Process Costing

PROCESS COSTING
It is a method used in those industries where masses of similar or identical products or services are
produced.
It is a costing procedure where products are produced in the same manner and consume the same
amount of direct costs and overheads.
It is therefore unnecessary to assign costs to individual units of output.
Instead the average cost per unit of output is calculated by dividing the total costs incurred during the
period by number of units of output for the period.
It is used by the industries having a continuous flow of identical products where it is not possible to
distinguish one unit from another.
These industries produce standard products meant for stock and all other factory procedures are
standardized.
Costs are compiled for each process or department by preparing a separate account for each process.
Process costing is employed in the following types industries;- Chemical works, foam manufacturing,
Oil refining, Textile mills, Cement manufacture, Food manufacturer, Paper manufacturer, Soap making,
Breweries, Sugar works, Distilleries and Paint manufacture.
Features of Process Costing.
1. Production is continuous and the final product is the result of a sequence of processes/operations.
2. Costs are accumulated by processes.
3. Products are standardized and homogeneous.
4. Cost per unit produced is the average cost which is calculated by dividing the total process costs by the
number of units produced.
5. Finished output of one process becomes the input of the next process and that of the last process is
transferred to the finished goods stock.
6. The sequence of operations/processes is specific and predetermined.
7. Some loss of materials in process (due to chemical reaction, evaporation etc) is unavoidable.
8. Processing of a raw material may give rise to the production of several products. These can be termed
as joint products or by-products.
Process Costing in a Diagram

Process A

Input/output

Process B
Input/output

Finished Stock
Completed Production

Work in - Progress

Notes;
No attempt to allocate costs to individual units of production.

Direct costs and factory overload costs are allocated to all processes.
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When units are completed, they are transferred to finished goods stock at average unit cost.
Finished goods stock consists of like units valued at average unit cost of production.
Accumulation of Costs
As production moves from process to process, costs are transferred with it.
Say costs of process A are transferred to process B, added to this cost, are the costs of B for the
period. The total is transferred to C. Added to this, are the costs of C for the period resulting into total
cost of production which is divided by no. of units of output to obtain the cost per unit.

Thus cost per unit (CPU)

= Cost Incurred during the period

Number of units produced
Process Losses and Wastages:

During production, a certain amount of loss occurs at various stages.

Such a loss may arise due to chemical reaction, evaporation, inefficiency etc.

It is therefore imperative to keep accurate records of inputs and output.

Process loss therefore is the loss of weight or volume of material during a process.

It may be of two kinds;

a) Normal Loss
b) Abnormal Loss
Normal Loss.
Loss which is inherent in the production process and cannot be eliminated.
This may be because of the nature of materials or process e.g. Liquids may evaporate, losses occur in
cutting wood to make furniture.

Such a loss is quite expected under normal efficient operating conditions and is unavoidable or
uncontrollable loss.

It is caused by factors like chemical change, evaporation, withdrawals for tests or sampling etc.
Accounting treatment of normal loss.

The cost of Normal loss is absorbed in the cost of producing good production.

Normal loss is generally given as a percentage of input and calculated in advance on the basis of past
experience.

Since a Normal loss is not physically present, it cannot have any value.

However, when normal wastage is physically present in form of scrap, it may have some value, that is,
it may be sold at lower price.

Whenever, scrapped material has any salable value, it is credited to the process account and debited
to the normal loss account. See these accounting entries;On recognition of the normal loss value
Dr. Normal loss A/c
Cr. Process A/c

Closing the normal loss account to the scrape sales account.

Dr. Cash/ Bank or scrape sales A/c
Cr. Normal loss A/c
Note;

When determining the CPU for period, the scrape value of normal loss is subtracted from the total cost
for period. See the formula below;

CPU = Total cost for the period Normal loss scrapes value

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Expected output

Abnormal loss:
Loss that occur under abnormal conditions.
Abnormal loss cannot be foreseen, it is avoidable, and controllable.
The Main causes of abnormal loss are; Carelessness, Machine break down, Accidents, Use of
defective materials, Inefficiency of workers, Poor estimates, unskilled manpower

The abnormal losses are always over and above normal loss and determined as follows;
Determining Abnormal loss

When actual loss is equal to the normal loss then there is no abnormal loss.

