In this article we will discuss about:- 1. Meaning and Definition of Process Costing 2. Characteristics or Features of Process Costing 3. Types 4. Suitability of Method 5. Process Costing is Applicable in Industries 6. Objects 7. Elements 8. Principles 9. Accumulation of Costs 10. Advantages 11. Disadvantages.
Contents:
- Meaning and Definition of Process Costing
- Characteristics or Features of Process Costing
- Types of Process Costing Method
- Suitability of Process Costing Method
- Process Costing is Applicable in Industries
- Objects of Process Costing
- Elements of Process Cost Accounting
- Principles of Process Costing or Process Costing Procedure
- Accumulation of Costs under Process Costing
- Advantages of Process Costing
- Disadvantages of Process Costing
1. Meaning and Definition of Process Costing
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Process costing is probably the most widely used method of cost ascertainment. Process costing refers to a method of accumulating cost of production by process. It is used in mass production industries producing standard products like steel, sugar, chemicals, oil, etc. In all such industries, goods produced are identical and all factory processes are standardised.
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Output in such industries consists of like units and every unit of product undergoes similar operation in the process. So it is implied that the same cost of material, labour and overhead is charged to each unit of product processed. Under this method, costing an individual unit is impossible.
Process costing is so called because, under process costing cost of the product is ascertained process wise. Process costing is also known as ‘Continuous Costing’, because industries which adopt process costing undertake production of goods on a continuous basis. Process costing is also known as ‘Average Costing’, because the cost per unit of each process is ascertained by averaging the expenditure incurred on that process during a period by the number of units produced in that process during the period.
The term ‘Process Costing’ has been defined by different scholars as under:
1. According to Wheldon, “Process costing is a method of costing used to ascertain the cost of product at each process, operation or stage of manufacture.”
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2. According to B. K. Bhar, “Process costing refers to costing of one or more processes involved while converting a raw material to finished product.”
3. According to Sharles, “Process Cost Accounts are applied to concerns which produce a commodity that has to go through several processes and which requires to know the cost of each process.”
4. According to Eric Kohler, “Process costing is a method of Cost Accounting whereby costs are charged to processes or operations and averaged over units produced.”
5. According to the Institute of Cost and Management Accountants (I. C.M.A.), London, “Process costing is that form of operation costing which applies where standardised goods are produced.”
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2. Characteristics or Features of Process Costing
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Process costing has certain characteristics of its own.
The chief characteristics of process costing are:
(1) The production of goods is continuous, except where the plant is shut-down for repairs, until the final product.
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(2) The finished product is the result of two or more processes.
(3) The product of the first process becomes the raw material for the second process and so on.
(4) Each process is distinct and is pre-determined.
(5) Costs are accumulated by processes.
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(6) The products are standardised and homogeneous.
(7) It is not possible to distinguish finished products while they are in the stage of processing.
(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.
(9) It is quite common to incur normal loss and wastage. Sometimes, owing to abnormal conditions even abnormal loss is also observed.
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(10) The production of main product is often accompanied by secondary products which are termed as point and bye-products.
(11) The semi-finished products are expressed in terms of complete products. This is technically termed as equivalent production.
(12) The production is undertaken on a continuous and large scale basis in anticipation of demand.
(13) Cost of production is ascertained at each process and finally after completion of production.
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(14) The production process is pre-determined and a definite sequence of production is followed. The raw material and work-in-progress flow from process to process according to the sequence of production.
(15) Some loss of materials in process (due to chemical action or evaporation, etc.) is unavoidable.
(16) The cost per unit produced is the average cost which is calculated by dividing the total process cost by the number of units produced.
3. Types of Process Costing Method:
There are three types of process costing method. They are:
(1) Sequential Process Cost Method:
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Under this method, all products pass through a series of processes in sequence. Under this method of process costing, output and cost of production is transferred from process to process until finished products are obtained. This method is used by industries which manufacture a single uniform product or products that are uniformly processed.
