In process industries detailed experienced-based knowledge is available to control the
manufacturing flow. This intimate knowledge can also be used to calculate product costs
and inventory valuation;
Process costing is the name for a group of costing systems which are
especially suited for accumulating costs in an environment where the
production is characterised by a constant repetition of large numbers of
identical or similar products in a continuous flow.
This means that calculating product cost for each identifiable product
(unit) is not efficient or even meaningful, because each product has
practically the same product costs.
In a job order costing system costs are accumulated for each separate job
order throughout the different stages of production. In a process costing
system the opposite is realized: the costs are accumulated for each
production stage (also: department) for each period. In order to be able to
calculate the product cost an additional step is necessary: averaging the
total costs incurred in each production stage over the units produced
during the period. Before entering into a discussion on process costing
methods (calculating product costs and the valuation of inventory) a few
words on process control are called for, because the process costing
methods rest on data that are used to control the manufacturing
In the field of Operations management a host of techniques are available
to control manufacturing processes. One of the most popular among them
is Statistical Process Control (SPC). This method is based on the statistical
properties of repetitive processes. When advanced computer-based
production technology is used an impressive amount of data is gathered
during the production flow. In addition to technical information quite a lot
of data are registered on productivity, resource consumption, reject rates
etc. Because the processes are repetitive this control information can be
summarized in a few statistics (for example: average, variance). In the
figure below the resource consumption over the most recent 100
production runs is gathered in a graph.
Over the last 100 runs the average consumption of raw material was 40
kilo\u2019s for each product. The dispersion around the mean was 5 kilo\u2019s
(expressed in the standard deviation). Assuming that the distribution is
normal there is a 95% change that material consumption for each unit is
between 30 and 50 kilo. These values are called control limits: each
consumption rate above the lower control limit and below the upper
control limit is supposed to be \u2018 in-control\u2019 or normal. Resource
consumption outside the control limits is seen as \u2018out-of-control\u2019 or
abnormal (this apparently is caused by factors not included in normal
The distinction between normal and abnormal is important because in the
absence of absolute process control \u2018 normal\u2019 resource consumption and \u2018
normal\u2019 spoilage (rejection of substandard products) is treated as part of
the costs of production, where as abnormal resource consumption or
spoilage is taken as a period cost (written off as a loss).
problems arise. The first is the treatment of normal costs versus abnormal
gains or losses. The second is the handling of inventory changes. Both
problems will be dealt with in this lecture note.
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