Session-11

 Process Costing- Part-I: Accounting for abnormal

loss/gain

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 Product Costing Systems
2

1. J k Corp. (paper 1. Boeing (aircraft

manufacturing) manufacturing)
2. Reynolds Aluminum
2. L & T (large scale
(refining aluminum ingots)
construction and
3. Coca-Cola (mixing and
bottling beverages)
Engineering)
3. Walt Disney Studios
(movie production)

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 Product Costing Systems
3

Process Costing Job Costing

1. J k Corp. (paper 1. Boeing (aircraft

manufacturing) manufacturing)
2. Reynolds Aluminum (refining 2. L & T (large scale
aluminum ingots) construction and
3. Coca-Cola (mixing and Engineering)
bottling beverages) 3. Walt Disney Studios
(movie production)
a. Many different products are produced each
a. Produce many units of a single product. period.
b. Output are identical. b. Manufactured to customers’ specifications.
c. Tracing or allocating costs to each job.
 Process Costing System
4

 A process costing system is best used by

companies:
that produce many units of a single product
and when one unit of output is indistinguishable
from any other unit of output.
Because the units of output are identical, the company will
probably use an average cost system to determine product cost.

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 Example: Process Costing
5

 An example of a company that may consider a

process costing system is JK Corp., a manufacturer
of paper products.
 When we think of paper manufacturing, we
generally think about continuous production of a
single roll of paper that may eventually be cut into
sizes needed by customers. Certainly the desire of
this company is to make each unit of output
consistent with the quality standards established.

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 Job-Order Costing
6

 A company would use a job order costing system

when many different products are produced each
period.
 The products are usually manufactured to customers’
specifications and are unique in nature. The unique
nature of each order requires tracing or allocating
costs to each job, and maintaining cost records for
each job.

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 Example: Job-Order Costing
7

 Companies that may benefit from using job order

costing systems include L&T, Boeing, and Walt
Disney Studios.
 L & T engaged in construction industry. The company
works on huge projects that are unique to customer
needs. Walt Disney Studios produces movies.

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 Difference between job costing
8
and process costing
Job Costing Process costing
1. Production is carried on specific order Production is a continuous flow

2. Costs are determined by jobs or Costs are compiled on time basis-for a

batches given accounting period for each process
3. Jobs are separated and independent Processes are related to each other.

4. Costs are calculated when a job is Costs are calculated at the end of period
completed under each process
5. There is normally no transfer from one Transfer from one process to another is
job to another. an usual feature

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 Difference between job costing
and process costing
9

A. Process costing is used when a single product is produced on

a continuing basis or for a long period of time. Job-order
costing is used when many different jobs having different
production requirements are worked on each period.
B. Process costing systems accumulate costs by department. Job-
order costing systems accumulated costs by individual jobs.
C. Process costing systems compute unit costs by department.
Job-order costing systems compute unit costs by job on the job
cost sheet.

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 Comparing Process and Job-Order Costing
10

Job-Order Process
Number of jobs worked Many Single Product
Cost accumulated by Job Department
Average cost computed by Job Department

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 Process Costing
11
Costs are traced and
applied to departments
Direct in a process cost
Materials system.

Direct Labor
Processing Finished
Department Goods

Manufacturing Cost of
Overhead Goods
Sold
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 Job-Order Costing
12
Costs are traced and
applied to individual
Direct jobs in a job-order
Materials cost system.

Finished
Direct Labor Jobs Goods

Manufacturing Cost of
Overhead Goods
Sold
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 Analyst’s point
13

There are number of industries where,

1. Final product emerge only after two or more
process i.e. Paper, Oil refining company.
2. Product of one process becomes input or raw
material of another process i.e. Refined groundnut
oil is the material for making vegetable ghee.
3. Different products may have a common prior
process i.e. brass goods will require melting of
brass commonly for all goods.
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 Paper Industry
14

Raw Material Bamboo/Sabai grass

WIP Pulp

Paper
Finished Good
(Finished/Glazed

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 More Application
15

1. Vegetable Ghee: Groundnut Crushing – Refining-

and Finishing.
2. Metallurgical industries (steel, aluminum)
3. Chemical industries (plastics and drugs)
4. Food processing industries (cheese, chocolates).
5. Petroleum products

‘Note: Special production is not arranged for meeting any particular order.
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 What we need?
16

A. Cost of each process needs to be estimated- BECAUSE EACH

PROCESS IS A COST OBJECT.
B. Process efficiency is the key.

Costing mechanism.
 Costs are charged to processes or operations and
averaged over units produced.
 Accounts are maintained only to show the cost of the
output as a whole.

Note: in job costing costs are assigned to specific orders, lots or units.
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 Application
17

A. Managers need to assign costs to products to

facilitate external financial reporting and internal
decision making.
B. This session illustrates an absorption costing
approach to calculate product costs known as
process costing.

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 Process costing
18

 Method of costing used to ascertain the cost of

production of each process , operation or stage of
manufacture. Where processes are carried on
having one or more of the following features:
 Product of one process is the material of another process
 Simultaneous production at one or more process of different
products
 During one or more processes or operations of a series, the
products or materials are not distinguishable from one
another.

