CHAPTER I

1.1 INTRODUCTION OF PROCESS COSTING :

Process costing is an accounting methodology that traces and accumulates direct cost,

and allocates indirect costs of a manufacturing process. Costs are assigned to
products, usually in a large batch, which might include an entire month's production.
Eventually, costs have to be allocated to individual units of product. It assigns average
costs to each unit, and is the opposite extreme of Job costing which attempts to
measure individual costs of production of each unit. Process costing is usually a
significant chapter. It is a method of assigning costs to units of production in
companies producing large quantities of homogeneous products.

Process costing is a type of operation costing which is used to ascertain the cost of a

product at each process or stage of manufacture.  Process costing is suitable for
industries producing homogeneous products and where production is a continuous
flow. A process can be referred to as the sub-unit of an organization specifically
defined for cost collection purpose.

Costing is an important process that many companies engage in to keep track of

where their money is being spent in the production and distribution processes.
Understanding these costs is the first step in being able to control them. It is very
important that a company chooses the appropriate type of costing system for their
product type and industry. One type of costing system that is used in certain industries
is process costing that varies from other types of costing (such as job costing) in
some ways. In process costing unit costs are more like averages, the process-costing
system requires less bookkeeping than does a job-order costing system. Thus, some
companies often prefer to use the process-costing system.

In process costing it is the process that is costed (unlike job costing where each job is
costed separately). The method used is to take the total cost of the process and
average it over the units of production.

Cost per unit = Cost of inputs

Expected output in units

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1.1 INTRODUCTION OF PROCESS COSTING :

1.2 DEFINITION OF PROCESS COSTING :

CIMA defines process costing as "The costing method applicable where goods or
services result from a sequence of continuous or repetitive operations or processes.
Costs are averaged over the units produced during the period". 

WHEN PROCESS COSTING IS APPLIED?

Process costing is appropriate for companies that produce a continuous mass of like
units through series of operations or process. Also, when one order does not affect the
production process and a standardization of the process and product exists. However,
if there are significant differences among the costs of various products, a process
costing system would not provide adequate product-cost information. Costing is
generally used in such industries such as petroleum, coal mining, chemicals, textiles,
paper, plastic, glass, food, banks, courier, cement, and soap.

1.3 REASONS FOR USE OF PROCESS COSTING:

Companies need to allocate total product cost to unit of product for the following
reasons:

a) A company may manufacture thousands or millions of units of product in a given

period of time.
b) Products are manufactured in large quantities, but products may be sold in small
quantities, sometimes one at a time (automobiles, loaves of bread), a dozen or
two at a time (eggs, cookies), etc.
c) Product costs must be transferred from Finished Goods to Cost of Goods Sold as
sales are made. This requires a correct and accurate accounting of product costs
per unit, to have a proper matching of product costs against related sales
revenue.
d) Managers need to maintain cost control over the manufacturing process. Process
costing provides managers with feedback that can be used to compare similar
product costs from one month to the next, keeping costs in line with projected
manufacturing budgets.

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1.1 INTRODUCTION OF PROCESS COSTING :

e) A fraction-of-a-cent cost change can represent a large dollar change in

overall profitability, when selling millions of units of product a month. Managers
must carefully watch per unit costs on a daily basis through the production
process, while at the same time dealing with materials and output in huge
quantities.
f) Materials part way through a process (e.g. chemicals) might need to be given a
value, process costing allows for this. By determining what cost the part
processed material has incurred such as labor or overhead an "equivalent unit"
relative to the value of a finished process can be calculated.

1.4 ADVANTAGES OF PROCESS COSTING:

1. The cost is calculated periodically.

2. Less clerical efforts and costs are enough to calculate cost.
3. It is simple and less expensive to find out the cost of each process.
4. It is easy to allocate the expense to process in order to have accurate costs.
5. Production activity in process costing is standardized. Hence, managerial
control and supervision become easier.
6. The calculation of average cost is very easy since the homogeneous products
are produced.

LIMITATIONS OF PROCESS COSTING:

1. Process costing is based on historical cost. The available cost
information may not be useful for future managerial decision-making.
2. Unfinished units (work in process) at the end of the period are
expressed in equivalent production units. This introduces subjective
element in scientific cost determination.
3. The whole concept of process costing system is based on average costs.
Average costs do not always reflect the true costs. If there is an error in
cost determination in one process, it will affect the cost estimation in
subsequent processes as well as the cost of work in process and finished
products.
4. When two or more products are produced in the same process, the joint
costs are prorated to the various products using some weightage say in
terms of points. Giving weightage in terms of points is a subjective
decision, which will give rise to approximate costs and cannot be taken
as fully reliable. Absence of scientific base makes the process costing
inadequate for managerial purposes
5. Work – in process is generally done on estimated basis which leads to
inaccuracy in total cost calculations.

