Process Costing
This is a form of operations costing used in cost where cost are passed through a series of processes
before the product is finally completed. An inherent feature of process costing is that the output of one
process becomes the input of the other process. In case of process costing all the costs (direct and
indirect) are charged to the specific process. Process costing is normally used in industries where masses
of similar products or services are produced e.g. Chemical processing, food processing, oil refining,
brewing, e.t.c. 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.
Common features
a) Similar units are produced continuously
b) The continuous nature of production results in some units being incomplete at the end of the
period.
c) Loss is a common feature due to spoilage, wastage, evaporation etc.
d) Costs cannot be identified with individual products.
e) In some cases output may be multiple products.
Flow of Production and costs in a process costing system
Production moves from one process (or department) to the next until final completion occurs. Each
production process performs some part of the total production and transfers its completed production
to the next process, where it becomes the input for further processing. The completed production of the
last process is transferred to the finished goods inventory. As production moves from process to
process, costs are transferred with it. The cost becomes cumulative as production proceeds. The cost
per unit of the completed product is the total cost accumulated in the final process divided by the
output of the period.
Process costing
Work in progress stock
Process A Process B Process C
Finishe
d goods
Completed production
Inpu output inpu outpu output stock
input
t t t
Consist of stock of like
units valued at average
unit cost of production
N.B.
No attempt is made to allocate costs to individual units of production. Direct costs and factory overhead
costs are allocated to process A, process B, and so on. When units are completed, they are transferred
to finished goods stock at the average unit cost.
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Job costing
Work in progress stock
Job A Job B Job C
Finished goods stock
Direct costs and factory overheads Consist of stock of unlike units
are allocated to individual units of production
Process losses
This represents loss of material due to spoilage, evaporation, shrinkage, e.t.c. which arises due to the
nature of the production processes.
Process costing when all output is fully complete
We consider the following cases assuming that all output within each process is fully complete;
1. No losses within a process
2. Normal losses with no scrap value
3. Abnormal losses with no scrap value
4. Normal losses with a scrap value
5. Abnormal losses with scrap value
6. Abnormal gains with no scrap value
7. Abnormal gains with scrap value
Illustration 1.
Portsmouth Company produces a liquid chemical within a single production process. In the month of
May, the input into the process was 12,000 litres at a cost of KES 120,000. There were no opening or
closing inventories and all output was fully complete. The following information is available and will be
used to analyze the six scenarios above.
Input Output Normal loss Abnormal Abnormal gain Scrap value of spoilt
Case (litres) (litres) (litres) loss (litres) (litres) output (KES/litre)
1 12,000 12,000 0 0 0 0
2 12,000 10,000 2,000 0 0 0
3 12,000 9,000 2,000 10,000 0 0
4 12,000 10,000 2,000 0 0 5
5 12,000 9,000 2,000 1,000 0 5
6 12,000 11,000 2,000 0 1,000 0
2
7 12,000 11,000 2,000 0 1,000 5
1. No losses within a process
Total process cost incurred 120,000
Cost per unit= = =KES 10 / Litre
output 12,000
The process a/c will be;
Process a/c
Qty Unit cost Total cost Qty Unit cost Total cost
12,00
Input cost 12,000 10 120,000 Output (to finished goods) 0 10 120,000
The finished goods a/c will be as follows:
Finished goods a/c
Qty Unit cost Total cost Qty Unit cost Total cost
Process a/c 12,000 10 120,000 P & L a/c 12,000 10 120,000
2. Normal losses with no scrap value
Normal losses are the expected losses and they are unavoidable. They are caused by inherent factors to
production processes e.g. liquids may evaporate, parts of the cloth required to make a suit may be lost,
and losses can occur in cutting wood to make furniture, e.t.c. These losses occur under efficient
operating conditions and are unavoidable and are absorbed by the good production.
Total process cost incurred 120,000
Cost per unit= = =KES 12/ Litre
expected output after normal loss 12,000−2,000
The process a/c will be;
Process a/c
Qty Unit cost Total cost Qty Unit cost Total cost
Input cost 12,000 10 120,000 Normal loss 2,000 - -
Output (to
finished goods) 10,000 12 120,000
120,000 120,000
The unit cost has increased by KES 2 because the cost of the normal loss has been absorbed by the good
production. The objective is to calculate the cost of the normal production under normal efficient
operating conditions.
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3. Abnormal losses with no scrap value
Abnormal losses are losses that are not expected to occur under efficient operating conditions and are
caused by, for example, improper mixing of ingredients, use of inferior materials, plant break-down,
power failure, industrial accidents, theft of materials, e.t.c. These losses are not an inherent part of the
production process and are not included in the process costs.