When actual loss > Normal loss, the difference is abnormal loss or

When actual output < Expected output or the expected output > actual output the difference is
abnormal loss.

Abnormal loss since is not expected, it is not taken as part of good production; rather it is regarded as
an operating expense taken to P& Loss A/c.

The units involved are expressed in monetary terms using the calculated CPU.

This is why the accounting procedure for normal and abnormal loss differs.

Consider the following entries

Accounting entries

Value of Abnormal loss.

Dr. Abnormal loss account
Cr. Process account.

Scrape value of abnormal loss

Dr. Cash book or scrape debtors account
Cr. Abnormal loss account.

The balance in the abnormal loss account is transferred to profit and loss account at the end of the
year.
Abnormal gain or effectiveness.

If normal process loss is less than expectations, then the difference between the actual loss and
normal loss is known as abnormal gain/effectiveness.

So abnormal gain = Actual loss < Normal loss.

Or if actual production is greater than expected production, then the difference is

Abnormal gain. The value of abnormal gain is calculated on the same basis as good production.
Accounting Treatment of Abnormal Gain

Value of Abnormal gain

Dr. Process account
Cr. Abnormal gain account.
Note;
Note: The reduced incomes of selling less of normal loss are debited to abnormal gain account and
credited to scrape debtors account.
Dr. Abnormal gain account
Cr. Scrape Debtors account

In doing this, the net figure of abnormal gain is obtained as well as the net incomes from sale of

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normal loss scrape.

The balance in the abnormal gain account is taken to P & L Account.

Illustration 1
Juice Modern Ltd processes a Coconut Juice that passes through 3 processes to completion. In one
month, the production costs are as follows;Cost element
Total costs
Processes
1
2
3
(Amounts in Uganda Shillings 000)
Additional materials
8,432
2,000
3,020
3,462
Direct labour
12,000
3,000
4,000
5,000
Direct expenses
726
500
226
0
Period Production overheads are Ugx.6, 000,000 absorbed in each process on the basis of 50% of the cost
of direct labour.
1,000 liters at 5/= each were issued to process 1. Outputs of each process were as follows;Process 1
920units
Process 2
870units
Process 3
800units
Normal loss per process;Process 1
10%
Process 2
5%
Process 3
10%
The loss in each process represented by scrap is to be sold to a merchant as follows;Process 1
UGX3per unit
Process 2
Ugx5 per unit
Process 3
Ugx 6 per unit
There was no stock of materials or WIP in any process at the beginning and at the end of the month.
Required; - Prepare Process 1, 2 & 3 Accounts, Normal loss, abnormal loss and abnormal gain accounts.
PROCESS COSTING WITH ENDING WORK IN PROGRESS

There are situations where output started during a period is partially complete at the end of the period.

In other words, ending work in progress exists within a process.

The work in progress represents uncompleted or semi finished production in each process at the end
of the accounting period.

This uncompleted production is carried forward to the next accounting period.

Whenever, uncompleted items exist at the end of the period, unit costs cannot be computed simply by
dividing the total costs for a period by output for that period.

E.g.1 If 8,000 units were started and completed during a period and another 2,000units were partly
completed,

These two items cannot be added together to ascertain their unit cost.

We must convert the work in progress into finished equivalents (also called Equivalent production) so
that the unit cost can be obtained.

To do this, we must estimate the percentage degree of completion of the work in progress and multiply
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this by the number of units in progress at the end of accounting period.

E.g. if 2,000 units were the partly completed, and these were 50% complete, we could express this as
an Equivalent production of 1,000 fully completed units = 50/ 100 x2, 000=1,000 units.

These would then be added to the completed production of 8,000units to give total Equivalent
production of 9,000 units
CPU = Total cost
= 180,000 = 20Shs/Unit
Total Equivalent production
9,000
Distribution of this cost will be as;

Completed &transferred to next process. 8,000x20 = 160,000

Work in progress (1,000 Eqv. Units at 20shs@) =

20,000
Total
180,000
Equivalent production

Represents production of a process in terms of completed units.

W.I P at the end of accounting period is converted into equivalent units.

