PROCESS COSTING
PROCESS COSTING
Process costing is a form of operations costing which is used where
standardized homogeneous goods are produced. This costing method is used in
industries like chemicals, textiles, steel, rubber, sugar, shoes, petrol etc.
Process costing is also used in the assembly type of industries also. It is
assumed in process costing that the average cost presents the cost per unit.
Cost of production during a particular period is divided by the number of units
produced during that period to arrive at the cost per unit.
Process costing is a method of costing under which all costs are
accumulated for each stage of production or process, and the cost per unit of
product is ascertained at each stage of production by dividing the cost of each
process by the normal output of that
process.
CIMA London defines process costing as “that form of operation costing
which applies where standardize goods are produced”
Features of Process
Costing:
(a) The production is continuous
(b) The product is homogeneous
(c) The process is standardized
(d) Output of one process become raw material of another process
(e) The output of the last process is transferred to finished stock
(f) Costs are collected process-wise
(g) Both direct and indirect costs are accumulated in each process
(i) The total cost of each process is divided by the normal output of
that process to find out cost per unit of that process.
Advantages of process costing:
1. Costs are be computed periodically at the end of a particular
period
2. It is simple and involves less clerical work that job costing
3. It is easy to allocate the expenses to processes in order to have
accurate costs.
4. Use of standard costing systems in very effective in process
costing situations.
5. Process costing helps in preparation of tender, quotations
6. Since cost data is available for each process, operation and
department, good managerial control is possible.
Limitations:
1. Cost obtained at each process is only historical cost and are not
very useful for effective control.
2. Process costing is based on average cost method, which is not that
suitable for performance analysis, evaluation and managerial control.
3. Work-in-progress is generally done on estimated basis which leads
to inaccuracy in total cost calculations.
4. The computation of average cost is more difficult in those cases
where more than one type of products is manufactured and a division of the cost
element is necessary.
5. Where different products arise in the same process and common costs
are prorated to various costs units. Such individual products costs may be
taken as only approximation and hence not reliable.
COSTING PROCEDURE
Items on the Debit
side of Process A/c.
Each process account is debited with –
a) Cost of materials used in that process.
b) Cost of labour incurred in that process.
c) Direct expenses incurred in that process.
d) Overheads charged to that process on some pre determined.
e) Cost of ratification of normal defectives.
f) Cost of abnormal gain (if any arises in that process)
Items on the Credit
side:
Each process account is credited with
a) Scrap value of Normal Loss (if any) occurs in that process.
b) Cost of Abnormal Loss (if any occurs in that process)
Cost of Process:
The cost of the output of the process (Total Cost less Sales value of
scrap) is transferred to the next process. The cost of each process is thus
made up to cost brought forward from the previous process and net cost of material,
labour and overhead added in that process after reducing the sales value of
scrap. The net cost of the finished process is transferred to the finished
goods account. The net cost is divided by the number of units produced to
determine the average cost per unit in
that process. Specimen of Process. Account when there are normal loss and
abnormal losses.
Process Losses:
In many process, some loss is inevitable. Certain production
techniques are of such a nature that some loss is inherent to the production.
Wastages of material, evaporation of material is unavoidable in some process.
But sometimes the Losses are also occurring due to negligence of Labour, poor
quality raw material, poor technology etc. These are normally called as
avoidable losses. Basically process losses are classified into two categories
(a) Normal Loss (b) Abnormal Loss
1. Normal Loss:
No of units of normal loss: Input x Expected percentage of Normal
Loss.
The cost of normal loss is a process. If the normal loss units can be
sold as a crap then the sale value is credited with process account. If some
rectification is required before the sale of the normal loss, then debit that
cost in the process account. After adjusting the normal loss the cost per unit
is calculates with the help of the following formula:
Cost of good unit:
(Total cost increased – Sale Value of Scrap) ÷ (Input – Normal Loss units)
2. Abnormal Loss:
Any loss caused by unexpected abnormal conditions such as plant
breakdown, substandard material, carelessness, accident etc. such losses are in
excess of pre-determined normal losses. This loss is basically avoidable. Thus
abnormal losses arrive when actual losses are more than expected losses. The
units of abnormal losses in calculated as under:
Abnormal Losses = Actual Loss – Normal Loss
The value of abnormal loss is done with the help of following formula:
Value of Abnormal
Loss:
((Total Cost increase – Scrap Value of normal Loss) ÷ (Input units –
Normal Loss Units)) x Units of abnormal loss
Abnormal Process loss should not be allowed to affect the cost of
production as it is caused by abnormal (or) unexpected conditions. Such loss
representing the cost of materials, labour and overhead charges called abnormal
loss account. The sales value of the abnormal loss is credited to Abnormal Loss
Account and the balance is written off to costing P & L A/c.
Abnormal Gains:
The margin allowed for normal loss is an estimate (i.e. on the basis
of expectation in process industries in normal conditions) and slight
differences are bound to occur between the actual output of a process and that
anticipates. This difference may be positive or negative. If it is negative it
is called ad abnormal Loss and if it is positive it is Abnormal gain i.e. if
the actual loss is less than the normal loss then it is called as abnormal
gain. The value of the abnormal gain calculated in the similar manner of
abnormal loss. The formula used for abnormal gain is:
Abnormal Gain
{(Total Cost incurred – Scrap Value of Normal Loss) ÷ (Input units –
Normal Loss Units)} x Abnormal Gain Unites
The sales values of abnormal gain units are transferred to Normal Loss
Account since it arrive out of the savings of Normal Loss. The difference is
transferred to Costing P & L A/c. as a Real Gain.