The abnormal loss is treated as a period cost and written off in the P & L a/c.
Total process cost incurred 120,000
Cost per unit= = =KES 12/ Litre
expected output 12,000−2,000
The unit cost is the same for output of 10,000 or 9,000 litres since our objective is to calculate the cost
per unit of normal output. The distribution of the input costs is as follows;
Completed production transferred to
the next process (9,000 litres @ KES 12) 108,000
Abnormal loss (1,000 litres @ KES 12) 12,000
120,000
The abnormal loss is valued at the cost per unit of normal production. The accounting entries will be;
DR: Abnormal loss a/c 12,000
CR: Process a/c 12,000
The process a/c will be;
Process a/c
Qty Unit cost Total cost Qty Unit cost Total cost
Input cost 12,000 10 120,000 Normal loss 2,000 - -
Abnormal loss 1,000 12 12,000
Output (to finished
goods) 9,000 12 108,000
120,000 120,000
At the end of the period the abnormal loss is treated as a period cost and written off in the P & L a/c.
DR: P & L 12,000
CR: Abnormal loss a/c 12,000
Abnormal loss a/c
Qty Unit cost Total cost Qty Unit cost Total cost
Process a/c 1,000 12 12,000 P&L 1,000 12 12,000
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4. Normal losses with a scrap value
The sales value of the spoiled units should be offset against the costs of the appropriate process where
the loss occurred i.e. 2,000 units × KES 5 = KES 10,000. The accounting entries will be;
DR: Normal loss a/c 10,000
CR: Process a/c 10,000
DR: Cash a/c 10,000
CR: Normal loss a/c 10,000
Process cost incurred−value of normal loss 120,000−10,000
Cost per unit= = =KES 11/ Litre
expected output 12,000−2,000
Process a/c
Qty Unit cost Total cost Qty Unit cost Total cost
Input cost 12,000 10 120,000 Normal loss 2,000 - 10,000
Output (to
finished goods) 10,000 11 110,000
120,000 120,000
Normal loss a/c
Qty Unit cost Total cost Qty Unit cost Total cost
Process a/c 2,000 5 10,000 Cash 2,000 5 10,000
5. Abnormal losses with scrap value
Since our objective is to calculate the cost per unit for the expected (normal) output, only the scrap
value of the normal loss of 2,000 litres should be deducted in ascertaining the cost per unit.
Process cost incurred−value of normal loss 120,000−10,000
Cost per unit= = =KES 11/ Litre
expected output 12,000−2,000
The sales value of the additional 1,000 litres lost represent revenue of an abnormal nature and should
not be used to reduce the process cost. This revenue is offset against the cost of the abnormal loss to be
investigated by management i.e. the sales revenue received from sale of abnormal loss units is offset
against the cost of abnormal loss in the abnormal loss account to arrive at the net abnormal loss that
shall be charged to the profit and loss account in the period in which it arises. The net cost incurred in
the process is KES 105,000 (KES 120,000 input cost less 3,000 litres lost with a scrap value of KES 5 per
litre).
The distribution of the input costs is as follows;
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Completed production transferred to the next process (9,000 litres @ KES 11) 99,000
Abnormal loss (1,000 litres @ KES 11) 11,000
Less: scrap value (1,000 litres @ KES 5) (5,000)
Total cost 105,000
The accounting entries will be;
DR: Abnormal loss a/c 11,000
CR: Process a/c 11,000
The entries in the process a/c will be;
Process a/c
Qty Unit cost Total cost Qty Unit cost Total cost
12,00
Input cost 0 10 120,000 Normal loss 2,000 - 10,000
Abnormal loss 1,000 11 11,000
Output (to
finished goods) 9,000 11 99,000
120,000 120,000
The accounting entries for the abnormal loss a/c will be;
DR: Cash a/c 5,000
DR: P & L 6,000
CR: Process a/c 11,000
Abnormal loss a/c
Process a/c 11,000 Cash sale for units scrapped 5,000
Balance transferred to P & L 6,000
11,000 11,000
6. Abnormal gains with no scrap value
In some cases the actual loss in a process may be less than the expected, in which case an abnormal gain
occurs. We first compute the cost per unit of normal output (a normal loss of 2,000 units with no scrap
value)
Total process cost incurred 120,000
Cost per unit= = =KES 12/ Litre
expected output after normal loss 12,000−2,000
The process a/c will be;
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Process a/c
Qty Unit cost Total cost Qty Unit cost Total cost
Input cost 12,000 10 120,000 Normal loss 2,000 - -
Output (to
Abnormal gain 1,000 12 12,000 finished goods) 11,000 12.000 132,000
132,000 132,000
The abnormal gain a/c will be;
Abnormal gain a/c
Qty Unit cost Total cost Qty Unit cost Total cost
P & L a/c 1,000 12 12,000 Process a/c 1,000 12 12,000
7. Abnormal gains with scrap value
We first compute the cost per unit of normal output (a normal loss of 2,000 units and a scrap value of
KES 5)
Input cost −scrap value of normal loss 120,000−10,000
Cost per unit= = =KES 11/ Litre
expected output 12,000−2,000
The net cost incurred in the process is KES115,000 (KES 120,000 input cost less 1,000 litres spoilt with a
sales value of KES 5 per litre). The distribution of this cost is as follows;
Completed production transferred to the next process (11,000 litres @ KES 11) 121,000
Less: Abnormal gain (1,000 litres @ KES 11) 11,000
Lost sales of spoiled units scrap value (1,000 litres @ KES 5) (5,000) (6,000)
Total cost 115,000
Note:
The cost per unit is based on the normal production cost per unit and is not affected by the fact that an
abnormal gain occurred or that sales of the spoiled units with a sales value of KES 5,000 did not
materialize. Our objective is to produce a cost per unit based on normal operating efficiency.
