PROCESS COSTING SYSTEM

cost management accounting  PROCESS COSTING SYSTEM

(An introduction) Definition Process costing system applies when standardised goods are produced tom a series of interconnected operations. In some industries, the output produced emerges from a continuous process. An example might be an oil refinery; Oil in a raw state is input and subjected to a process of purification. Refined oil emerges at the end of the process. Problems that arise in such situations include the attribution of materials costs and conversion costs to units of finished output and the occurrence of losses during the process (spoilt or lost production). The characteristics and application of process costing

Continuous production

In the job order costing, costs were directly allocated to a particular job. When standardised goods or services result from a sequence of repetitive and continuous operations, it is useful to work out the cost of each operation. Then because every unit produced may be assumed to have involved the same amount of work, costs for a period are charged to processes or operations, and unit costs are ascertained by dividing process costs by the quantity of output units produced This is know n as process costing.

Series of interconnected operations

Process costing applies when standardised goods are produced from a series of interconnected operations. Process costing system is employed by industries possessing following characteristics:

1.  There is mass production of a single product or two or more products in successive runs of scheduled duration e.g., vegetable canning or fruit juice bottling.

2.  All units of output are exactly similar and are produced by the same manufacturing process.

3.  Entire manufacturing process is divided into departments or processes, each performing a specific set of operations.

4.  Completed output of each department, except the last one, is the raw materials for the next department.

5.  Manufacturing operations may result in production of joint products or by products.

6.  Production is not in response to customers’ orders but in anticipation of demand.

Examples of industries using Process Costing include: Bottling, Pharmaceuticals, Cement, Paint, Coal, Distilleries Electricity, Ice, Soap, Sugar, Canning, Chemicals, Cooking oil, Electric appliances, Flour, Natural gas, Petroleum Products, Rubber, Steel,Textile. Under process costing, for the purpose of cost control, each department involved in manufacturing process is regarded as a cost centre and product costs are accumulated separately for each department.

Cost Centre means a division or segment for which an individual is made responsible .for the incurrence of cost

Departmental costs are passed through department work in process accounts and not through a single work in process control account as in job costing. As all units are produced from the same raw materials and by same manufacturing operations, therefore, it is assumed that same cost is chargeable to each unit. Instead of accumulating cost of individual units, an average unit cost is computed by dividing total cost by total output of the period. Cost is associated only with departments and not with jobs. It reduces clerical efforts for accumulation and analysis of cost. In this way process costing is less expensive, as compared with job costing.

The Process Cost Sheet also called Cost of Production Report is the basic document in process costing. This document is prepared for each department and shows the quantities processed, total and unit cost, and cost of work transferred out, and still in process. .

Following table is meant to make the difference between the two costing systems more clear.

Job order costing system Process costing system
Application Where different productshaving peculiarspecifications are producedagainst customers’ orders Where single standard product is produced or two or more standard products are produced in successive runs. Production is for stock and in anticipation of demand.
Accumulation of Cost In order to determine cost of each job, costs arecompiled job wise. At the same time, to evaluate efficiency of departmental management cost are also compiled department wise Costs are associated only with departments
Cost per unit Unit cost is computed on completion of job. The job may itself be a single cost unit e.g. a machine or it may be a multi unit An average unit cost is computed at the end of costing period by dividing total cost by units of output of the period
Work in process a/c Only one work in process control account is maintained A separate work in process control account is
maintained for each producing department
Cost of operating the system More clerical efforts are needed to accumulate costs by jobs and by departments,-therefore, the system is more expensive Cost accumulation is simple as costs are accumulated only by departments; therefore, the system is comparatively less expensive.

Process costing procedures

In process costing industries standard products are produced in accordance with production budget. Therefore, it becomes unnecessary to issue a production order. Production Planning and Control Department communicates production targets to departmental heads by means of written letters. Data of quantities produced by each department are collected and compared with budgeted quantities for control purposes. This information is collected by departmental supervisors or  quality inspectors may recording these data. Each producing department is a cost centre because for the purpose of cost control management is interested in ascertaining departmental costs. In process costing, generally, a separate work in process account is maintained for each producing department.

Data Collection

Collection of departmental cost figures of direct materials, direct labor and factory overhead is based on similar procedure as for, job order costing. However, the source documents used for the data collection are comparatively simple. These documents identify costs only with departments and not with jobs as well.

Direct Materials: Production people secure materials by issuing properly authorised Materials Requisitions. At the end of each month, these requisitions are sorted and a Materials Requisition Summary indicating cost of direct and indirect materials issued to each department is prepared. Monthly totals of direct and indirect materials issued are debited to departmental work in process control accounts and factory overhead control account respectively and credited to materials control account.

Direct Labor: Instead of using Job Time Tickets, labor cost data are accumulated on Clock Cards and Daily Time Sheets. These documents show labor time utilized by each department and classification of labor cost as direct and indirect. At the end of each month, labor cost data accumulated on these source documents are summarised in Labor Cost Analysis Sheet indicating direct and indirect labor cost for each department. Monthly totals of direct labor are debited to departmental work in process accounts and indirect labor is debited to factory overhead control account.