INTER PROCESS
PROFITS:
Normally the output of one process is transferred to another process
at cost but sometimes at a price showing a profit to the transfer process. The
transfer price may be made at a rice
corresponding to current wholesale market price or at cost plus an agreed
percentage. The advantage of the method is to find out whether the particular process is making
profit (or) loss. This will help the management whether to process the product
or to buy the product from the market. If the transfer price is higher than the
cost price then the process account will show a profit. The complexity brought
into the accounting arises from the fact that the inter process profits
introduced remain a part of the prices of process stocks, finished stocks and
work-in-progress. The balance cannot show the stock with profit. To avoid the
complication a provision must be created to reduce the stock at actual cost
prices. This problem arises only in respect of stock on hand at the end of the
period because goods sold must have realized the internal profits. The
unrealized profit in the closing stock is eliminated by creating a stock
reserve. The amount of stock reserve is calculated by the
following formula.
Stock Reserve = Transfer
Value of stock x Profit included in transfer price Transfer Price
VALUATION OF
WORK-IN-PROGRESS
Meaning of
Work-in-Progress:
Since production is a continuous activity, there may be some
incomplete production at the end of an accounting period. Incomplete units mean
those units on which percentage of
completion with regular to all elements of cost (i.e. material, labour
and overhead) is not 100%. Such incomplete production units are known as
Work-in-Progress. Such Work-in-Progress is valued interms of equivalent or
effective production units.
Meaning of equivalent production units :
This represents the production of a process in terms of complete
units. In other words, it means converting the incomplete production into its
equivalent of complete units. The term equivalent unit means a notional
quantity of completed units substituted for an actual quantity of incomplete
physical units in progress, when the aggregate work content of the incomplete
units is deemed to be equivalent to that of the substituted quantity. The
principle applies when operation costs are apportioned between work in progress
and completed units.
Equivalent units of work in progress = Actual no.
of units in progress x Percentage of work completed
Equivalent unit should be calculated separately for each element of
cost (viz. material, labour and overheads) because the percentage of completion
of the different cost component may be different.
Accounting Procedure:
The following procedure is followed when there is Work-in- Progress
(1) Find out equivalent production after taking into account of the
process losses, degree of completion of opening and / or closing stock.
(2) Find out net process cost according to elements of costs i.e.
material, labour and overheads.
(3) Ascertain cost per unit of equivalent production of each element
of cost separately by dividing each element of costs by respective equivalent
production units.
(4) Evaluate the cost of output finished and transferred work in
progress The total cost per unit of equivalent units will be equal to the total
cost divided by effective units and cost of work-in progress will be equal to
the equivalent units of work-in progress multiply by the cost per unit of
effective production.
In short the following from steps an involved.
Step 1 – prepare statement of Equivalent production
Step 2 – Prepare statement of cost per Equivalent unit
Step 3 – Prepare of Evaluation
Step 4 – Prepare process account
The problem on equivalent production may be divided into four groups.
I. when there is only closing work-in-progress but without process
losses
II. when there is only closing work-in-progress but with process
losses
III. when there is only opening as well as closing work-in progress
without process losses
IV. when there is opening as well as closing work-in progress with
process losses
Situation I :
Only closing
work-in-progress without process losses :
In this case, the existence of process loss is ignored. Closing
work-in-progress is converted into equivalent units on the basis of estimates
on degree of completion of materials, labour and production overhead.
Afterwards, the cost pr equivalent unit is calculated and the same is used to
value the finished output transferred and the closing work-in-progress
Situation II:
When there is closing
work-in-progress with process loss or gain.
If there are process losses the treatment is same as already discussed
in this chapter. In case of normal loss nothing should be added to equivalent
production. If abnormal loss is there, it should be considered as good units
completed during the period. If units scrapped (normal loss) have any reliable
value, the amount should be deducted from the cost of materials in the cost
statement before dividing by equivalent production units. Abnormal gain will be
deducted to obtain equivalent production.
Situation III:
Opening and closing
work-in-progress without process losses.
Since the production is a continuous activity there is possibility of
opening as well as closing work-in-progress. The procedure of conversion of
opening work-in-progress will vary depending on the method of apportionment of
cost followed viz, FIFO, Average cost Method and LIFO.
Let us discuss the methods of valuation of work-in-progress one by
one.
(a) FIFO
Method: The FIFO method of costing is based on the
assumption of that the opening work-in-progress units are the first to be
completed. Equivalent production of opening work-in-progress can be calculated
as follows:
Equivalent Production =
Units of Opening WIP x Percentage of work needed to finish the units
(b) Average
Cost Method: This method is useful when price fluctuate from period to period. The closing
valuation of work-in-progress in the old period is added to the cost of
new period and an average rate obtained. In calculating the equivalent
production opening units will not be shown separately as units of
work-in-progress but included in the units completed and transferred.
(c) Weighted
Average Cost Method: In this method no distinction is made between
completed units from opening inventory and completed units from new production.
All units
finished during the current accounting period are treated as if they
were started and finished during that period. The weighted average cost per
unit is determined by dividing the total cost (opening work-in-progress cost +
current cost) by equivalent production.
(d) LIFO
Method: In LIFO method the assumption is that the units
entering into the process is the last one first to be completed. The cost of
opening work-in-progress is charged to the closing work-in-progress and thus
the closing work-in progress appears cost of opening work-in-progress. The
completed units are at their current cost.
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