A process consists of steps that must be followed in order to complete a task. In a process costing system, the costs of a production process are accumulated and assigned to the products the business produces. As part of the process costing system, a production report must be prepared. It involves accruing expenses for all interdependent processes in a cost accounting system. In manufacturing companies that employ process pricing, raw materials are transformed into final commodities after undergoing a series of processes. Typically, for cotton textiles, the first step is spinning, the second step is weaving, and the final step is finishing.
The ideal costing approach is to use process costing when identical items cannot be tracked back economically to a given unit using direct materials, direct labor, and manufacturing overhead. In batch production, process costing is especially prevalent. It is the responsibility of each department, production process, and batch process to keep track of its direct material and direct labour costs, as well as the number of units produced.
Using a process costing system, the actual cost to produce each unit varies, but the average result provides a sufficient estimate. In the event a company does not customise its end products for particular consumers, soft drinks, petroleum products, and even chairs can be manufactured and accounted for using a form of the process costing method. Manufacturers mostly use process costing. In addition to textiles, biscuits, cement, paper, and oil refining, this method of costing is also used in other industries. This diagram illustrates the sequence of processes in which the output of the first process becomes the input of the second process, and so forth.
Favorable Conditions for Process Costing
- Plants that produce a single output.
- Processes and departments within a plant are divided. A single product is manufactured by each process.
- A single product is processed for a set period of time, followed by successive runs of other products. There is a separate calculation for each run here.
- Producing several products from the same process at the same time.
- A factory is divided into separate operations that follow standard protocols and procedures.
- Process-based costs are calculated.
Industries that Adopt Process Costing
- Process costing is used in so many industries except for those where job, batch, or unit operation costing is necessary.
- Process costing is practiced in the following industries:
- Industries that produce chemical products, textiles, weavings, spinnings, etc.
- The industries that produce gas, electricity, water, ice, steel, paper, cement, rubber, bread, etc.
- Manufacturing industries include bakeries, confectioneries, flour mills, canneries, medicine manufacturers, and fabricators.
- The industries of foundries, laundries, dyers, and cleaners, for example.
- Industries that produce spare parts, fittings, equipment, fertilizer, etc.
- Box making, paper mills, biscuit factories, oil refining, milk dairy, meat product factories.
Characteristics/Features of Process Costing
- Production is continuous.
- A sequence of processes leads to the end product.
- A homogeneous product with identical and standardized features ensures quality.
- Process sequences are predetermined and specific.
- The finished products from one process become the raw materials of the next, which continues until the whole process is complete.
- The cost of each process is calculated separately.
Steps Involved in Process Costing
- Analyze inventory: Identify the amount of inventory at the beginning of the period, the number of items started during the period, the number completed and transferred out, and the number that was incomplete at the end of the period.
- Calculate equivalent units: The concept of equivalent units is used in process costing to account for items that are unfinished at the end of each period. By multiplying the number of incomplete units at the end of the period by a percentage representing their progress through the production process, we can determine how many units are still incomplete at the end of the period.
- Calculate applicable costs: Include direct material costs and conversion costs in total production costs.
- Calculate cost per unit: Multiply the total cost by the number of units. Both completed and equivalent units are included in this calculation.
- Allocate costs to complete and incomplete products: Costs associated with completed and ending work-in-progress inventory should be allocated to the appropriate accounts. In this way, we can determine how much money is tied up in current work-in-progress inventory.
Pros of Process Costing / Advantages of Process Costing
- Each activity’s cost can be calculated easily and inexpensively using Process Costing.
- In Process Costing, expenses can be allocated to processes for precise costing.
- In process costing, production activities are standardised. As a result, management control and monitoring are simplified.
- It is homogenous to cost goods in process. By averaging the overall cost, costs per unit can be easily determined, and prices can be quoted easily.
- Estimating periodic process costs using short integrals is feasible with Process Costing.
Cons of Process Costing /Disadvantages of Process Costing
- In terms of management control, the costs collected at the end of the accounting period are of historical significance.
- Analyzing, evaluating, and controlling departmental performance may not be possible using process cost, since it is an average cost.
- An error propagates to succeeding processes after it occurs in one.
- Individual employees and supervisors are not assessed through process costing.
- It is difficult to calculate average costs when several types of a product are created.
- Weighted Average Costs,
- Standard costs, and
- First-in First-out (FIFO)
Similarly, You May Also Like: