Process Costing Definition, Examples, Features & System

If two or more processes are involved in manufacturing one finished product, the question arises, « which process has consumed the expense? » The answer lies within process costing. A process costing system accumulates the costs of a production process and assigns them to the products that the business outputs. For example, it would be impractical and inefficient for a company that bottles cola to separate and record the cost of each bottle of cola in the bottling process. As a result, the corporation would allocate costs to the entire bottling process for a set period of time.

What is a Process Costing System?

Process costing can also accommodate increasingly complex business scenarios. While making drumsticks may sound simple, an immense amount of technology is involved. Rock City Percussion makes 8,000 hickory sticks per day, four days each week.

Manufacturing overhead is another cost of production, and it is applied to products (job order) or departments (process) based on an appropriate activity base. Process costing is a type of operation costing which is used to ascertain the cost of a product at each process or stage of manufacture. A process can be referred to as the sub-unit of an organization specifically defined for cost collection purpose.

Presentation of Process Costs

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1. In general, the simplest costing approach is the weighted average method, with FIFO costing being the most difficult.
2. This percentage is a key part of the calculation to assign costs to work-in-process inventory, and so can be used to shift costs into or out of the current period to modify reported levels of profitability.
3. For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online.
4. While both systems produce a cost of goods sold for a given period, Process Costing focuses on the product’s progression through various stages of production.
5. For example, it would be impractical and inefficient for a company that bottles cola to separate and record the cost of each bottle of cola in the bottling process.

The procedure begins with the inventory recording, continues with the conversion of work-in-progress inventory, calculates inventory costs, calculates the inventory per unit, and concludes with the cost allocation. Industries such as cement, soaps, steel, paper, chemicals, medicines, vegetable oils, rubber, etc., use this method to assign the costs. international speaker and fundraising coach Process costing has some drawbacks, including the possibility of inaccuracy.

During the month of March, the casting department incurs $50,000 of direct material costs and $120,000 of conversion costs (comprised of direct labor and factory overhead). The department processes 10,000 widgets during March, so this means that the per unit cost of the widgets passing through the casting department during that time period is $5.00 for direct materials and $12.00 for conversion costs. The widgets then move to the trimming department for further work, and these per-unit costs will be carried along with the widgets into that department, where additional costs will be added. Why have three different cost calculation methods for process costing, and why use one version instead of another? The different calculations are required for different cost accounting needs.

Step #2. Calculate equivalent units

The sticks made of maple and birch are manufactured on the fifth day of the week. It is difficult to tell the first drumstick made on Monday from the 32,000th one made on Thursday, so a computer matches the sticks in pairs based on the tone produced. In addition to setting the sales price, managers need to know the cost of their products in order to determine the value of inventory, plan production, determine labor needs, and make long- and short-term plans.

Process costing also relies on equivalent unit calculations, which are derived by allocating costs to unfinished goods at the beginning and end of an accounting period. On balance sheets, companies include the value of this work in the process. The true cost of these unfinished goods may vary, for example, if raw material prices fluctuate from month to month. Companies will wind up with inaccurate product pricing if they do not accurately estimate the cost of work-in-progress components. Process costing is the only reasonable approach to determining product costs in many industries. It uses most of the same journal entries found in a job costing environment, so there is no need to restructure the chart of accounts to any significant degree.

The main objective is to allocate total manufacturing costs to the various products according to the proportion of resources consumed by each product. Under process costing, the procedure used to manufacture a product is divided into well-defined processes. A separate account is opened for each process to which all incurred costs are charged. Process costing is more practical and simpler to use than other cost accounting systems, such as job costing, which requires recording the cost of each item and component part, as well as managing salary, other materials, and overhead.

Alternatives to the Process Costing System

These costs will then be transferred to second department where its processing costs will be added. Process costing is appropriate for companies that produce a continuous mass of like units through series of operations or process. Also, when one order does not affect the production process and a standardization of the process and product exists. However, if there are significant differences among the costs of various products, a process costing system would not provide adequate product-cost information.

A student’s first thought is that this is easy—just divide the total cost by the number of units produced. The finished material of one process constitutes the raw material of the next. Therefore, as the finished material is transferred to the next process, the cost of each process is also transferred, until it ends in the finished stock account. This step involves the identification of inventory at the end of each process. The organization can identify such inventory by physically counting the units or through software inbuilt into the manufacturing process. In addition, the costs of inventory under each process are also identified at this change.

Eventually, costs are averaged over the units produced asset turnover formula during the period to determine the cost of one item. If a process costing system does not mesh well with a company’s cost accounting systems, there are two other systems available that may be a better fit. The job costing system is designed to accumulate costs for either individual units or for small production batches. The typical manner in which costs flow in process costing is that direct material costs are added at the beginning of the process, while all other costs (both direct labor and overhead) are gradually added over the  course of the production process. For example, in a food processing operation, the direct material (such as a cow) is added at the beginning of the operation, and then various rendering operations gradually convert the direct material into finished products (such as steaks).

In process costing unit costs are more like averages, the process-costing system requires less bookkeeping than does a job-order costing system. A process costing system accumulates costs when a large number of identical units are being produced. In this situation, it is most efficient to accumulate costs at an aggregate level for a large batch of products and then allocate them to the individual units produced. The assumption is that the cost of each unit is the same as that of any other unit, so there is no need to track information at an individual unit level. The most difficult process costing method, FIFO is used to provide more precise product costing, particularly when expenses vary dramatically from one period to the next.

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