Process costing

What is Process costing? Advantages & Disadvantages of process costing?Normal loss,Abnormal loss and Gains

Process is a set of sequential steps followed to complete a certain activity. The way of maintaining the costing records of each process is called costing. It refers to the method of cost accounting under which cost are accumulated for every process which are interrelated to each other. Process costing is used in manufacturing concerns where the raw materials are converted to finished goods after passing through a number of processes. For example; in case of cotton textiles, the first process may be spinning, second process may be weaving and the final process may be finished.

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.”

Process Costing is used where the production moves from one process or department to the next until its final completion and there is a continuous mass production of identical units through a series of processing operations. It is applied for various industries like chemicals and drugs, oil refining, food processing, paints and varnish, plastics, soaps, textiles, paper etc.

Process Costing method may also be adopted in firms that produce a variety of products, provided that the overall production process can be broken down into sub-operations of a continuous repetitive nature like automobile, toy, plastics etc.
Process costing is mostly used in manufacturing concerns. T determines the cost of a product at each stage of manufacturing or process. This method of costing is adopted by industries involved in the manufacturing of textiles, biscuits, cement, paper, oil refining, etc. the output of first process becomes the input of the second process and so on as shown in following figure.

Advantages of process costing

The following are the advantages of process costing:

a. It is simple and less expensive to find out the cost of each process.

b. It is easy to allocate the expense to process in order to have accurate costs.

c. Production activity in process costing is standardized. Hence, managerial control and supervision become easier.

d. In process costing, the products are homogeneous. As a result, costs per unit can be easily computed by averaging the total cost and price quotations become easier.

e. It is possible to determine process costs periodically at short integrals.

Disadvantages of process costing

The following are the disadvantages of process costing:

a. The cost obtained at the end of the accounting period is historical in nature and is of little use for effective's managerial control.

b. Since process cost is average cost, it may not be accurate for analysis, evaluation and control the performance of various departments.

c. Once an error is committed in one process, it is carried to the subsequent processes.

d. Process costing does not evaluate the efficiency of individual workers or supervisor.

e. The computation of average cost is difficult in those cases where more than one type of product is manufactured.

Features of Process Costing:

The distinctive features of Process Costing are as follows:

(a) The process cost centres are clearly defined and all costs relating to each process cost centre are accumulated.

(b) The cost and stock records for each process cost centre are maintained accurately. The records give clear picture of the units introduced in the process or received from the preceding process cost centre and also units passed to the next process.

(c) The total costs of each process are averaged over the total production of that process, including partly completed units.

(d) The charging of the cost of the output of one process as the raw materials input cost of the following process.

(e) Appropriate method is used in absorption of overheads to the process cost centres.

(f) The process loss may arise due to wastage, spoilage, evaporation etc.

(g) Since the production is continuous in nature, there will be closing work-in-progress which must be valued separately.

(h) The output from the process may be a single product, but there may also be by-products and/or joint products.

Elements of production cost

The following are the main elements of productions cost in process costing:

a. Direct materials: materials are used for manufacturing products. The materials required for production are issued to the first process. The output of first process is passed to the next process and so on. Hence, the output of first process becomes the input of second process and so on, sometimes; new materials may be introduced in the second and subsequent processes.

b. Direct labour: payment madden to the manpower involved in process work against their work is called labour cost. Generally, employees are engaged in one process and wages paid to them is debited in the concerned process account. But if the employs are engaged in more than one process, the total wages paid to them are apportioned among the process on equitable basis.

c. Direct expenses: cost of electricity, hire charges of machine, depreciation of machine are the cost that are directly attributable to a particular process. The process account is debited by such direct costs.

d. Production overhead: the overhead covers a significant portion of the total process cost. Great attention should be paid to ensure that each process is charged with a reasonable share of production overhead like store service, cafeteria services, services etc. are allocated on the basis of absorption rate. The overheads are debited to the process account.

Accounting for process costing

Process accounts

Under process costing, a separate account is maintained for each process. The account is debited with the value of materials, labour, direct expenses and overhead relating to the process. The value of by-products and scrap, if any, is credited to this account. The balance of this account, representing the cost of partially worked out product, is passed on to the next process and so on until the product is completed. Thus the finished product of one process becomes the raw material of the next process.
The following situations arise while preparing process accounts.
a. Process costing having no process loss and stock
All the costs like materials, direct, labour expenses and production overhead relating to the particular process are debited to the process accounts. Since there is no process loss, the output of a process is equal to the unit of input introduced in the process. The total cost of the process is transferred to the next process. The format of the process account having no process loss and stock is given below:

b. Process costing having process loss
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.
Normal loss
Normal loss or uncontrollable loss means the less of materials, which is inherent in the processing operations or in the nature of material. Normal loss includes loss of leakage and normal scrap. Normal loss is considered to be an integral part of process cost. It is unavoidable but efficient workers can reduce it to some extent. The accounting treatment of normal loss is as follows:
Abnormal loss
Any loss caused by unexpected or abnormal condition such as accident, carelessness, etc. is called abnormal loss. It is the excess of over the normal loss. For example, if 1,000 units of raw material are introduced in a process subject to wastage of 10 percent, i.e. the output of the process should be 900 units. But the actual output is 830 units; the extra losses of 70 units are abnormal loss. In other words, the excess loss of 70 units over the normal loss of 100 units is the abnormal loss.
Calculation of the unit and of abnormal loss:
Normal output/yield= inputs – normal loss/ scrap unit
Total normal cost = total cost of input – scrap value of normal loss
Abnormal loss unit = normal output unit – actual output unit
Normal cost per unit = total normal cost/ normal yield

