What is Process Costing?
Manufacturing companies follows the process costing and the production process is carried on in two or more centers continuously. It is a basic method of allocating total costs to a unit of product in process wise. This system accumulates costs by time period and associates them with the output produced during the same period.
According to Harold Bieman Jr. and Thomas R. Dyckman,
The process cost system makes no attempt to account for the goods of individual items or specific groups of items. Instead, all costs are placed into reservoirs and allocated to products, on a systematic basis. The costs may be accumulated for different processes in the production of one product or it may be necessary to have different reservoirs for different products. The reservoirs or places accumulate costs. are actually work-in progress.
Hence, process costing is termed as operations costing, which applies where standardized goods are produced in large volume with continuous flow of production.
The cost per unit is calculated by dividing the number of units produced in a particular period into by total amount of costs incurred in the same period. Here, standard products are produced rather than specific products. It means that goods are produced and maintained as stock. Therefore, the costs are calculated as cost of goods processed and sent to the next process or as finished goods and sent to store room or as ending work in progress.
Definition of Process Costing
Kohler, in his book “Dictionary for Accountants” defines process costing as
A method of cost accounting whereby costs are charged to processes or operations and averaged over units produced.
S.P. Iyengar defines the process costing as,
A form of operation costing which applies where standardized goods are produced.
Principles of Process Costing
The principles of process costing are briefly presented below.
1. The whole factory operation is divided into several operations or production centers, each performing standard operations.
2. All the items of process costing i.e. materials, labour and overheads are collected in process wise.
3. The records are maintained in process wise as the number of units produced, the total costs incurred and the cost per unit.
4. The total cost of one process is transferred to next process along with the number of units transferred to next process for further processing.
5. The cost per unit is calculated by dividing the number of units produced in a process into the total costs incurred for processing the same number of units in a specified period.
6. Likewise, the cost of finished product is calculated by dividing the total production cost into the number of units produced.
Thus, in the process cost accounting system, the cost is determined for completed production and work-in-progress also.
Features of Process Costing
The process costing has the following features.
1. The production is carried on continuously and passing two or more processes.
2. Only homogeneous products are produced.
3. The production will be stopped if the plant and machinery is shut down for repairs.
4. The management has clearly defined process cost centers and the accumulation of costs such as cost of material, cost of labour and overheads by the cost centre.
5. The accurate accounting records are maintained in process wise as the number of units produced completely, the number of units partly produced and total costs incurred.
6. The finished product of one process becomes the raw material of the next process or operation and so on until the final product is obtained.
7. Some losses may arise in all the processes due to avoidable and unavoidable reasons. Such losses may be normal and/or abnormal.
8. Accounting treatment of normal losses and abnormal losses are studied in this method of costing.
9. Sometimes, abnormal gain is also available in certain processes.
10. Accounting treatment of such abnormal gain is also studied in this method of costing.
11. Sometimes, goods are transferred from the process to next process at transfer price instead of cost price.
12. The transfer price is compared with market price to know the level of efficiency or losses occurring in a particular process.
13. All the input units cannot be converted into finished products in all the processes for a specified period. Some may be in process. At the same time, the calculation of effective unit rate is carried on in this method of costing. Therefore, accurate average cost is obtained.
14. Sometimes, more than one product is produced. All the products are having equal value and importance. If so, these products are called joint product.
15. In certain cases, more than one product is produced. One product has more value and gets more important than others. If so, more value product is main product and less value product is by-product.
16. Main product may not require any further processing. But, by-products may require further processing before they can be sold.
17. Both main product and by-products are valued under this method of costing.
18. Joint cost is apportioned to both main product and by-products on suitable basis.
19. A main product of one firm may be a by-product of another firm.
20. Output is uniform. Hence, the cost per unit of production can be ascertained only by averaging the expenditure incurred during a particular period.
21. Work in progress is converted into finished products through the cost of equivalent production.
Objectives of Process Costing
The chief objectives of process costing are listed below.
1. To determine the unit cost.
2. To determine the method of allocation of manufacturing costs incurred during a given period.
3. To allocate the accumulated materials, labour and factory overhead costs to process cost centers.
4. To express incomplete units in terms of completed units.
5. To give accounting treatment to process losses such as waste, scrap, defective goods and spoiled goods.
6. To differentiate the main product from by-product and joint product.
7. To give accounting treatment to joint product and by-product.
8. To calculate the cost of main product accurately.
Application of Process Costing
Generally, an industrial unit follows the process costing system where there are at least two production processes. In other words, the industrial units, which are following single production process, can apply operation-costing system instead of process costing system.
Moreover, an industrial unit can apply operation costing system instead of process costing system even though these industrial units are not able apply process costing system and having at least two production processes.
The following are the examples of industries where process costing is applied.
Chemical works, Steel, Soap making, Oil refining, Box making, Textiles, Distillation process, Rubber, Paper mills, Paints, Beer, Coke works, Ink and Varnishing, Meat products factory, Milk diary, Biscuit works, Food products, Canning factory.
Process costing deals with the flow of units and costs through several stages or operations. As such, when the homogeneous products are produced through continuous process, a process costing system is usually appropriate.