PROCESS COSTING –

INTRODUCTION
Process costing is a method of applying costing systems to goods or
services that are produced in a series of processes. Every unit is assumed
to have involved the same amount of work and therefore the costs for a
period are charged to processes or operations, and unit costs are
calculated by dividing process costs by the quantity of units produced.
Calculation of cost per unit
๏ Calculate the total of all costs incurred in the process during a period.
‣ If using absorption costing then include all overheads.
‣ If using marginal costing then only include variable overheads.
๏ Divide the total cost by the number of units produced to arrive at a cost
per unit.

Example 1
During February the following costs were incurred in a process:
Materials $20,000
Labour $10,000
Overheads $8,000
2,000 units were produced.

Calculate the cost per unit.

Process T-Accounts
If a T-account is shown in the examination, then the entries are as follows:
๏ Debit the Process Account with each cost incurred
๏ Credit the Process Account with the unit cost previously calculated.
It is normal and useful to have 2 columns in the Process Account – one for
units and one for $’s
 Process account
Dr
Cr
unit $ units $
s

Problem areas
There are three problem areas that can occur in the examinations
๏ Losses
Some of the units started in a process may not end up as finished output
due to loss or damage
๏ Work-in-progress
At the start and end of a period there may be some units in the process
that are only partly finished and which need more work in the next
process
๏ Joint Products
More than one product may be produced in the same process.

PROCESS COSTING – LOSSES

In many processes it is unlikely that the output units will equal the input
units. For example, in the manufacture of beer it is very unlikely that the
litres produced will equal the number of litres that
were input, due to evaporation.
We need to deal with any losses in our costings.

Normal loss
Normal loss is the amount of loss that is expected from the process,
based on past experience. It is also known as the expected loss.
In our costings, we spread the process costs over the number of units that
we expect to produce.
Example 1
During March the following costs were incurred in a process:
Materials (1,000 kg) $12,000
Labour $7,000
Overheads $8,000
A normal loss of 10% was expected. The actual output was 900 kg.

Calculate the cost per kg, and prepare a Process Account.

Normal loss with a scrap value

The word ‘loss’, when used in process costing, does not just mean units
that are lost but also units that were damaged. Any damaged units may
be saleable as scrap.
If there are any expected scrap proceeds from damaged units, then these
scrap proceeds are subtracted from the total costs of the process before
spreading over the units we expect to produce.

Example 2
During April, the following costs were incurred in a process:
Materials (3,000 kg) $30,000
Labour $12,000
Overheads $10,800
A normal loss of 10% was expected. The actual output was 2,700 kg.
Losses have a scrap value of $5 per unit.
Calculate the cost per kg and prepare a Process Account and a
Loss Account.

Abnormal losses
Even though we may expect a normal loss of (for example) 10% to occur
each month, it is unlikely that we will actually lose exactly 10% each
month. Some months we will probably lose more than 10%, and some
months less than 10%.
Any excess loss in any month is known as an abnormal (or unexpected)
loss.
We prepare costings as normal, taking into account any normal loss, and
spreading the total cost over the units that we expect to produce.
Any abnormal losses are charged separately at the full cost per unit.

Example 3
During May, the following costs were incurred in a process:
Materials (1,000 kg) $9,000
Labour $18,000
Overheads $13,500
A normal loss of 10% of input was expected.
Actual output was 850 kg.
Losses are sold as scrap for $9 per kg.
Calculate the cost per kg and prepare a Process Account and a
Loss Account.

Abnormal Gains
In the same way that the actual output may be less than that expected, in
some months it may be more than expected.
If this happens, then we say that we have an abnormal gain.
The treatment of abnormal gains is exactly the same as for abnormal
losses.

Example 4
During June the following costs were incurred in a process:
Materials (2,000 kg) $18,000
Labour $36,000
Overheads $27,000
A normal loss of 10% of input was expected.
Actual output was 1,840 kg.
Losses are sold as scrap for $9 per kg.
Calculate the cost per kg, and prepare a Process Account and a
Loss Account.

