What is Process Costing?
Definition
Process costing is a method of cost accounting used primarily in industries where production is continuous, and goods are produced in a series of sequential processes or stages. This system accumulates all costs (i.e., materials, labor, and overhead) for the entire production process and assigns an average cost per unit to each stage of production. This method is ideal in sectors such as chemical manufacturing, oil refining, food production, and textile industries.
Characteristics
- Cost Accumulation: Costs are accumulated and tracked for each production process or department rather than for individual units.
- Average Cost Computation: Average unit costs are computed at each stage of production by dividing total costs by the number of units produced.
- Special Valuation Rules: Special rules apply to the valuation of work in progress, normal losses, and abnormal losses.
- Distinction of Products: It is common to distinguish among the main product, by-products, and joint products in the cost allocation.
Examples of Process Costing
Example 1: Chemical Industry
In a chemical manufacturing company, raw materials undergo several chemical reactions in different stages to produce a final product such as plastic. Costs are accumulated at each stage, say mixing, heating, and finalizing. At the end of each stage, an average cost per unit is calculated.
Example 2: Textile Production
In textile production, different processes such as spinning, weaving, and dyeing are carried out in continuous stages. Costs incurred for each process step are collected over a period, and the average cost per meter of fabric is calculated at each processing stage.
Example 3: Food Manufacturing
In a company producing bottled beverages, processes include mixing ingredients, pasteurizing, bottling, and packaging. Costs for each process are recorded, and the average cost per bottle is determined.
Frequently Asked Questions (FAQs)
Q1: How is process costing different from job costing?
Process costing accumulates costs for the entire production process over a period, whereas job costing tracks costs for specific jobs or batches. Process costing assigns an average cost per unit, while job costing uses the specific costs for each job.
Q2: What are normal and abnormal losses in process costing?
- Normal Losses: Expected losses due to the nature of the production process, such as evaporation or spillage.
- Abnormal Losses: Unexpected or excessive losses above the normal level, often caused by mechanical failure or human error.
Q3: How do you handle by-products in process costing?
By-products are valued at their estimated sales value and subtracted from the total process costs. This reduces the overall cost of the main product.
Q4: Why is it important to value work in progress in process costing?
Valuing work in progress allows companies to allocate costs accurately and calculate the cost of finished goods, essential for financial reporting and inventory management.
Q5: Can process costing be used in non-manufacturing industries?
Yes, process costing can be adapted for use in any industry where services or products go through multiple stages, including pharmaceuticals, energy production, and even certain service industries.
Related Terms
Average Costing
Assigning costs to products based on the average cost of all units produced, rather than tracking individual costs.
Work in Progress (WIP)
Partially finished goods that are still in the production process at the end of an accounting period.
Normal Losses
Losses that are expected as part of the normal production process, such as material wastage.
Abnormal Losses
Losses that are unexpected and above the normal level, often due to accidents or inefficiencies.
Main Product
The primary output of a production process that generates the main revenue for the business.
By-products
Secondary products generated incidentally during the production of the main product, often of lesser value.
Joint Products
Two or more products that are produced simultaneously from a common process or input and have significant sales value.
Online References
- Investopedia: Process Costing
- AccountingCoach: Process Costing
- Corporate Finance Institute: Process Costing
Suggested Books for Further Studies
- “Cost Accounting: A Managerial Emphasis” by Charles T. Horngren, Srikant M. Datar, and Madhav V. Rajan
- “Process Costing (Cost Accounting and Management Essentials Series)” by Frank Wood
- “Management and Cost Accounting” by Alnoor Bhimani, Charles T. Horngren, Srikant M. Datar, and Madhav V. Rajan
Process Costing: Fundamentals Quiz
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