What is Process costing? Pros and Cons of process costing

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    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. (7) The total cost of production of each process for a particular period is divided by the number of units produced in that process during that period, and the average cost per unit of production for a period is obtained. The next step in a process cost system is to calculate the equivalent units in order to account for items that are unfinished at the end of each period. For this step, the number of incomplete units at the end of the period is multiplied by a percentage that represents their progress in the production process.

    • For example, how would you determine the precise cost required to create one gallon of aviation fuel, when thousands of gallons of the same fuel are gushing out of a refinery every hour?
    • The first in first out (FIFO) method of costing is used to introduce the subject of materials costing.
    • In companies producing similar products, process costing is more practical and more accessible to use than job costing.
    • It is necessary to know the cost at every stage of production and this is fulfilled by process costing method.

    Let’s assume, a manufacturing business completed 4,000 products and has another 1,000 units halfway through production, the total costs would be divided by 4,500 units [i.e. If the total cost calculated across all departments to produce these units was $16,875, it means that the cost per unit will be determined by simply dividing the total cost of $16,875 by the 4,500 number of units. The costing methods commonly used in manufacturing include process costing and job costing.

    Comparing Job And Process Costing

    The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. For example, when an airline provides transportation for passengers the way it would produce any product. She has conducted a large number of process mining projects with companies such as Philips Healthcare, Océ, ASML, Philips Consumer Lifestyle, and many others.

    • Process costing is employed by the industries whose production process is continuous and repetitive, as well as the output of one process is the input of another process.
    • (2) It helps in the computation of costs of processes as well as the finished product.
    • With NetSuite, you go live in a predictable timeframe — smart, stepped implementations begin with sales and span the entire customer lifecycle, so there’s continuity from sales to services to support.
    • By understanding what is process costing, companies can compare changes in costs over time by using the same standardized costing method each period.

    As a result, they have completed 8,000 pairs of shoes and pass the next stage. All production costs will be accumulated and allocate equally to all products by assuming that they are consumed the same resource. Accountants will calculate the total overhead cost of each month and separate them to each finished product at the month-end. The units that have been complete during the period have been completed in the above stage of the process costing.

    What Is Process Costing?

    During the month of March, the casting department incurs $50,000 of direct material costs and $120,000 of conversion costs (comprised of direct labor and factory overhead). The department processes 10,000 widgets during March, so this means that the per unit cost of the widgets passing through the casting department during that time period is $5.00 for direct materials and https://quick-bookkeeping.net/ $12.00 for conversion costs. The widgets then move to the trimming department for further work, and these per-unit costs will be carried along with the widgets into that department, where additional costs will be added. Process costing system is an accounting method usually used by manufacturing companies that mass produces very identical products or units of output.

    Calculating Unit Cost Under Process Costing

    For example, in a job order cost system, each job is unique, which allows management to establish individual prices for individual projects. By dividing the total cost of a process by the total number of units produced, the cost per unit can be obtained. Process costing is the only reasonable approach to determining product costs in many industries. https://kelleysbookkeeping.com/ It uses most of the same journal entries found in a job costing environment, so there is no need to restructure the chart of accounts to any significant degree. This makes it easy to switch over to a job costing system from a process costing one if the need arises, or to adopt a hybrid approach that uses portions of both systems.

    (8) The cost of production of one process is transferred to subsequent process or processes just as output on one process is transferred as input of other process. Process costing is suitable for some businesses, which produces similar products, such as a footwear manufacturing. Besides that, It is also applicable to manufacturing that has many processes which cannot identify the cost of each production process. This method of costing is utilised by the textile, biscuit, cement, paper, and oil refining sectors, among others.

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    (3) The computation of costs under process costing involves less clerical work and expenses. Indirect expenses or overheads incurred on two or more processes are apportioned https://bookkeeping-reviews.com/ on the basis of direct wages or on any other suitable basis. Sometimes, overheads are recorded at predetermined rates based on direct wages, prime cost, etc.

    The physical flow of the units can be calculated by reviewing the documents that record the flow of the completed units in and out of the production system. The actual flow can be calculated depending on the policy of the company which can be the FIFO method and AVCO method as well. Process costing is a method of allocating costs in the manufacturing environment where production is carried in batches and requires different stages to be completed. The use of process costing can help companies provide products at competitive prices. In this way, companies can identify obsolete, inefficient, and redundant processes. Let’s assume Coca cola carries out similar calculations for the labeling and packaging departments and discovers that it spent a total of $100,000 to produce 50,000 bottles in the month of May.

    (2) It helps in the computation of costs of processes as well as the finished product. (4) The production records of each process are kept in such a way as to show the quantity of production and the wastage and scrap and the cost of production of each process for each period. (2) Each Process Account is debited with material cost, labour cost, direct expenses and overheads allocated or apportioned to the process. Overheads incurred on two or more processes are apportioned on the basis of direct wages or on any other suitable basis. Sometimes overheads are recorded at pre-determined rate based on direct wages, prime cost, etc. The method assumes that materials are issued from the oldest supply in stock and that the cost of those units, when placed in stock, is the cost of those same units when issued.


    Marry Rose

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