In industries where similar types of products are produced, the process costing is the best cost accounting system. The products consume the same amount of overheads and direct costs. It would not be wise to apportioned cost to individual units. So, in process costing we calculate average cost per unit of output.
Average cost per unit of output = Total cost assigned to the product / number of units of output
In a manufacturing process, goods are not completed in a single process. Instead, they move from one process to the second process and from there to the third process. At the end, the finished goods are produced in the last process. So, in process costing we calculate cost per unit of each process.
For the manufacturing of any goods, we need materials, labors and overheads. So, we charge these elements of cost to each process account. In every process, it happens that the output received from the process is different from the input to the process. This means that the output would be less than the input to the process. This results in a loss. Loss can be of two types:
Normal Loss – This is the loss which manufacturer is already aware of. This cannot be avoided or controlled.
Abnormal Loss – This is the loss which is not of routine nature and which can be controlled by exercising some sort of cost and internal controls.
Abnormal Gain – This is the gain which arises due to total loss less than the normal loss.
Example
1.ABC produces chemicals for industrial usage. In its 1st process, ABC input 1,000 Kg of raw materials, but the actual output from this process is 800 Kg. The normal loss of this process is estimated @ 10%.
As you can see normal loss in process = 10% x 1,000 = 100 Kg
But total loss = 1,000 – 800 = 200 Kg
So, the extra 100 Kg is abnormal loss.
2.ABC produces chemicals for industrial usage. In its 1st process, ABC input 1,000 Kg of raw materials, but the actual output from this process is 920 Kg. The normal loss of this process is estimated @ 10.
As you can see normal loss in process = 10% x 1,000 = 100 Kg
But total loss = 1,000 – 920 = 80 Kg
So, the 20 Kg is abnormal gain.
Specimen Process Account
| Debit | Credit | ||
| Materials Labor Overhead Abnormal gain | Normal loss Abnormal loss Transferred out to next Process |
In process account, we valued normal loss at Scrap value. Abnormal loss and transferred out units are measured at cost per unit.
Example
Input to the process = 10,000 units introduced in the process costing $ 50,000
Various process related expenses = $ 5,000
Direct labor = $20,000
Unit produced from the Process = 9,000 units
Other direct expenses = $ 11,000
Normal loss is estimated @ 10%. Normal loss scrape value is $ 1.
Solution
Total loss = 10,000 – 9,000 = $ 1,000
Abnormal loss = total loss – normal loss = 1,000 – 5,000 = $ 500
Scrap value of normal loss = 500 x 1 = $ 500
Cost per unit
= {(50,000 + 5,000 + 20,000 + 11,000) – 500} / 10,000 – 500 = 86,000 / 9,500 = 9 per unit
Process Account
| Units | Debit | Units | Credit | ||
Materials Labor Overhead Direct expenses Abnormal gain | 10,000 | 50,000 5,000 20,000 11,000 – | Normal loss – scrap value Abnormal loss (500×10.47) Transferred out to next Process (9,000 x 9) | 500 500 9,000 | 500 4,500 81,000 |
| 86,000 | 86,000 |
Process Costing Problems and Solutions
The following information pertains to the goods in process No 3 the month of November, 1999:
| Goods in process inventory November 1, (40,000 units 100% complete and 75% as to conversion cost | Rs. | 387,000 |
Cost of 140,000 units transferred in form process No. 2 during November: Rs. 700,000
Manufacturing costs added in process No. 3 during November:
| Direct material | Rs. | 280,000 |
| Direct labor | Rs. | 125,000 |
| Factory overhead | Rs. | 375,000 |
On November 30, 50,000 units are still in process No. 3 which is 100% complete as to materials and 50% complete as to conversion cost.
| a) i) Equivalent units of production |
| ii) Cost per unit |
| (iii) Cost of units transferred to finished goods warehouse |
| (iv) Cost of units in process, on November 30. |
| b) General Journal entries to record: |
| i) Transfer of 40,000 units from process No.2 to process No.3 |
| ii) Manufacturing costs added in process No.3 during November |
| iii) Transfer of 130,000 units from process No.3 to finished |
| goods warehouse. |
Solution
Equivalent Units of Process 3
| Material | Labor | F.O. | |
| Units transferred to finished goods | 130,000 | 130,000 | 130,000 |
| Add: Units in process at end Material (50,000 X 100%) Labor (50,000 X 50%) OH (50,000 X 50%) | 50,000 | ||
| Less: Units in process at start Material (40,000 X 100%) Labor (40,000 X 75%) Overhead (40,000 X 75%) | 25,000 | 25,000 | |
| 180,000 | 155,000 | 155,000 | |
| 40,000 | |||
| 30,000 | |||
| 30,000 | |||
| Equivalent Units | 140,000 | 125,000 | 125,000 |
Per Units Cost
| Cost | Equivalent Units | Per Unit | |
| Cost of units transferred in from Process No. 2 | 700,000 | 140,000 | 5.00 |
| Cost of Process No.3 | |||
| Material | 280,000 | 140,000 | 2.00 |
| Labor | 125,000 | 125,000 | 1.00 |
| Overhead | 375,000 | 125,000 | 3.00 |
| Total per unit cost | 11.00 |
Process No. 3
Completed Units Cost during Nov, 1999
| Beginning inventory cost | 387,000 |
| Add: Cost completed during November Material Labor (40,000 X 25% X 1) | 10,000 |
| Overhead (40,000 X 25% X 3) | 30,000 |
| Less: Total cost of first 40,000 units Units started & finished during Nov. | 427,000 |
| Material & conversion cost (90,000 X 11) | 99,000 |
| Total cost of 130,000 units . | 14,17,000 |
Process No. 3
Cost of Units in Process at End
| Cost from Process No.2 (50,000 X 5) | 250,000 |
| Material (50,000 X 100% X 2) | 100,000 |
| Labor (50,000 X 50% X 1) | 25,000 |
| Overhead (50,000 X 50% X, 3) | 75,000 |
| Cost of ending goods in Process Inventory | 450,000 |
Process No. 3
Journal Entries
| No. | Particulars | P.R. | Debit | Credit |
| 1 | Work in process (No.3) Work in process (No.3) Cost of goods transferred from Process No.2 to Process No.3 | 700,000 | 700,000 | |
| 2 | Work in process (No.3) Material | 780,000 | 280,000 | |
| Accrued payroll | 125,000 | |||
| Factory overhead | 375,000 | |||
| To record the cost allocated to production in November |
| 3 | Finished goods | 14,17,000 | |
| Work in process (No.3) | 14,17,000 | ||
| Cost of goods transferred from Process No.3 to finished goods |