Process costing

 Process costing is a cost accounting method used in industries where goods

are mass-produced in a continuous flow or through sequential processes. It
helps determine the cost of production at each stage, operation, or process by
accumulating and assigning costs systematically. This method is ideal for
manufacturing environments with standardized, repetitive production,
ensuring accurate cost allocation across various production stages.

Industries where Process costing may be used

 Process costing is typically used in industries where products are
manufactured through a continuous process and are homogeneous. Here are
some examples of such industries:
a) Chemical Industry
 Examples: Production of paints, fertilizers, and pharmaceuticals.
 Reason: Materials are processed in large quantities, and each stage adds
value until the final product is created.

b) Food and Beverage Industry

 Examples: Baking, brewing, soft drink manufacturing, and dairy
production.
 Reason: Products like bread, beer, and milk are produced in bulk with
standardized processes.

c) Textile Industry
 Examples: Yarn spinning, weaving, and dyeing.
 Reason: Each stage, from raw material (cotton or wool) to finished fabric,
follows a sequential process.
d) Oil Refining Industry
 Examples: Petroleum refining, lubricant production, and kerosene.
 Reason: Raw crude oil undergoes several processing stages to create various
products.

e) Cement Industry
 Examples: Production of cement and concrete.
 Reason: The production process involves multiple stages, from grinding raw
materials to producing the final cement.
 f) Steel and Metal Industry
 Examples: Iron and steel manufacturing, aluminum extrusion.
 Reason: The process includes smelting, rolling, and other continuous steps
to create metal products.

g) Plastic Industry
 Examples: Manufacturing of plastic bottles, sheets, or films.
 Reason: Standardized processes like molding or extrusion are used.

h) Soap and Detergent Industry

 Examples: Bar soap and liquid detergent production.
 Reason: Ingredients are processed through mixing, heating, and packaging
stages.

i) Paper and Pulp Industry

 Examples: Paper manufacturing, cardboard production.
 Reason: Pulp undergoes processes like pulping, pressing, and drying to
become paper.

j) Glass Manufacturing
 Examples: Production of bottles, windows, and fiberglass.
 Reason: Glass is melted, shaped, and cooled in a continuous process.

Characteristics of the process and output for which process costing may be
used;
1. Process Costing Method is applicable where the output results from a
continuous or repetitive operations or processes.
2. Products are identical and cannot be segregated.
3. It enables the ascertainment of cost of the product at each process or stage of
manufacture.
4. The output consists of products, which are homogenous.
5. Production is carried on in different stages (each of which is called a
process) having a continuous flow.
6. The input will pass through two or more processes before it takes the shape
of the output. The output of each process becomes the input for the next
process until the final product is obtained, with the last process giving the
final product.
 7. The output of a process except the last may also be saleable in which case
the process may generate some profit.
8. The input of a process except the first may be capable of being acquired
from the outside sources.
9. The output of a process is transferred to the next process generally at cost to
the process. It may also be transferred at market price to enable checking
efficiency of operations in comparison to the market conditions.
10.Normal and abnormal losses may arise in the processes.

Question
The manufacture of product “Fanta” requires three distinct processes. On
completion of the product is passed from Process 3 to finished stock. During the
month of December 1992, the following information was obtained:
Elements of Costs Total Cost Process I Process II Process III
Direct Material 26,000 15,000 11,000 -
Direct Labor 26,500 12,500 6,000 8,000
Direct Expenses 8,000 3,000 - 5,000
Production Overhead 79,500
Production Overhead is absorbed by processes at a percentage of direct wages.
Production during the period was 1,000 kgs. There was no stock of raw materials
or work-in-progress at the beginning or at the end of the month.
Solution
Production OH absorption in Process I = 12,500/26,500 = 0.471 x79,500 = 37,500
Production OH absorption in Process II = 6,000/26,500 = 0.226 x79,500 = 18,000
Production OH absorption in Process III = 8,000/26,500 = 0.302 x79,500 = 24,000

Process I A/c

Particulars Amount Particulars Amount

To Material 15,000 By Process II 68,000
To Direct Labor 12,500
To Direct Expenses 3,000
Production OH 37,500
68,000 68,000
 Process II A/c
Particulars Amount Particulars Amount
To Process I A/c 68,000 By Process III 103,000
To Material 11,000
To Direct Labor 6,000
Production OH 18,000
103,000 103,000

Process III A/c

Particulars Amount Particulars Amount
To Process II A/c 103,000 By Finished Stock A/c (1000 kgs) 140,000
To Direct Labor 8,000
To Direct Expenses 5,000
Production OH 24,000
140,000 140,000