(2) Parallel Process Cost Method:
Under this method, two or more products pass through two or more separate sets of processes. The different sets of processes may be carried on simultaneously or one set may be run for a while and then another started.
(3) Selective Process Cost Method:
Under this method, cost is accumulated from various processes for various products. They are used where the products pass through only some of the processes but not all the processes of the industry. Thus, the process cost vary for different products. Meat packing industry is an example of this type of process costing.
4. Suitability of Process Costing Method:
Process costing method is most suitable in the following cases:
(1) Where production is continuous and on large scale.
(2) Where products are homogeneous or identical.
(3) Where goods pass through two or more distinct processes to completion.
(4) Where output of one process becomes the input of the subsequent processes.
(5) Where production function and products are standardised.
5. Process Costing is Applicable in Industries
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(1) Iron and Steel Industry
(2) Automobile Industry
(3) Cement Industry
(4) Chemical Industry
(5) Sugar Industry
(6) Plastic Industry
(7) Textile Industry
(8) Paper Industry
(9) Paints and Varnish Industries
(10) Industries Producing Drugs and Medicines
(11) Ice Plants
(12) Soap Industry
(13) Oil Industry
(14) Leather Industry
(15) Flour Milling Industry
(16) Biscuit Factories
(17) Aluminium Industry
(18) Mining of Gold, Silver, Zinc, Sulphur, etc.
(19) Timber Industry
(20) Perfumery Industry
(21) Glass Industry
(22) Box-making Industry
(23) Meat Packing
(24) Concerns Producing Explosives
(25) Public Utilities Companies—Water supply, Electricity, etc.
6. Objects of Process Costing
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Following are the main objects of process costing:
(1) To Ascertain the Cost of Each Process:
It is necessary to know the cost at every stage of production and this is fulfilled by process costing method. On this basis management is able to take decision in respect of make or buy the required commodities. For example – in Process 1st yarn is produced or manufactured at a cost of Rs. 125 per kg. whereas, it can be obtained from the market at Rs. 115 per kg. In this case, it is profitable to buy the yarn from the market at a saving of Rs. 10 per kg. This example shows the importance of process costing.
(2) To Ascertain the Cost of Bye-Product:
Bye-product is that which is obtained with the main product in the course of production. For example – while producing mustard oil, cake is also obtained which is termed as bye-product and the cost of which is necessary to know the actual cost of main product. Cost of bye-product is ascertained by preparing bye-product Account, under process costing.
(3) To Know the Wastage in Each Process of Production:
During the courage of production, different wastages, such as, loss in weight, normal wastage and abnormal wastage, etc. may arise. Management of any concern may know about these wastages by Process Costing Account.
(4) To Ascertain the Profit or Loss of Each Process:
The output or the part of output at the stage of every process can be sold out either at profit or loss. Thus the management can know about the profit or loss at every process by preparing Processes Account.
(5) Base of the Valuation of Opening and Closing Stock of Each Next Process:
If the total cost of production of any process is divided by the number of units, we get cost of production per unit of that particular process and on this basis opening and closing stock of next process is valued.
7. Elements of Process Cost Accounting
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Under process costing, the cost of materials, labour, direct expenses and overheads are collected as follows:
(1) Materials:
Raw materials and sundry supplies required for each process are obtained from stores through stores requisitions. So, the costs of materials and sundry supplies chargeable to any process can be ascertained from stores requisitions.
In case, the materials are issued in bulk to any process, the process concerned intimates to the cost office the exact quantity of materials consumed in the process during the particular period, and with the help of this data, the cost of materials chargeable to the process is ascertained.
(2) Labour:
Wages paid to workers engaged in a particular process are ascertained through the pay-rolls maintained for the concerned process, and are allocated directly to the process concerned.
However, where workers are engaged in two or more processes, their wages, ascertained through the relevant wage records, are apportioned among the different processes on the basis of time spent.