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1.1 INTRODUCTION OF PROCESS COSTING :

POCEDURE FO PROCESS COSTIN

For each process an individual process account is prepared. Each process of

production is treated as a distinct cost centre.

I. ITEMS ON DEBIT SIDE OF PROCESS A/C

Each process account is debited with

a. Cost of materials used in that process.

b. Cost of labour incurred in process.
c. Direct expenses incurred in that process.
d. Overheads charged to that process on some pre determined.
e. Cost of ratification of normal defectives.
f. Cost of abnormal gain (if any arises in that process)

II. ITEMS ON CREDIT SIDE OF PROCESS A/C

Each process account is credited with

a. Scrap value of normal loss (if any) occurs in that process

b. Cost of abnormal loss (if any in that process)

COST OF PROCESS:

The cost of the output of the process (total cost less sales value of scrap) is
transferred to the next process. The cost each process is thus up to cost
brought forward form the previous process and net cost of material,labour and
overhead added in that process after reducing the sales value of scrap. The net
cost of the finished process is to transferred to the finished goods account. The
net cost is divided by the number of units produced to determine the average
cost per unit in that process. Specimen of process account when there normal
loss and abnormal losses.

Particulars Units Rs. Particulars Units Rs.

To Basic Material Xxx Xx By Normal Loss Xx Xx

To Direct Xx By Abnormal Xx Xx
Material Loss

To Direct Wages Xx By Process II A/c. Xx Xx

To Direct Xx (output transfer

Expenses

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1.1 INTRODUCTION OF PROCESS COSTING :

to

To Production Xx next process)

Overhead

To Cost of Xx By Process I Xx Xx
Rectification of
Normal Defects Stock A/c.

To Abnormal Xx
gains

Xx Xxx xx Xxx

Dr. process I A/c. Cr.

PROCESS LOSS:

In many process, some loss is inevitable. Certain production techniques

are of such a nature that some loss is inherent to the production. Wastages of
material, evaporation of material is unavoidable in some process. But
sometimes the losses are also occurring due to negligence of laboure, poor
quality raw material, poor technology etc. these are normally called as
avoidable losses. Basically process losses are classified into two categories

(a) Normal Loss

(b) Abnormal Loss

a. NORMAL LOSS:

Normal loss is an unavoidable loss which occurs due to the inherent nature of
the materials and production process under normal conditions. It is normally
estimated on the basis of past experience of the industry. It may be in the
form of normal wastage, normal scrap, normal spoilage, and normal
defectiveness. It may occur at any time of the process.

No of units of normal loss: Input x Expected percentage of Normal Loss

The cost normal loss is a process. If the normal loss units can be sold as scrap
then the sale value is credited with process account. If some rectification is

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1.1 INTRODUCTION OF PROCESS COSTING :

required before the sale of the normal loss, then debit that cost in the process
account. After adjusting the normal loss the cost per unit is calculated with the
help of the following formula:

Cost of good unit: Total cost increased – Sale value of scrap

Input- Normal Loss units

b. ABNORMAL LOSS:

Any loss caused by unexpected abnormal conditions such as plant

breakdown, substandard material, carelessness, accident etc. such losses
are in excess of pre-determined normal losses. This losse is basically
avoidable. Thus abnormal losses arrive when actual losses are more than
expected losses. The units of abnormal losses in calculated as under:

Abnormal Losses = Actual Loss – Normal Loss

The value of abnormal loss is done with the help of following formula:

Value of Abnormal Loss:

Total Cost increase – Scrap Value of Normal Loss x Units of Abnormal Loss

Input – Normal Loss Units

Abnormal process loss should not be allowed to affect the cost of

production as it is caused by abnormal (or) unexpected conditions. Such
loss representing the cost of material, labour and overhead charged called
abnormal loss account. The sales value of the abnormal loss is credited to
abnormal loss account and the balance is written off to costing P & L A/c.

Dr. Abnormal Loss A/c. Cr.

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1.1 INTRODUCTION OF PROCESS COSTING :

Particulars Units Rs. Particulars Units Rs.

