The importance of process costing[edit]

Costing is an important process that many companies engage in to keep track of where their money
is being spent in the production and distribution processes. Understanding these costs is the first
step in being able to control them. It is very important that a company chooses the appropriate type
of costing system for their product type and industry. 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. Thus, some companies often
prefer to use the process-costing system.

When process costing is applied?[edit]

Process costing is appropriate for companies that produce a continuous mass of like units through
series of operations or process. Also, when one order does not affect the production process and a
standardization of the process and product exists. However, if there are significant differences
among the costs of various products, a process costing system would not provide adequate product-
cost information. Costing is generally used in such industries such as petroleum, coal mining,
chemicals, textiles, paper, plastic, glass, food, banks, courier, cement, and soap.

Reasons for use[edit]

Companies need to allocate total product costs to units of product for the following reasons:

 A company may manufacture thousands or millions of units of product in a given period of time.
 Products are manufactured in large quantities, but products may be sold in small quantities,
sometimes one at a time (automobiles, loaves of bread), a dozen or two at a time (eggs,
cookies), etc.
 Product costs must be transferred from Finished Goods to Cost of Goods Sold as sales are
made. This requires a correct and accurate accounting of product costs per unit, to have a
proper matching of product costs against related sales revenue.
 Managers need to maintain cost control over the manufacturing process. Process costing
provides managers with feedback that can be used to compare similar product costs from one
month to the next, keeping costs in line with projected manufacturing budgets.
 A fraction-of-a-cent cost change can represent a large dollar change in overall profitability, when
selling millions of units of product a month. Managers must carefully watch per unit costs on a
daily basis through the production process, while at the same time dealing with materials and
output in huge quantities.
 Materials part way through a process (e.g. chemicals) might need to be given a value, process
costing allows for this. By determining what cost the part processed material has incurred such
as labor or overhead an "equivalent unit" relative to the value of a finished process can be
calculated.

Process cost procedures[edit]

There are four basic steps in accounting for Process cost:

 Summarize the flow of physical units of output.

 Compute output in terms of equivalent units.
 Summarize total costs to account for and Compute equivalent unit costs.
 Assign total costs to units completed and to units in ending work in process inventory.
The journal entries for process costing are the same as those for job-order costing with one
exception. The entry to transfer cost from one work-in-process account to another is:
Work-in-process inventory-second department Debit (Left)
Work-in-process-first department Credit (Right)
e.g.(1) Micro Labs Company produces house paint in two processing departments: the Mixing
Department which mixes the paint colors and the Finishing Department which puts the paint in
containers and labels them. The following information related to the company’s operation for October
follows:
A) Raw materials were issued for use in production: Mixing department, $551,000, and the Finishing
department, $629,000. B) Direct labor costs incurred: Mixing department $230,000, and Finishing
department $270,000. C) Manufacturing overhead cost applied: Mixing department $665,000, and
Finishing department, $405,000. D) The cost of the mixed paint transferred from the Mixing
department to the Finishing department was $1,850,000. E) Paint that had been prepared for
shipping was transferred from the Finishing department to Finished Goods. Cost of the transferred
paint was $3,200,000.
Required: Prepare journal entries to record items A) through E) above.
Solution(1):

–Work in Process – Mixing 551,000

–Work in Process – Finishing 629,000
–Raw Materials 1,180,000
–Work in Process – Mixing 230,000
–Work in Process – Finishing 270,000
–Wages and Salaries Payable 500,000
–Work in Process – Mixing 665,000
–Work in Process – Finishing 405,000
–Manufacturing Overhead 1,070,000
–Work in Process – Finishing 1,850,000
–Work in Process – Mixing 1,850,000
–Finished Goods 3,200,000
–Work in Process – Finishing 3,200,000

e.g.(2) Larney Corporation uses process costing. A number of transactions that occurred in June are
listed below. As follows:
A) Raw materials that cost $38,200 are withdrawn from the storeroom for use in the Mixing
Department. B) Direct labor costs incurred $36,500,in the Mixing Department. C) Manufacturing
overhead of $42,100 is applied in the Mixing Department. D) Units with a carrying cost of $112,400
finish processing in the Mixing Department and are transferred to the Drying Department for further
processing. E) Units with a carrying cost of $143,800 finish processing in the Drying Department, the
final step in the production process, and are transferred to the finished goods warehouse. F)
Finished goods with a carrying cost of $138,500
Required: Prepare journal entries to record items A) through F).
Solution (2):

–work in process-mixing department $38,200

—raw materials $38,200
–work in process $36,500
–salaries/wages payable $36,500
–work in process-mixing department $42,100
–manufacturing overhead $42,100
–work in process-drying department. $112,400
–work in process mixing department $112,400
–finished goods $143,800
–work in process-drying department $143,800
-costs of goods sold $138,500
–finished goods $138,500

Operation cost in batch manufacturing[edit]

Batch costing is a modification of job costing. When production is repetitive nature and consists of a
definite number of articles, batch is used. In batch costing, the most important problem is to
determine the optimum size of the batch that follows the fact that production of two elements of
costs:

 Set up costs which are generally fixed per batch.

 Carrying costs which vadetermination of batch quantity requires considerations of some factors:
 setting up costs per batch.
 cost of manufacturing such as (direct materials cost + direct wages + direct overhead) per piece.
 cost of storage.
 rate of interest on the capital invested in product and rate of demand for product.