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Process Costing

Definition: Process costing is a method of allocating manufacturing cost to products in


their specific process.
Operation Costing
It is defined as the refinement of process costing. It is concerned with the determination of
the cost of each operation rather than the process. In those industries where a process
consists of distinct operations, the method of costing applied or used is called operation
costing.
Operation costing offers better scope for control. It facilitates the computation of unit
operation cost at the end of each operation by dividing the total operation cost by total
output units.

Terminologies
Normal Loss:
It is defined as the loss of materials which is inherent in nature of work. Such a loss can be
reasonably anticipated from past experiences. It is unavoidable because of nature of
material. Normal Process Loss is absorbed by Good Units. While ascertaining Cost per Unit
we will only deduct units and scrap so that cost per unit is increased.
Abnormal Loss:
It is defined as the loss in excess of the predetermined loss. While calculating Cost per unit
we will assume as if there is no abnormal loss. While calculating cost per unit we will
deduct abnormal loss from total cost as if there is no loss.

Abnormal Gain:
While calculating cost per unit we will ignore Abnormal gain.
Valuation of W.I.P.
1. Using FIFO method.
2. Using weighted average method.
Treatment of Normal Loss:
i.
ii.

For normal loss we will keep equivalent units column blank.


Estimated scrap of normal loss unit should be deducted from material for calculating
cost per unit.

Treatment of Abnormal Loss:


For calculating cost per unit we will assume there is no loss and full units will be written in
Statement showing equivalent units of production.
Treatment of Abnormal Gain:
i.
ii.
iii.

Abnormal gain units should be deducted as output in equivalent units column.


D O C should always be 100 %.
We should deduct Scrap of estimated normal loss while calculating Cost P.U.

Equivalent Production
When opening and closing stocks of work-in-process exist, unit costs cannot be computed by
simply dividing the total cost by total number of units still in process. One can convert the
work-in-process units into finished units called equivalent units so that the unit cost of
these units can be obtained.
Equivalent Completed Units = Actual No. of Units in the process of manufacture % of
Work Completed
It consists of balance of work done on opening work-in-process, current production done
fully and part of work done on closing WIP with regard to different elements of costs viz.,
material, labour and overhead.

Two Materials Concept


Some points to remember:

a) Two Material Concepts will apply only after Process-1 and where DOC of Material is
always < 100% in Opening WIP or Closing WIP or Abnormal Loss .
b) M1 will be material coming from previous process and M2 will be the material
introduced in the same process.
c) Always take M1 = 0% in opening WIP completed.
d) In all other cases DOC of M1 will always be = 100%.
e) Scrap of Normal Loss will always be deducted from M1.
Inter Process Profit
The price at which the output of one process is transferred to another process is cost plus a
profit percentage. This profit is called inter process profit.
Thus inter process profit is the profit made by the transfer of output from one process to
another. Inter process profit facilitates to evaluate the performance of each process, from
the cost effectiveness point of view and also from the profit point of view.
Advantages of Inter Process Profit
1. Comparison between the cost of output and its market price at the stage of completion is
facilitated.
2. Each process is made to stand by itself as to the profitability.
Disadvantages of Inter Process Profit
1. The use of inter-process profits involves complication.
2. The system shows profits which are not realized because of stock not sold out.