To process A/c. Xx xx By Bank A/c. Xx Xx

By costing P & Xx Xx
L A/c.

Xx xxx Xx xxx

ABNORMAL GAIN:

The margin allowed for normal loss is an estimated (i.e. om the basis of
expectation in process industries is normal condition) and slight differences
are bound to occur between the actual output of a process and that
anticipate. This difference may be positive or negative. If it is negative it is
called as abnormal loss and if it is positive it is abnormal gain i.e. if the
actual loss less than it is called as abnormal gain. The value of the
abnormal gain calculated in the similar manner of abnormal loss. The
formula used for abnormal gain is:

Abnormal Gain

Total Cost Incurred – Scrap Value of Normal loss x Abnormal Gain Units

Input Units – Normal Loss Units

The sales values of Abnormal Gain units are transferrd to Normal Loss
since it arrive out of the savings Normal Loss. The difference is transferred
to costing P & L A/c. as a real gain.

Dr. Abnormal Gain A/c Cr.

Particulars Units Rs. Particulars Units Rs.

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1.1 INTRODUCTION OF PROCESS COSTING :

To Normal Xx Xx By process A/c. Xx Xx

Loss A/c.

To Costing P & Xx Xx
L A/c.

Xx Xx Xx xx

1.5 DIASTINCTION BETWEEN JOB COSTING AND PROCESS

COSTING

There are various cost accounting techniques used to measure the

cost of the product. When the goods are produced only against special
orders, job costing is used by firms. On the other hand, when a
product passes through several processes or stages, the output of one
process becomes the input of next process, and to determine the cost
of each process, process costing method is applied. It is generally
used when like units are to be manufactured, that too in a continuous
flow.

In other words, the former is used to calculate the cost of jobs or

contracts which are distinct in nature, while the latter used to
compute the cost charged to each process. So, here in this article
excerpt, we present all the differences between Job Costing and
Process Costing, in a tabular form.

BASIS FOR
JOB COSTING PROCESS COSTING
DISTINCTION

Meaning Job costing refers to A costing method, in which

calculating the cost of a
special contract, work order
where work is performed as
per client's or customer's
instructions.
the costs which are charged
to various processes and
operations is ascertained, is
known as Process Costing.

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1.1 INTRODUCTION OF PROCESS COSTING :

BASIS FOR
JOB COSTING PROCESS COSTING
DISTINCTION

Nature Customized production Standardized production

Assignment of Calculating cost of each job. First of all, cost is

cost determined for the process,
thereafter spread over the
produced units.

Cost Center Job Process

Scope of cost Less High

reduction

Transfer of Cost No transfer Cost is transferred from

one process to another

Identity Each job is different from Products are manufactured

another. consecutively and so they
lose their identity.

Cost Completion of the job. End of the cost period.

Ascertainment

Industry type Job costing is suitable for Process costing is perfect

the industries which for the industry where mass
manufactures products as production is done.
per customer's order

Losses Losses are usually not Normal losses are carefully

segregated. ascertained and abnormal
losses are bifurcated.

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1.1 INTRODUCTION OF PROCESS COSTING :

BASIS FOR
JOB COSTING PROCESS COSTING
DISTINCTION

Work-in-progress WIP may or may not exist WIP will always be present
(WIP) at the beginning or at the in the beginning or at the
end of the financial year. end of the accounting
period.

1.6 INTER PROCESS PROFITS:

The profit associated with the transfer of goods from one process to another
process is called inter-process profit. Normally, finished goods are transferred to
the immediate next process at the cost of production basis. In some process
industries, finished goods are transfer to the immediate next process by
including a nominal amount of profit. The profit so incorporated is called inter-
process profit. The price fixed by adding the nominal amount of profit for the
transfer of finished goods to the next process is known as transfer price. Adding
profit on the goods transferred is termed as mark-up price.

Transfer Price = Cost of output+ Profit

VALUATION OF WORK-IN-PROGRESS

MEANING OF WORK IN PROGRESS:

MEANING OF Equivalent Production:

This represents the production of a process in terms of

complete unit. In other words, it means converting the
incomplete production into its equivalent of complete units.
The term equivalent unit means a notional quantity of
completed units substituted for an actual quantity of

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1.1 INTRODUCTION OF PROCESS COSTING :

incomplete physical units in progress, when the aggregate

work content of the incomplete units is deemed to be
equivalent to that of the substituted quantity of completed
units.

Equivalent completed units = Actual number of units in the

process of manufacture x Percentage of work completed

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