Process Costing - Meaning, Features, Applications, Advantages and Disadvantages of Process Costing, Difference between Process Costing and Job costing, Treatment of Losses in Process Costing
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. |
Advantages
of Process Costing:
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.
Disadvantages
of Process Costing:
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.
Also Read: Important Questions for Upcoming Exams
Unit – 4: job, Contract and Process Costing
(These Questions are subject to modification, if necesary. Download DTS Application for complete notes)
Q. Explain the features, advantages and disadvantages of job costing.
Q. What is process costing? What are the fundamental principles of Process Costing? Point out the advantages and limitations of Process costing. 2019
- Preparation of process accounts together with normal, abnormal loss and abnormal gain account, preparation of profit and loss account and costing profit and loss account, treatment of process finished stock and stock of raw material in process accounts. Follow examples of BASU AND DAS COST ACCOUNTING BOOK. 2013, 2016, 2018
- Preparation of contract account (Question bank given in Mobile application)
(Refer a
practical question for example of treatment of losses in process costing –
consult your teacher.
Difference between normal loss
and abnormal loss:
|
Bases |
Normal Loss |
Abnormal Loss |
|
1. Source |
It arises due to internal factors. |
It arises due to external factor. |
|
2. Nature |
It is recurring in nature. |
It is accidental in nature. |
|
3. Estimation |
It can be estimated in advance from the past
experience. |
It cannot be estimated in advance. |
|
4. Access to insurance |
It is not insurable loss. |
It is insurance loss. |
|
5. Avoidance |
It is unavoidable loss. |
It is avoidable. |