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.
Expected output from a manufacturing process is calculated as the amount of the
input less the normal loss.
Treatment of Normal loss; Total costs allocated to the expected output i.e. cost
per unit for a period is total cost divided by expected output.
Units declared as “Normal loss” are still saleable i.e. having scrap value then such
amount shall be deducted from the total process cost.
Question:
ABC Ltd. manufactures a chemical product in a single process. The following data
relates to the production for the month of November:
  Input: 10,000 liters of raw material
 Cost of raw material: $50,000
 Labor cost: $30,000
 Overheads: $20,000
 Normal loss: 5% of input (scrap value: $2 per liter)
Calculate:
1. The cost per liter of the finished product.
2. The total process cost, after accounting for the normal loss.
Solution
 Determine the expected normal loss:
Normal loss = 5% of 10,000 liters = 500 liters.
 Calculate scrap value of normal loss:
Scrap value = 500 liters × $2 = $1,000.
 Allocate process costs:
Total process cost before scrap value = $50,000 + $30,000 + $20,000
= $100,000.
Adjust for scrap value: $100,000 - $1,000 = $99,000.
 Calculate cost per liter:
Cost per liter = Total cost ÷ Expected output = $99,000 ÷ 9,500 liters
= $10.42.
Normal loss example
Mr Bean’s chocolate Wiggly bars pass through two processes. The data for the
month just ended are:
$ kg $
Process 1 Ingredients 5,000 4,000 Process 2 Packaging 10,000
Labor & Overhead 6,000

Solution
Process 1 Account
Kg $ Kg $
Ingredients 4000 5000 Normal loss (W1) 200
Labor and OH 6000 Transfer to Process 2 3800 11000
4,000 11,000 4,000 11,000

Workings
(1) The staff normally eat 5% of the chocolate, so the normal loss is
4,000 x 5% = 200kg
(2) Number of kg transferred = kg input less normal loss = 4,000 – 200 =
3,800kg

Process 2 Account
Kg $ Kg $
Transfer from Process 1 Finished Goods 3800 21,000
Above 3,800 11,000
Packaging 10,000

3,800 21,000 3,800 21,000

Cost per kg = Total costs / Number of expected kg

$21,000 / 3,800 = $5.53 per kg

Abnormal loss or gain in a process is the actual output less the expected output. If
actual output is less than expected output an abnormal loss occurs. If actual output
exceeds expected output an abnormal gain occurs.

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.
Question:
XYZ Ltd. processes 10,000 units of raw material in its production process. The
following details are available for the month of November:
 Input: 10,000 units
 Cost of raw material: $40,000
 Labor cost: $25,000
 Overheads: $15,000
 Normal loss: 8% of input (scrap value: $3 per unit)
 Actual output: 9,000 units
Required:
1. Calculate the expected normal loss and the abnormal loss.
2. Prepare a statement to calculate the cost per unit of finished goods and the
total value of abnormal loss.
Solution:
1. Expected Normal Loss:
Normal loss = 8%×10,000=800 units.
2. Abnormal Loss:
Expected output = 10,000−800=9,200.
Actual output = 9,000 units.
Abnormal loss = 9,200−9,000=200.
3. Cost Allocation:
Total process cost = $40,000 + $25,000 + $15,000 = $80,000.
Scrap value of normal loss = 800x3 = $2,400.
Adjusted process cost = $80,000 - $2,400 = $77,600
Cost per unit = 77,600/9,200 = $8.43
4. Abnormal Loss Valuation:
Value of abnormal loss = 200 x 8.43 = $1,686
5. Total Process Cost = 77,600 + 1,686 = 79,286
Equivalent Units
The concept of equivalent units in process costing is used to measure the amount
of work done on incomplete/work-in-process units.
Example:
A company produces paint cans. During the month:
Total units started: 1,000
Completed and transferred out: 600 units
Work-in-Process (WIP) at month-end: 400 units
Detail of work done on incomplete units:
Direct materials: 100% complete
Conversion costs: 25% complete

Costs incurred for the month:

Direct materials: $5,000
Conversion costs: $4,000

For incomplete units we apply percentage of completion on WIP units:

i.e. for direct material equivalent units are 400 x 100% = 400 units
and for conversion cost equivalent units are 400 x 25% = 100 units

Therefore, calculation of total units will be as follows:

a. With respect to direct material cost $5,000 is applied 100% on both kinds of
units i.e. completed and equivalent units. Total of both kinds of units is 600 +
400 = 1000. Moreover, if we want to determine per unit direct material cost
then direct material cost will be divided by total of completed and equivalent
units i.e. 5000/1000 = $5 per unit.
b. With respect to conversion cost $4,000 is applied 100% on completed units but
only 25% on WIP. Therefore, for application of conversion cost 400 units of
WIP will be considered as 100 equivalent units. So, conversion cost of $4,000 is
applied on 600 completed units and 100 equivalent units i.e. 700 units. Further,
in order to determine per unit conversion cost we have to divide total
conversion cost $4000 by 700 units; 4000/700 = 5.71
c. If we want to determine total per unit then we have to add direct material per
unit cost i.e. $5 and conversion cost per unit $5.71 so total per unit cost will be
$10.71.