Difference between normal loss and abnormal loss

The differences between the normal loss and abnormal loss are given below:

c. Process costing having abnormal gain

We know that margin allowed for normal loss is just an estimate and slight differences are bound to occur between the actual and anticipated output of a process. These differences do not always represent increased loss may be less than the expected. Thus, when actual loss in a increased   loss, on occasions the actual loss may be less than the expected. Thus, when actual loss in a increased   loss, in a process is lower than the expected, an abnormal gain results. The value of the gain is calculated in a similar manner to an abnormal loss.

Abnormal gain being the result of actual loss being less than the normal, the scrap realization shown against normal loss gets reduced by the scrap value of abnormal gain. Consequently, there is an apartment loss by way of reduction in the scrap realization attributable to abnormal gain. The loss is set off against abnormal gain by debiting this account. The balance of this account becomes abnormal gain and is transferred to costing profit and loss account. The balance of this account becomes abnormal gain normal yield or actual loss is less than normal loss.

Calculation of abnormal gain unit and value

Total normal cost= total cost of input – scrap value of normal loss

Normal output/ yield= input – normal loss/ scrap unit

Normal cost per unit = total normal cost/ normal yield

Sales account and income statement

Income statement is prepared to find out profit and loss. Income statement is based on sales account, if sales is recorded in related process account. Incomes statement is also prepared on the basis of profit and loss of every process. If sales are not recorded in related procuress account, incomes statement is prepared on the basis of total sales. Incomes statement can be prepared as follows:

a. When sales  is included in the process account

Interest process profit

The profit associated with the transfer of goods form one process to another is called inter process profit. Normally finished goods of one process are transferred to the immediate next process at cost of production basis. In some process industries, transfer of finished goods is made to the immediate next process by including some account of profit. The procedure is followed to demonstrate the department efficiency of concerned processes. It helps in recognizing the profit on each process of production. The profit so incorporated is called inter-process profit. The price fixed by adding nominal balance sheet for the transfer of the finished goods to the next process is called as transfer price. For balance sheet purpose, intern process profit cannot be included in stock, as a firm cannot make profit by trading itself. To avoid these   complications a provision must be created to reduce the stock to actual cost price. This problem arises only in respect of stock on hand at the end of the period.

The following are the objectives of inter process profit.

• To assess the performance of process operation

• To assess whether the output can compete with the market.

• To decide whether the output can be sold without further processing.

Advantages of inters-process profit

• It shows whether the cost of production computers with the market price.

• By comparing the transfer prices with the corresponding market prices, the 'week' or strong' sports in the manufacturing activity can be located. As a result, measures can be adopted to improve the conditions wherever necessary.

• It makes each process stand on its own efficiency and economics.

Disadvantages of inter-process profit

• This system involves an unnecessary complication of the accounts.

• This systems shown unrealized profits in respect of unsold stocks on the closing date of the accounting period.

• In the balance sheet, stock is conventionally shown at 'cost or market price whichever is lower' to make it acceptable to auditors and tax authorities. Thus, the profit included in stocks has to be eliminated from the stock value before they are shown in final accounts and balance sheet.

Wastage, scrap, spoilage and diffractive unit

Differences between job costing and process costing

The differences between job costing and process costing are as follow:

List of formula

Normal output/yield = inputs – normal loss/ scrap unit

Total normal cost = total cost of input –scrap value of normal loss

Normal cost per unit = total normal cost/ normal yield

Abnormal loss (unit) = normal output unit –actual output unit/ normal output unit – actual output unit

Abnormal loss (Rs.) = abnormal loss unit x normal cost per unit

Abnormal gain (units) = actual loss unit – actual loss unit

Abnormal gain (RS.) =abnormal gain unit x normal cost per unit

Inter process:

Cost of losing stock = given closing stock x total amount of cost column/ total amount of total column

Unrealized profit on closing stock = given closing stock – cost of closing stock

Calculation of inter process profit:

a.  It percentage  of item process is given on processing cost, then

Inter process profit = total cost x %profit

a. If percentage of inter process profit is given on transfer price , then

Inter process profit =total cost x %profit / 100- %profit

Actual released profit = gross profit + unrealized profit on opening stock – unrealized profit on closing stock