The accounting entries in the process are as follows;
Process a/c
Qty Unit cost Total cost Qty Unit cost Total cost
Input cost 12,000 10 120,000 Normal loss 2,000 5 10,000
Output (to
Abnormal gain 1,000 11 11,000 finished goods) 11,000 11 121,000
131,000 131,000
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The accounting entries for the abnormal gain a/c will be;
DR: Process a/c 11,000
CR: Normal loss a/c 5,000
CR: P & L 6,000
Abnormal gain a/c
Normal loss a/c 5,000 Process a/c 11,000
P & L (Balance) 6,000
11,000 11,000
The accounting entries for the normal loss a/c will be;
Normal loss a/c
Process a/c 10,000 Cash from spoiled units (1,000 litres ×5) 5,000
Abnormal gain a/c 5,000
10,000 10,000
The abnormal gain has been removed from the process account and it is valued at the cost per unit of
the normal production (KES 11). However, as 1,000 litres were gained, there was a loss of sales revenue
of KES 5,000 and this lost revenue is offset against the abnormal gain The net gain is therefore KES 6,000
(to be credited to the P & L a/c).
The process account is credited with the expected sales revenue from the normal loss (2,000 × 5 = KES
10,000), since the objective is to record in the process a/c normal net costs of production. Because the
normal loss of 2,000 litres does not occur, the company will not obtain the sales value of KES 10,000
from the expected lost output. This is resolved by making a corresponding debit entry in the normal loss
a/c, which represents the amount due from the sales proceeds from the expected normal loss. The
amount due (KES 10,000) is then reduced by KES 5,000 to reflect the fact that only 1,000 litres were lost
(we credit the normal loss a/c and debit the abnormal gain a/c with 5,000). The balance of the normal
loss a/c shows the actual amount of cash received from the spoiled units (1,000 litres at KES 5/litre).
Illustration 2
ABC Chemicals Ltd. manufactures a chemical compound branded 'X' used in making plastics. The
chemical compound involves two processes; A and B. The output of process A is passed to process B
where further material is added to mix. The details of the process costs for the production period ended
30 April were as follows:
Process A:
Direct materials: 5,000 Kg at KES 10 per kg
Direct labour: KES 40,000
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Process plant time: 200 hours at KES 220 per hour
Overheads: KES 20,000
Process B:
Direct materials: 3,000 Kg at KES 10 per kg
Direct labour: KES 25,000
Process plant time: 120 hours at KES 220 per hour
Overheads: KES 12,000
Additional information:
1. Assume no finished stock at the beginning of the period and no work in progress at either the beginning
or the end of the period.
2. Normal loss is sold as scrap for KES 1.00 per kilogram from process A and KES 2.00per kilogram from
process B, for both of which immediate payment is received.
3. The expected and actual output for the processes was as follows.
Process A Process B
Expected output 90% of input 95% of input
Actual output 4,200 Kg 7,340 Kg
Required:
a) Process A account.
b) Process B account.
c) Abnormal loss/gain account
d) Normal loss account
Solution
a) ABC Chemicals Ltd
Process A
Expected output = 90% × 5,000 = 4,500
Process Plant time = 200 × 220 = KES 44,000
Scrap value = KES 1/unit
Process B
Expected output = 95%×3,000 = 2,850
Process plant time = 120×250 =KES 30,000
Scrap value = KES 2/unit
