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## Friday, May 09, 2014

### Comprehensive Note on Process Costing System

Process Costing
Process costing is a method of operation costing which is used to ascertain the cost of production at each process, operation or stage of manufacture, where processes are carried in having one or more of the following features:
a)      Where the product of one process becomes the material of another process or operation
b)      Where there is simultaneous production at one or more process of different products, with or without by product,
c)       Where, during one or more processes or operations of a series, the products or materials are not distinguishable from one another, as for instance when finished products differ finally only in shape or form’.
Process costing is defined by Kohler as: “A method of accounting whereby costs are charged to processes or operations and averaged over units produced; it is employed principally where a finished product is the result of a more or less continuous operation, as in paper mills, refineries, canneries and chemical plants; distinguished from job costing, where costs are assigned to specific orders, lots or units.
Features/Characteristics of Process Costing:
a)      Process Costing Method is applicable where the output results from a continuous or repetitive operations or processes.
b)      Products are identical and cannot be segregated.
c)       It enables the ascertainment of cost of the product at each process or stage of manufacture.
d)      The output consists of products, which are homogenous.
e)      Production is carried on in different stages (each of which is called a process) having a continuous flow.
f)       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.
g)      The output of a process except the last may also be saleable in which case the process may generate some profit.
h)      The input of a process except the first may be capable of being acquired from the outside sources.
i)        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.
j)        Normal and abnormal losses may arise in the processes.
Application of Process Costing
There are number of industries where Process costing system can be used except where job, Batch or Unit Operation Costing is necessary. The following are examples of industries where process costing is applied:
a)      Where the final product merges only after two or more process such as paper-the raw material, bamboo is made into pulp; pulp is a made into paper and then it is finished, glazed etc. for sale;
b)      The product of one process becomes the raw material of another process or operation e.g. refined groundnut oil is the material for making vegetable ghee and
c)       Different products may have a common prior process e.g. brass goods will require melting of brass commonly for all goods. Another example is petroleum products by the same refinery.
d)      Some other industries where Process Costing is applied are:
e)      Chemical works        ,Textiles, weaving, spinning , Soap making, Food product, Box making, Canning factory, Coke works, Paint, ink and varnishing etc.
Difference between Job costing and Process Costing
 Basis of distinction Job Costing Process Costing Basic Job costing is used when the cost object is an individual (or a lot/batch) unit or a distinct product or service. Process Costing is generally used for a mass of identical product or service. Accumulation of Cost Costs can be accumulated by each individual product or service. The Costs are accumulated in a period. The total costs in a period are divided over the number of units to get an average unit cost. Cost Determination Job costing is done against a specific order being produced. Costs are compiled for each process over a period of time. Cost Calculation Costs are calculated when a job is over. Costs are calculated at the end of a cost period like an accounting year. Transfer There are usually no transfers of costs from one job to another. Transfer of costs from one process to another is made as the product moves from one process to the other. Forms and Details There is more paper work. It has lesser paper work. Inventory There is little or no inventory. There is regular and significant inventory. Mechanization It is less amenable to mechanization & automation. It is more amenable to mechanization & automation.

The following are the main advantages of Process Costing:
a)      It is possible to determine process costs periodically at short intervals. Average unit cost can be computed weekly or even daily.
b)      It is simple and less expensive to find out the process costs.
c)       It is possible to have managerial control by evaluating the performance of each process.
d)      It is easy to allocate the expenses to processes in order to have accurate costs.
e)      It is easy to quote the prices with standardization of process. Standard costing can be established easily in process type of manufacture.
The following are the main disadvantages of Process Costing:
a)      Cost obtained at the end of the accounting period are only of historical value and are not very useful for effective control.
b)      Valuation of work-in-progress is generally done of estimated basis which introduces further inaccuracies in total cost.
c)       Where different products arise in the same process, it is not possible to exactly ascertain the total cost of the products.
d)      If any error occurs while calculating average costs, it will be carried through all the processes to the valuation of work in process and finished goods.
e)      The computation of average cost is more difficult in those cases where more than one type of product is manufactured and a division of the cost element is necessary.
Fundamental Principles of Process Costing:
The following are the fundamental principles of process costing:
a)      Cost of material, wages and overheads expenses are collected for each process or operation in a period.
b)      Adequate records in respect of output and scrap of each processes or operation during the period are kept.
c)       The cost per unit of each process is obtained by dividing the total cost incurred during a period by the number of units produced during that period after taking into consideration the losses and amount realized from sale of scrap.
d)      The finished product of one process is transferred as a raw material to the next process.
Treatment of losses in process costing
It is rare that the output of a process is equal to its input. In most of the cases, the output of a process is less than the input. The difference between the input and output and output is called process loss. The process loss may be in the form of loss in weight, scrapes or wastes. These process losses may be classified into:
a)      Normal Loss: The fundamental principle of costing is that the good units should bear the amount of normal loss. Normal loss is anticipated and in a process it is inevitable. It is included in total cost of the product due to which cost per unit is increases. The cost of normal loss is therefore not worked out. The number of units of normal loss is credited to the Process Account and if they have some scrap value or realizable value the amount is also credited to the process account. If there is no scrap value or realizable value, only the units are credited to the process account.
b)      Abnormal Loss: If the units lost in the production process are more than the normal loss, the difference between the two is the abnormal loss. It is excluded from total cost due to which it does not affect the cost per unit of the product. The relevant process of account is credited and abnormal loss account is debited with the abnormal loss valued at full cost of finished output. The amount realized from sale of scrap of abnormal loss units is credited to the abnormal loss account and the balance in the abnormal loss account is transferred to the Costing Profit and Loss Account.
c)       Abnormal Gain: If the actual production units are more than the anticipated units after deducting the normal loss, the difference between the two is known as abnormal gain. It is excluded from total cost due to which it does not affect the cost per unit of the product.  The valuation of abnormal gain is done in the same manner like that of the abnormal loss. The units and the amount is debited to the relevant Process Account and credited to the Abnormal Gain Account.
(Refer a practical question for example of treatment of losses in process costing – consult your teacher.
Difference between normal loss and abnormal loss