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 Processing Departments
19

Any unit in an organization where materials, labor

or overhead are added to the product.
The activities performed in a processing
department are performed uniformly on all
units of production. Furthermore, the output of
a processing department must be homogeneous.
Products in a process costing environment
typically flow in a sequence from one department
to another.

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 Process Account

particulars Cost per unit Total particulars Cost per unit Total

Note: 1. There is no departure from the principles regarding direct and indirect expenses.
2. If two or more processes are carried on in the same department, the department expenses
will be apportioned among the process carried on there.
3. Indirect expenses common to all processes (i.e. work manager’s salary) have to be
allocated to all processes. Normally on the basis of direct wages.
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 Wastage and By-products (WB)
21

 Normally in each process there is a residue left after transfer

of the partially completed product to the next process.
 The residue if it can be sold in the market and if it can be used
as a raw material for another finished article is known as by-
product*.
 The quantity not accounted for is a loss – effort should be
made to keep it as low as possible.

*: In the process of converting coal into coke, useful by-products

such as coal tar, sulphate of ammonia and benzol are obtained.

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 Case:
22

Crushing of oil seeds

Oil produced Oil cake

Refining

Finishing

Note: Oil cake is not wastage it can be sold in the market. It is useful as a
manure (fertilizer) or as a cattle feed.

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 Wastage and By-products (WB)
23

Treatment in 1. If sold in the market- price realized

accounts
should be credited to the process
accounts in which the wastage or by-
products arose.
2. Individual process WB is insignificant –
then at the end combine together and
the sale proceeds are credited to the
indirect expenses. Hence all processes
reap the benefit.
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 Normal and Abnormal wastage
24

 Elimination of wastage is important. At least the

wastage must be within the prescribed limit.
 Reasonable wastage- Must be estimated for each
process on the basis of past experience and by
experiments.
 This what we called as normal wastage, and
anything beyond this amount is treated as abnormal
wastage.
 Anything below it treated as abnormal effective or
abnormal gain.
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 Normal Wastage
25

Normal Spoilage- is spoilage inherent in a particular

production process that arises under efficient operating
conditions
 Management determines the normal spoilage rate
 Costs of normal spoilage are typically included as a
component of the costs of good units manufactured
because good units cannot be made without making
some units that are spoiled

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 Abnormal loss
26

Abnormal Spoilage – is spoilage that is not inherent in a

particular production process and would not arise under
normal operating conditions
 Abnormal spoilage is considered avoidable and
controllable
 Units of abnormal spoilage are calculated and
recorded in the Loss from Abnormal Spoilage
account, which appears as a separate line item in
the income statement

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 Example
27

 Suppose 100 units are introduced to P-1, with the cost

of $ 4500. if the firm has the practice of taking 10%
as normal wastage.
Transferable output to P-2 is 90
Situation I: Actual output transferred to P-2 is 85 units
Situation II: Actual output transferred to P-2 is 93 units
Cost per unit:
Normally cost per unit = $4500/90 = $ 50
What about for the cost per unit for-
S-1 = ?
S-II = ?

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 Implication
28

 Abnormal wastage = 5*50=$ 250 debited to

abnormal wastage account and credited to process
1 account.
 The amount transferable to process 2 is $4500-
$250 = $4250 for 85 units. (per unit = 50 $).

Note: in this way the effect of abnormality will be

separated from the normal cost of production which
alone can change in efficiency.
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 Abnormal gain
29

Actual loss in  Abnormal gain = 03 units i.e. produced by

process is less
than the extra efficiency, Value = 3* 50= $ 150.
estimated
normal loss or
 Will be credited to the abnormal
actual output is effective/gain account and debit to process
more than the
estimated account.
normal output
 93 units will be transferred to process 2
account with a value of $4500 +$ 150= $
4650 (4650/93 = $50 per unit.)

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Normal and Abnormal wastage: Treatment
30

1. Normal wastage is a part of cost of production.

2. Value of abnormal wastage /effective does not
affect cost of production but will be transferred
to the costing Profit and Loss account.

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 Case 1:
A product passes through two distinct processes A and B and
there after it is transferred to finished stock. From the following
information you are required to prepare process accounts:
Particulars Process A Process B
(Rs.) (Rs.)
Materials consumed 12000 6000
Direct Labor 14000 8000
Manufacturing Expenses 4000 4000
Inputs in process A (units) 10000
Inputs in process A (value) 10000
Output (units) 9400 8300
Normal wastages percentage of input 5% 10%
Value of normal wastage (per 100 units) 8 10
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 Case-2: A product is obtained after it passes through three
distinct processes. The following information is obtained from
the accounts for the month ending January 2016.

Particulars Process I Process II Process III

(Rs.) (Rs.) (Rs.)
Additional Direct Materials 2600 1980 2962
Direct wages 2000 3000 4000
Production overhead 2000 3000 4000
Output (units) 950 840 750
Normal wastages percentage of 5% 10% 15%
input
Value of scrap per unit 2 4 5
1000 units at Rs. 3 each were introduced to process I. There
was no stock of materials or WIP at the beginning or end of
the period. Prepare process cost accounts and abnormal loss
32 and gain accounts. 10/31/2019