Factory Overhead: Factory overhead costs, other than indirect materials and indirect labor discussed earlier, are accumulated in Voucher Register and in General Journal by means of adjusting entries for depreciation, expired insurance etc, Monthly total, are debited to factory overhead control account. Factory overhead is charged to production through predetermined departmental factory overhead applied rates. Some industries using process costing charge actual factory overhead to departments. This method gives satisfactory results if production is stable from month to month, But if there are fluctuations in production volume, charge of actual factory overhead is unsatisfactory especially when considerable portion of factory overhead is a fixed cost,

Cost of Completed Output:

Cost of completed output of each production department is calculated in Cost of Production Report. Cost of units completed and transferred out is credited to work in process control account of the respective department and debited to work in process control account of the department receiving the units. Cost transferred out by the last department is, however, debited to finished goods control account

Cost of Production Report

In process costing Cost of Production Report also called Process Cost Sheet is the key document. At the end of costing period, generally a month, a Cost of Production Report is prepared. It summarizes the data of quantity produced and cost incurred by each producing department. It also serves as a source document for passing accounting entries at the end of costing period. Cost of production report is divided into five sections. Each section is meant to provide specific information. A brief description of these sections is presented below:

  1. Quantity schedule.
  2. Cost accumulated in the department/process.
  3. Calculation of equivalent units produced.
  4. Calculation of cost per unit.
  5. Accounting treatment / apportionment of the accumulated cost

Quantity Schedule:

The first section Quantity Schedule contains input and output data in terms of quantities. The information is presented in the following order.

(i)Units in process at the beginning of costing period.

(ii)Units started in process or received from preceding department during the period. (Total of (i) and (ii) constitutes total units to be accounted for)

(iii) Units completed and transferred to next department or to finished goods.

(iv)Units completed but still in the department.

(v)Units in process at the end of the period and their degree of completion.

(vi)Units lost in process during the period indicating whether normal loss or abnormal loss.

The stage of completion at which the loss occurs is also specified. (Total of (iii) , (iv) , (v) and (vi) is again the total units to be accounted for) The quantity schedule assists management to look at a glance production performance of departments as well as it provides necessary data for preparing remaining sections of the report.

Cost accumulated in the department/process.

The second section Cost Accumulated to Departments shows total cost for which the departments are accountable. Total costs include cost of beginning work in process inventory, cost transferred in from the preceding department and cost of direct materials, direct labor and factory overhead added by the department. If there is normal loss of units, unit cost received from preceding department requires adjustment. This adjustment for lost units is also shown in this section. This section provides data for debiting work in process control accounts of the departments.

Calculation of equivalent units produced.

In order to arrive at cost per unit of output, total of each cost element is divided by the number of units produced, For this purpose, where at the end of costing period, there are some partially completed units in process, these units must be stated in terms of equivalent completed units, For example, if 4,000 units. are in process at the end of month estimated as 50% complete, these will be equivalent to 2,000 completed units. These equivalent units are added to units completed by the department to arrive at equivalent production. Then total cost is divided by this equivalent production figure to calculate unit cost.

Calculation of cost per unit

In process costing, costs are averaged over the units produced. The costs accumulated to a process for a period are collected and divided by the number of units equally produced during the period. Accounting treatment / apportionment of the accumulated cost

The last section presents a summary to the explaining the accounting treatments of the costs incurred in the department. This includes

(i)Adjustment for lost units for normal loss, if any.

(ii)Cost transferred out.

(iii) Cost of abnormal loss, if any.

(iv)Cost of work in process ending inventory and

(v)Any other accounting adjustment, if necessary to present.

Cost of production report is generally presented to management with supplementary reports of usage of materials, labor and factory overhead.

Standard format of a simple Cost of Production Report

I-Quantity Schedule:

Units put into the process ***

Units completed in this process & transferred

to next department. ***

Units not yet completed at the end of the

Period. ***

*** II-Cost Accumulated In The Department / Process:

Direct Material Cost ***

Direct Labor ***

Factory Overhead (Applied) ***

***

III-Calculation of Equivalent Units Produced 100% of completed units + % completed of the in process units IV-Calculation Of Per Unit Cost = Total Cost . Equivalent Units Produced

V-Accounting Treatment

1- Finished goods

2- Closing Work in process

Problem Questions

Q. 1: Heera Manufacturing Company manufactures a product. Production made and manufacturing costs incurred in the first department during the month of October .are given below: 10,000 units were started in process out of which 9,400 units were transferred to next department

and remaining 600 units were 1/2 complete as to materials, labor and overhead. Direct materialsRs. 19,400, direct labor Rs. 24,250 and factory overhead Rs. 14,550 was charged to production.

Required: Cost of production report for the month.

Q. 2: Production and cost data of first production department of Excellent Manufacturing Company for the month of March 2006 are as follow: Units started in process were 5,000. Units completed and transferred to second department were 4,500. Remaining units were in process estimated to be 50%, 40%, 60% completed as to materials, labor and factory overhead respectively. Costs of materials, labor and overhead were Rs. 50,000, Rs. 60,000 and Rs. 40,000 respectively.

Required: Cost of production report.

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