormal gain - (100)
Input 2,000 3,000*
* 1,750 units from Process 1 + 1,250 units input to process.
Step 2 Calculate cost per unit of output and losses

Process 1 Process 2
$ $
Cost of input
– material 8,100 1,900
– from Process 1 – (1,750 × $10) 17,500
– labour 4,000 10,000
– overhead (150% × $4,000) 6,000 (120% × $10,000) 12,000
18,100 41,400
Less: scrap value of
Normal loss (200 × $0.50) (100) (300 × $3) (900)
18,000 40,500
Expected output
90% of 2,000 1,800
90% of 3,000 2,700
Cost per unit
$18,000 ÷ 1,800 $10
$40,500 ÷ 2,700 $15
Step 3 Calculate total cost of output and losses

Process 1 Process 2
$ $
Output (1,750 × $10) 17,500 (2,800 × $15) 42,000
Normal loss (200 × $0.50)* 100 (300 × $3)* 900
Abnormal loss (50 × $10) 500 –
18,100 42,900
Abnormal gain – (100 × $15) (1,500)
18,100 41,400
* Remember that normal loss is valued at scrap value only.
Step 4 Complete accounts PROCESS 1 ACCOUNT
Units $ Units $
Direct material 2,000 8,100 Scrap a/c (normal loss) 200 100
Direct labour 4,000 Process 2 a/c 1,750 17,500
Production overhead a/c 6,000 Abnormal loss a/c 50 500
2,000 18,100 2,000 18,100

PROCESS 2 ACCOUNT

Units $ Units $
Direct materials: From process 1 1,750 17,500 Scrap a/c (normal loss) 300 900
Added materials 1,250 1,900 Finished goods a/c 2,800 42,000
Direct labour 10,000
Production o'hd 12,000
3,000 41,400
Abnormal gain 100 1,500
3,100 42,900 3,100 42,900
 ABNORMAL LOSS ACCOUNT
$ $
Process 1 (50 units) 500 Scrap a/c: sale of scrap of extra loss (50 units) 25
Income statement 475
500 500

ABNORMAL GAIN ACCOUNT

$ $
Scrap a/c (loss of scrap revenue Process 2 abnormal gain 1,500
due to abnormal gain, (100 units)
100 units × $3) 300
Income statement 1,200
1500 1500

SCRAP ACCOUNT
$ $
Scrap value of normal loss Cash a/c - cash received
Process 1 (200 units) 100 Loss in process 1 (250 units) 125
Process 2 (300 units) 900 Loss in process 2 (200 units) 600
Abnormal loss a/c (process 1) 25 Abnormal gain a/c (process 2) 300
1025 1025
VALUING CLOSING WORK IN PROGRESS
■ When units are partly completed at the end of a period (i.e. when there is closing work in
progress) it is necessary to calculate THE EQUIVALENT UNITS OF PRODUCTION in order to
determine the cost of a completed unit.

In the earlier process costing we have looked at so far we have assumed that opening
and closing inventories of work in process have been nil.
We must now look at more realistic issue and consider how to allocate the costs
incurred in a period between completed output (i.e. finished units) and partly completed
closing inventory.
Example: valuation of closing inventory
■ Trotter Co is a manufacturer of processed goods. In March 20X3, in one process, there was
no opening inventory, but 5,000 units of input were introduced to the process during the
month, at the following cost.
$
– Direct materials 16,560
– Direct labour 7,360
– Production overhead 5,520
29,440
■ Of the 5,000 units introduced, 4,000 were completely finished during the month and
transferred to the next process.
■ Closing inventory of 1,000 units was only 60% complete with respect to materials and
conversion costs.
■ Solution:
■ (a) The problem in this example is to divide the costs of production ($29,440) between the
finished output of 4,000 units and the closing inventory of 1,000 units. It is argued, with
good reason, that a division of costs in proportion to the number of units of each
(4,000:1,000) would not be 'fair' because closing inventory has not been completed, and
has not yet 'received' its full amount of materials and conversion costs, but only 60% of the
full amount. The 1,000 units of closing inventory, being only 60% complete, are the
equivalent of 600 fully worked units.
■ (b) To apportion costs fairly and proportionately, units of production must be converted into
the equivalent of completed units, i.e. into equivalent units of production.

Equivalent units are 'notional whole units representing

incomplete work. Used to apportion costs between work in
progress and completed output …' CIMA Official Terminology
Step 1 Determine output
Step 2 Calculate cost per unit of output, and WIP
For this step in our framework we need to prepare a statement of equivalent
units.
For this step in our framework we need to prepare a statement of costs per equivalent unit
STATEMENT OF EQUIVALENT UNITS because equivalent units are the basis for apportioning costs.
Total Equivalent
STATEMENT OF COSTS PER EQUIVALENT UNIT
units Completion units
Fully worked units 4,000 100% 4,000
=Total costs / Equivalent units
Closing inventory 1,000 60% 600 = $29,440 /4,600 .
5,000 4,600 = Cost per equivalent unit $6.40

Step 3 Calculate total cost of output and WIP Step 4 Complete accounts
For this step in our framework a statement of evaluation may now be The process account would be shown as follows.
prepared, to show how the costs should be apportioned between finished
output and closing inventory. PROCESS ACCOUNT
STATEMENT OF EVALUATION Units $ Units $
Equivalent Cost per equivalent Direct materials 5,000 16,560 Output to next process 4,000 25,600
Item units unit Valuation $
Direct labour 7,360 Closing inventory c/f (WIP) 1,000 3,840
Fully worked units 4,000 $6.40 25,600
Production o'hd 5,520
Closing inventory 600 $6.40 3,840
4,600 29,440 5,000 29,440 5,000 29,440

A few hints on preparing accounts:

When preparing a process account, it might help to make the entries as follows.
(a) Enter the units first. The units columns are simply memorandum columns, but they help you to make sure
that there are no units unaccounted for (for example as loss).
(b) Enter the costs of materials, labour and overheads next. These should be given to you.
(c) Enter your valuation of finished output and closing inventory next. The value of the credit entries should,
of course, equal the value of the debit entries.
 Example: changes in inventory level and losses

The following data have been collected for a process.

Opening inventory None Output to finished goods 2,000 units
Input units 2,800 units Closing inventory 450 units, 70% complete
Cost of input $16,695 Total loss 350 units
Normal loss 10%; nil scrap value
Required:
Prepare the process account for the period.
Step 1 Determine output and losses
STATEMENT OF EQUIVALENT UNITS
Equivalent
units
of work Step 2 Calculate cost per unit of output, losses and WIP
done this STATEMENT OF COST PER EQUIVALENT UNIT
= Costs incurred/ Equivalent units of work done
Total units period
= $16,695 / 2,385
Completely worked units 2,000 (× 100%) 2,000 Cost per equivalent unit = $7
Closing inventory 450 (× 70%) 315
Normal loss 280 0
Abnormal loss 70 (× 100%) 70
2,800 2,385

Step 3 Calculate total cost of output, losses and WIP Step 4 Complete accounts
STATEMENT OF EVALUATION PROCESS ACCOUNT
Equivalent Units $ Units $
units $ Opening inventory – – Normal loss 280 0
Completely worked units 2,000 14,000 Input costs 2,800 16,695 Finished goods a/c 2,000 14,000
Closing inventory 315 2,205 Abnormal loss a/c 70 490
Abnormal loss 70 490 Closing inventory c/d 450 2,205
2,385 16,695 2,800 16,695 2,800 16,695