Process costing
Process costing is a method of costing used mainly in manufacturing where units are continuously mass-produced through one or more processes. Examples of this include the manufacture of erasers, chemicals or processed food. In process costing it is the process that is costed (unlike job costing where each job is costed separately). The method used is to take the total cost of the process and average it over the units of production.
Cost per unit = Cost of input /Expected output in units
Important terms to understand In a manufacturing process the number of units of output may not necessarily be the same as the number of units of inputs.
There may be a loss.
Normal loss This is the term used to describe normal expected wastage under usual operating conditions. This may be due to reasons such as evaporation, testing or rejects.
Abnormal loss This is when a loss occurs over and above the normal expected loss. This may be due to reasons such as faulty machinery or errors by labourers.
Abnormal gain This occurs when the actual loss is lower than the normal loss. This could, for example, be due to greater efficiency from newly-purchased machinery.
Work in progress (WIP) This is the term used to describe units that are not yet complete at the end of the period. Opening WIP is the number of incomplete units at the start of a process and closing WIP is the number at the end of the process.
Scrap value Sometimes the outcome of a loss can be sold for a small value. For example, in the production of screws there may be a loss such as metal wastage.
Job costing involves the detailed accumulation of production costs attributable to specific units or groups of units. For example, the construction of a custom-designed piece of furniture would be accounted for with a job costing system.
The costs of all labor worked on that specific item of furniture would be recorded on a time sheet and then compiled on a cost sheet for that job. Similarly, any wood or other parts used in the construction of the furniture would be charged to the production job linked to that piece of furniture. This information may then be used to bill the customer for work performed and materials used, or to track the extent of the company's profits on the production job associated with that specific item of furniture.
Process costing involves the accumulation of costs for lengthy production runs involving products that are indistinguishable from each other. For example, the production of 100,000 gallons of gasoline would require that all oil used in the process, as well as all labor in the refinery facility be accumulated into a cost account, and then divided by the number of units produced to arrive at the cost per unit. Costs are likely to be accumulated at the department level, and no lower within the organization.
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