As total costs for the period need to be spread over the total equivalent production, the following
procedure is adopted;
Total Effective or Equivalent Production =
completed + Equivalent units in W.I.P
Cost per unit
=Total cost
Total Equivalent production
Elements of costs with different degrees of completion

There may happen to be a complication concerning Equivalent units.

This happens when in any given stock of W.I.P, not all of the elements that make up the total cost
may have reached the same degree of completion.

Usually materials are added at the start of the process or at certain stage in the process.

But labour & manufacturing overheads (conversion costs), may be added throughout the process.

Where this situation arises, separate Equivalent production calculations must be made for each
element of cost.

When this is done, the cost per unit of equivalent production of each cost element is also done.

Subsequently, the value of finished production and work in progress is ascertained using unit costs
of each element of cost.

Therefore, in order to calculate Equivalent production and for its valuation, the following three
statements are prepared;1. Statement of equivalent production
2. Statement of cost (per unit)
3. Statement of valuation
Input materials and material introduced

The raw material introduced in the first process is transferred to the second process after processing.

The output of process 1 becomes the input of process 2 and so on.

The full cost of the completed units transferred from the previous process forms the input cost of the
current process and by nature the input material cost must be 100% complete.

Materials introduced in the current process, is extra material needed in the process and should always
be shown separately from input material.

Sometimes input material is referred to as material 1 and materials introduced as material 2.

Input material is always 100% complete.

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Additional materials (Material2) are always added when the process is 80% complete. This is a
practice adopted by most companies.
When added at 80% and above, the equivalent units of material2 must be obtained by applying the
percentage of completion.
But when the materials are added before 80% stage, the equivalent units equals zero.
Assume no opening W.I.P and no process losses

Illustration 2
Andrew manufacturing firm produces a product that passes through two distinct stages or processes i.e. 1
& 2. The following data have been extracted from its records representing the month of January 2016.
Process1:20,000kgs of materials introduced to the process @ 1,000/=
Direct labour costs

Ugx.17, 000,000

Overhead costs

Ugx.20, 800,000

Andrew expected to register an output of 95% of input and planned to dispose off any scraped units at
800/=each.
At the end of the process1, the firm registered actual loss of 1,600kgs and output of the process was
transferred to process2.
Process2:The following conversion costs were incurred;Direct labour hours were 1,550 at a rate of Ugx.10, 000 per hour.
Additional material costs of Ugx.11, 635,000
Overheads were absorbed on the basis of direct labour at a rate of 300/- per hour.
No loss was expected at process2.
The final output was 17,000units and 1,400units of WIP.
Additional materials are always added when the process is 80% complete. The degree of completion of
CWIP was as follows;Additional materials

90%

Direct labour

85%

Overheads

90%

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Process Costing

Required;a)
b)
c)
d)

Statement of Equivalent production

Statement of Cost/CPU
Statement of Valuation
Process account 1& 2

OWIP & CWIP Both Exist

If a given process has partly completed units at the end of the period (Closing WIP), there will be
opening WIP at the beginning of the next period.

This opening WIP is partly complete and have a value brought forward from the previous period.

Sometimes the OWIP is divided into various elements of materials, labour and overheads each with a
given degree of completion and cost value.

Because of having OWIP, the finished units completed during the period will comprise of two lots;1. OWIP which is partially incomplete and which will be completed during the period.
2. Units introduced into the process during the current period and have been completed during the
period.

In such cases the problem arises of how to value the closing WIP and the completed units
transferred out to the next process.

Since costs tend to vary from period to period, each lot may carry different unit costs.

The procedure of calculating equivalent production in OWIP units depends on the method of costing
(Cost flow assumption) used.

Two widely used methods are;1. First in Out (FIFO)

2. Average Weighted Cost Method (AWCM)
FIFO (FIRST IN FIRST OUT) METHOD.

This method is based on the assumption that W.I.P moves on a first in first out basis.

This means that unfinished work on the opening stock is completed first, before work on any other new
units is taken up.

Thus no units from opening WIP will be left incomplete and none of these finds their way in the closing
WIP.

In other words, closing stock will be out of the material introduced during the current period and will be
valued at the current costs.

The costs incurred during the current period will be distributed over opening stock of WIP (for its
completion), units introduced and completed during the period, and closing stock of W.I.P.

This is done by dividing the costs incurred by the relevant equivalent production so as to arrive at the
cost per unit of equivalent production.