QUESTION
JJ has a factory which operates two production processes, Process 1and Process 2.
Normal loss in each process is 10%. Scrapped units out of the Process 1 sell for $3
per unit whereas scrapped units out of the Process 2 sell for $5. Output from the
Process 1is transferred to the Process 2: output from the Process 2 is finished
output ready for sale.

Process 1

Input material 18000 units @ $54000

Output transferred to Process 2 16000 units
Labor and overheads $32400

Process 2
From process 1 16000 units
Added materials 14000units @ $70000
Labor and overheads $ 135000
Output to Finished goods 28000 units

Required
Prepare accounts for the Process 1, the Process 2, abnormal loss, abnormal gain
PROCESS COSTING – WORK-IN-PROGRESS

At the end of a process there may be some units that have been started
but not completed. These are known as closing work-in-progress. They
are still there at the start of the next period, waiting to be finished. They
are therefore opening work-in-progress of the next period.

Equivalent units
In our costings we still wish to calculate the cost of a finished unit. For
costing purposes we assume the work done on 100 units that are only half
finished is equivalent to 50 fully finished units. Therefore, 100 units each
50% finished is regarded as 50 equivalent complete units.

Closing Work-in-Progress (no opening Work-In-Progress

When we have closing work-in-progress, we calculate a cost per unit for
each category of cost,
using equivalent units. The total cost per unit is the sum of these separate
costs

Example 1
During January the following costs were incurred in a process:
Materials (1,000 units) $5,000
Labour $2,760
Overheads $3,440
During the month, 800 units were finished and transferred to the next
process.
The remaining 200 units were WIP and were complete as follows:
Materials 100%
Labour 60%
Overheads 30%

(a) calculate the cost per unit;

(b) value the finished output and the WIP;
(c) prepare Process Account.

PROCESS COSTING – JOINT PRODUCTS

Sometimes, one process may produce several products. In this case we
need to decide on a cost per unit for each of the products. These
products, produced in the same process, are known as joint products.
Joint products refer to our main products with full sales value. However,
there may be an additional product (or products) which is produced
incidentally and has a relatively low sales value (effectively a waste
product). This is known as a by-product.

Accounting treatment
๏ Any sale proceeds of a by-product are subtracted from the joint costs of
the process.
๏ The net total cost of the process is then split between the joint products.
๏ For the examination, there are two ways of splitting the joint costs:
‣ The physical units basis
‣ The market value at the point of separation basis.

Physical units basis

Under this method, the same cost per unit is applied to all the joint
products
Example 1
During August, the following costs were incurred in a process:
Materials (3,500 kg) $5,000
Labour and overheads $2,300
The production from the process was as follows:
kg
Product A 1,000 selling price $5 per kg
Product B 2,000 selling price $2 per kg
by-product X 500 scrap value $0.20 per kg

Calculate a cost per kg and profit per kg for A and B using the
physical units basis.

Market value basis

Under this method the costs per unit are calculated so as to be in the
same proportions as the
market values of each product

Example 2
During August, the following costs were incurred in a process:
Materials (3,500 kg) $5,000
Labour and overheads $2,300
The production from the process was as follows:
kg
Product A 1,000 selling price $5 per kg
Product B 2,000 selling price $2 per kg
by-product X 500 scrap value $0.20 per kg
Sales during the period were 800 kg of A and 1,500 kg of B.

Calculate a cost per kg and profit per kg for A and B using the
market value basis

Job Costing
Job costing is relevant in the situation where a customer orders a specific
job (as opposed to simply purchasing goods that we already produce in
quantity).
In this situation the job is costed separately, with all associated costs
listed to arrive at a total cost.
Example 1
The estimated costs for job XXX are as follows:
Direct materials 4 kgs at $25 per kg
Labour 10 hours @ $5 per hour
Variable overheads are recovered at the rate of $2 per direct labour hour.
Fixed production overheads are absorbed at the rate of $4 per direct
labour hour.
Other, non-production, overheads are charged at the rate of $100 per job.

What is the total cost of job XXX?