Process Costing Systems

• A process costing system is applicable when all units produced during a specified time frame are treated as one unit of output– Every unit made during the time period is

essentially identical

Multistage Process Costing

• For many factories engaged in continuous processing, production flows from one process stage to the next

• At each stage, there is progress toward converting the raw materials into the finished product

• In continuous processing it is necessary first to determine costs for each stage of the process and then to assign their costs to individual products

Process-Oriented Industries

• Examples of continuous processing,– chemicals, basic metals, pharmaceuticals, grain milling and

processing, and electric utilities industries

• Also found in some discrete-parts manufacturing factories e.g. those producing car components, small appliances, and electronic instruments and computers

• The common feature is that the products manufactured have few and small differences for batches of different products

Comparison With Job Order Costing

• Both systems have the same objective:– Assign material, labour, and manufacturing

support activity costs to product

• Process costing systems differ in that they:– Do not maintain separate cost records for

individual jobs– Measure costs only for process stages– Determine cost variances only at the level of the

process stages instead of at the level of individual jobs

Some concepts

• Conversion cost– The cost of transforming raw materials into finished output

• Normal losses– Unavoidable losses that occur under efficient operating

conditions

• Abnormal losses– Losses that occur due to inefficient operations (mistakes!) –

note abnormal gains

• Scrap– Production of something you don’t want – it may or may not

have a value.

Some principles

• Cost of normal loss is absorbed by good production

• Abnormal losses are avoidable and are identified as a period cost.

• A series of accounts are used to collect costs (debits for inputs, credits for outputs)

• These process accounts have columns for quantities and values

• When there is work in progress stock, we have to calculate equivalent units

Worked example – 1Normal Loss

• Process A information• Inputs • Material 20 units at £4• Labour £100• Overheads £120

• Normal loss 10%

Worked example – 1Normal Loss

• Process A A/c• Units £ Units

£• Materials Output to B• Labour Normal Loss

• Overheads

• Unit Cost

Worked example – 2Abnormal Loss

• Information as above• Normal loss 10%, • But - Actual loss 15%

Worked example – 2Abnormal Loss

• Process A A/c• Units £ Units

£• Materials Output to B• Labour Normal loss

• Overheads Abnormal loss

• Unit Cost

Worked example – 3Abnormal Gain

• Information as above• Normal loss 10%, • But Actual loss 5%

Worked example – 3Abnormal Gain

• Process A A/c• Units £ Units £• Materials Output to B• Labour Normal Loss

• Overheads• Abnormal gain•  • Unit cost

Scrap

• Process losses may be sold as scrap, and the income may be used to offset;– The process if the loss is normal OR– The abnormal loss if abnormal

Worked example – 4Scrap sales – abnormal loss

• Information as above• Normal loss 10%, • Actual loss 15%, • Scrap sold at £5 per unit

Worked example – 4Scrap sales – abnormal loss

• Process A A/c• Units £ Units £• Materials Output to B• Labour Normal Loss • (Cash)• Overheads Ab loss•  • Unit cost

Stock Valuation

• Work in Progress is expressed as equivalent units of production.

•  • For example, in costing terms, 100

units half complete is equivalent to 50 units complete

Worked example – 5Equivalent Units

• New information• Input• Materials 14 units at £5• Labour £48• Output 10 units • Work in Process 4 units - 50%

complete for labour and overheads • Note – no losses or scrap

Worked example – 5Equivalent Units

• Workings Cost Output WIP Total Cost equiv per

unit• Materials £70 10 4 14 £5• Conversion£48 10 2 12 £4•  • Output 10 *£9 = £90•  • WIP 4*£5 = £20• 2*£4 = £8

Worked example – 5Equivalent Units

• Process A A/c• Units £ Units £• Materials Output to B• Conversion WIP

If there is opening WIP…

• There are two possibilities (you will be told which);– The opening WIP is assumed to be

processed first - FIFO– The opening WIP is merged with the

units introduced and averaged - AVCO

Worked Example 6Equivalent units and opening stock

• Opening WIP 6 units (60% complete) • Opening WIP value

– Materials £24– Conversion cost £15.30

• Units added 16• Closing WIP 4 units (75% complete)• Material added £63• Conversion cost added £75

Worked Example 6Equivalent units and opening stock

• Workings – unit calculations

• opening WIP 6• units added 16• 22• closing WIP (4)• units completed 18

Worked Example 6Equivalent units and opening stock

• Calculations – AVCO• Opening WIP Cost Added

Total• Materials £24 £64 £88• Conversion £15.30 £75 £90.3•   Units Comp. WIPequ.

TotalEqu• Mats 18 4 22• Conversion 18 3 21• Cost per Unit

– Materials £88/22 = £4– Conversion £90.30/21= £4.30

Worked Example 6Equivalent units and opening stock

• Process A A/c• Units £ Units £• Opening WIP Output to B• Materials WIP• Conversion

Worked Example 6Equivalent units and opening stock

• Calculations FIFO• Mat Conv• Cost Added £64 £75• Work started • and completed 18-6 = 12 18-3.6 =

14.4• Closing WIP (equiv) 4 3• Equiv Unit 16 17.4• Prod Cost £4 £4.31

Worked Example 6Equivalent units and opening stock

• Summary• Completed production £• Opening WIP 39.3• Materials 12*4 48• Conversion 14.4 * 4.31 62.07• 149.37• Closing WIP• Materials 4*4 16• Conversion 3*4.31 12.93• 28.93

Worked Example 6Equivalent units and opening stock

• Process A A/c• Units £

Units £• Opening WIP Output to B• Materials• Conversion WIP