(3) Direct Expenses:
All direct expenses incurred on a particular process are directly allocated to that process.
(4) Overheads:
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.
8. Principles of Process Costing
or Process Costing Procedure:
The essential stages in process costing are:
(1) The factory is divided into a number of processes and an account is maintained for each process.
(2) Each Process Account is debited with material cost, labour cost, direct expenses and overheads allocated or apportioned to the process.
(3) The output of a process is transferred to the next process in the sequence. In other words, finished output of one process becomes input (materials) of the next process.
(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.
(5) In some cases the whole output of one process is not transferred to the next process. A part of the output may be transferred to the next process, and a certain portion of the output may be sold in semi-finished form or may be kept in stock and transferred to Process Stock Account. If output of any process is sold at a profit in semi-finished form, then profit on that particular sale will be shown in the debit side of that concerned profit, as profit on goods sold or transferred.
(6) In case there is loss or wastage of units in any process, the loss has to be borne by the good units produced in that process, and as a result, the average cost per unit increases to that extent.
It may be noted that, if there is loss or wastage in any process, the quantity of loss or wastage should be entered on the credit side of the concerned Process Account in the quantity column. In case the wastage has some scrap value, it should appear in the credit side of the concerned Process Account in the value column against the entry for wastage. But, if the scrap value of the wastage is not specifically given in the problem, it should be taken as nil.
(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.
(8) The finished output of the last process is transferred to the Finished Goods Account.
9. Accumulation of Costs under Process Costing
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Under process costing, the costs of materials, labour direct expenses and overheads are accumulated or collected as follows:
1. Materials:
Raw materials and sundry supplies required for each process are obtained from stores though stores requisitions. So, the costs of materials and sundry supplies chargeable to any process can be ascertained from stores requisitions.
In case the materials are issued in bulk to any process, the process concerned intimates to the cost office the exact quantity of materials consumed in the process during the particular period and with the help of this data, the cost of materials chargeable to the process is ascertained.
2. Labour:
Wages paid to workers engaged in a particular process are ascertained through the payrolls maintained for the concerned process, and are allocated directly to the process concerned.
However, where workers are engaged in two or more processes, their wages, ascertained through the relevant wage records, are apportioned among the different processes on the basis of time spent.
3. Direct or Chargeable Expenses:
All direct or chargeable incurred in a particular process are directly allocated to that process.
4. Indirect Expenses or Overheads:
Indirect expenses or 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 predetermined rates based on direct wages, prime cost, etc.
10. Advantages of Process Costing
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Process costing has the following advantages:
(1) Process costing helps in the computation of costs at shorter intervals, which is usually a week, a fortnight or a month.
(2) It helps in the computation of costs of processes as well as the finished product.
(3) The computation of costs under process costing involves less clerical work and expenses.
(4) The computation of costs per unit at any one process is very easy, as the units are homogeneous, and as such, the cost per unit can be found out easily by averaging.
(5) It ensures a chooser control over production and costs.
(6) It is easy to quote tender price because of standardised process.
(7) Control can be exercised through standard costing technique and it is possible to evaluate the performance of every process.
(8) Because cost of production is ascertained periodically, management is in a position to receive various reports periodically and review the progress and efficiency of the production process.
11. Disadvantages of Process Costing
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Following are the main disadvantages of process costing:
(1) When costs are recorded at the end of the period, it is not possible to exercise control over costs.
(2) It is difficult to apportion total cost among joint products and bye-products.
(3) Under this method of costing, it is difficult to value work-in-progress.
(4) It is difficult to value losses, wastes and scraps, under this method of costing.
(5) There is also the difficulty of ascertaining the value of closing stock where output of one process is transferred to another process at market price.
(6) The costs available under process costing are historical costs. The historical costs are not of much use for managerial control.
(7) This method provides the average cost per unit and the average cost per unit is not always accurate. As such, the average cost is not of much use for the purpose of detailed analysis and operating efficiency.