FIFO Method gives satisfactory results when prices of material, rates of wages and overheads are
relatively stable.

A common practice of calculating the cost of output completed in a period is worked as under;1. The cost incurred during the current period to complete the work in progress brought forward.
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Process Costing

2 .The costs of units started and completed in the current period.

3. The cost of work started but not completed in the current period.

Equivalent production of OWIP is calculated as follows;Eqv. Production = Units in OWIP *%ge of work needed to be completed (Portion not yet complete).

CPU is computed by dividing the total cost for the period by the equivalent production during the
period.

CPU = Total cost incurred during the period

Equivalent production
Where Eqv. Production =
Eqv. Units in OWIP
xx
+ Units completed
xx
+Eqv. Units in CWIP
xx
Note;
The OWIP is charged separately to completed production and the CPU is based only on the current
costs and the production for the current period.

The CPU is used for valuing CWIP and the effect of this is that CWIP is valued at current period costs
and part of the previous period costs brought forward in OWIP valuation is added to the cost of
completed units.
AVERAGE COST METHOD

In this method, the cost of opening W.I.P is not kept separate but is averaged with the additional costs
incurred during the period.

This method thus combines the cost of opening W.I.P and new production.

In order to find out the cost per unit of equivalent production, the cost of each element (material,
labour and overheads) applicable to the opening W.I.P is added to the cost incurred in the current
period for that element.

A single cumulative total and unit cost is obtained.

Units completed and transferred as well as closing W.I.P will be valued at this average unit cost.

In this method, opening W.I.P is treated as part of current production. It means, opening W.I.P loses its
identity.
Procedure;
EqV. Production = Ignore the stage of completion of OWIP and rather consider work to complete as
100% complete.

CPU = B/f Costs+ Current period costs

Total Eqv. Production (Completed + Eff.units in CWIP

Valuation = Use one average unit cost for all units completed.
Illustration 3
ABC ltd manufactures product X which passes through one process and uses process costing to account
for costs. Materials are always added at the start of the process. On 1.12.2015, there was OWIP of 12,000
units which was 60% complete. The costs of OWIP were as follows;Materials

Ugx.48, 000

Conversion costs

Ugx.30, 600

During December, the following costs were incurred;Bba3-cma-December2016 exams

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32,000 units of Materials were introduced to the process valued at Ugx.128, 000; Conversion costs of
Ugx.150, 000 were incurred. At 31st December, 2015, there was CWIP of 8,000 units which were 75%
complete with respect to conversion costs.
Required;a) Statement of Equivalent production
b) Statement of Cost/CPU
c) Statement of Valuation
CWIP and Process Losses

As mentioned and discussed earlier, losses are inherent in process operations.

Normal and abnormal process losses are treated differently in the calculation of equivalent production.

Process losses include; Normal loss

Abnormal loss
Normal loss:

Equivalent units of Normal losses are taken as nil if the loss is incurred at the stage that has already
been by passed by both CWIP and Completed units.

This implies that the normal loss should be shared by both CWIP and completed production.

By not computing individual equivalent normal loss units, it means that the unit cost calculated will
incorporate the normal loss portion.

It is the same CPU which will be used to value all the units processed during the period including
CWIP.

This means that Normal loss is not added in Equivalent production.

However, if the normal loss takes place towards the end, that is, at the inspection point, the value of
normal loss should be added to the cost of completed units only since CWIP has not yet reached that
stage (Level).

In such a case therefore, the equivalent units in normal loss units should be determined and treated to
be part of total equivalent production.
Note:

However, realizable value of Normal loss scrap is deducted from the cost of material so as to calculate
the net material cost.

This net material cost becomes the basis of calculating the material cost per unit in the statement of
cost.
Abnormal loss

Abnormal loss units are treated as if these were good production units.

Abnormal loss, thus is added to Equivalent production with due consideration of its degree of
completion.

Unless the degree of completion is specified, it may be assumed that all abnormal loss units are
100%complete in respect of all elements of costs.
Abnormal gain

Units of abnormal gain are represented by good finished production.

Its therefore, always taken as 100% complete in respect of all element of cost. I.e. material, labour and
overheads.

Abnormal gain units are deducted to obtain Equivalent production.

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