PROCESS COSTING

Process Costing is also a method of costing which is used in those industries where the production is in continuous
process, i.e. the output of one process becomes the input of the subsequent process and so on. Examples of such
industries are, paint works, chemical plants, food manufacturing, oil refining, paper mill, textile mills, sugar
factories, fruit canning, dairy and so on. In such industries, the input is put in the first process and the output of
each process becomes the input of the subsequent process till the final product emerges from the last process.
This method is employed where it is not possible to trace the items of prime cost [which consists of all direct costs]
to a particular order because its identity is lost in the continuous production.

The features of process costing are

1) The production is in continuous flow and is uniform. All units coming out as finished products are uniform with
each other in all respects.

2) The product is manufactured in a continuous flow and hence individual units lose their identity.

3) The unit cost is obtained by dividing the total cost for a particular period by the total output. This is the average
cost of the product units.

4) Cost per process is ascertained and cost of each process is transferred to the subsequent process until the
finished product emerges.

5) In a particular process normal and abnormal losses emerge. Normal loss is a loss, which is inevitable in any
process and thus cannot be avoided or controlled. Any loss, which, is over and above, the normal loss is called as
abnormal loss and is to be accounted for separately. For example, if 1000 units are put in Process 1 and it is
anticipated that there will be a normal loss of 1% in the process, the output expected is 1,000 – 1% of 1,000 that is
990. If actual production is 980, there is an abnormal loss of 10 units. On the other hand if the production is 995,
there is an abnormal gain of 5 units. Abnormal gain and abnormal loss are to be accounted for in the process cost
accounts.

6) Though the cost per unit is computed by dividing the total cost by the number of units, there can be a problem
on incomplete units at the end of a particular accounting period. In such cases equivalent units have to be worked
out for computing the cost per unit

ABNORMAL LOSS IN PROCESS

No. of units of abnormal loss = Expected output – Actual output

Cost of abnormal loss = (Total cost incurred – scrap value of normal loss)/ (Input – Normal loss)

Accounting treatment of abnormal loss

- Cost of abnormal loss not considered as part of COP

- Cost of abnormal loss not absorbed by good units produced
- It is charged to Costing P&L a/c

ABNORMAL GAIN IN PROCESS

Units of abnormal gain = Actual output – Expected output

Cost of Abnormal gain = (Tot cost incurred – scrap value of N.Loss)/(Input – normal loss)*Units of Abnormal gain

Accounting treatment of abnormal gain

- Cost of abnormal gain is not treated as recovery of COP

- Cost of good units is not reduced by Cost of abnormal gain
- It is credited to Costing P&L

Problem 1

Product B is obtained after it passes through three distinct processes. The following information is obtained from
the accounts for the week ending on 31st March 2006

Particulars Total Amount Proc I Proc II Proc III

Addtl material 7542 2600 1980 2962
Direct Wages 9000 2000 3000 4000
Production OH 9000

1,000 units @ Rs. 3 each were introduced in Process I. There was no stock of materials or work in progress at the
beginning or at the end of the period. The output of each process passes direct to next process and finally to
finished store. Production overheads are recovered on 100% of direct wages.

The following additional data are obtained.

Particulars - Output during % Normal loss to Value of scrap/unit

Process the week (units) input
I 950 5 Rs2
II 840 10 Rs 4
III 750 15 Rs 5

Prepare Process Cost Accounts and Abnormal Loss and Abnormal Gain Account

CONCEPT OF EQUIVALENT PRODUCTION

However in practice it may happen that at the end of a particular period, there may be some incomplete units in
the process. Further the degree of completion of the opening work in progress and closing work in progress may
be different. These incomplete units will create problems in finding out the cost per unit, as all the units will not
have the same degree of completion. In such cases, the equivalent units will have to be worked out for the
incomplete units. The concept of equivalent units states that 2 units, each complete 50% will be treated as
equivalent to 1 completed unit. This concept will have to be implemented for solving the problem of incomplete
units. For this, degree of completion will have to be ascertained for each element of cost, i.e. material, labor and
overheads. The following methods of pricing are used for valuing the equivalent units.

1) First In First out Method [FIFO]: In this method, the assumption is that the incomplete units from the opening
stock are completed first and then the units introduced in the process are completed. The costs added in each
process during the current period is prorated to the production necessary to complete the opening work in
progress, to complete the units added in the process and units in the work in progress. The objective of the
 first in first out method is to value the inventory at the current costs and as such the main problem is to
calculate the equivalent production under this method.

2) Weighted Average Method

If a manufacturing unit is manufacturing two or more products, which are quite dissimilar to each other,
weighted average method is used. Under this method, weighted average is computed and used in valuation of
the incomplete units.

Problem 2

AB Ltd is engaged in the process engineering industry. During the month, October 2007, 2000 units
were introduced in process ‘X’. The normal loss is estimated at 5% of input. At the end of the month,
1400 units had been produced and transferred to process ‘Y’, 460 were incomplete units, and 140
units had to be scrapped at the end of the process. The incomplete units reached the following
degree of completion:

Material: 75%, Labor: 50%, overheads: 50%

Following are the further details regarding process X.

o Cost of 2000 units introduced: Rs. 58,000
o Additional material consumed Rs. 14,400
o Direct labor: Rs. 33,400
o Allocated overheads: Rs. 16,700
Note: The scrapped units fetched Rs.10 each.
Required: [As per First In First Out Method]
a. Statement of equivalent production
b. Statement of cost
c. Statement of evaluation
d. Process ‘X’ Account.

Problem 3

Prepare a Statement of Equivalent Production, Cost Statements, Statement of Valuation and Process
Account from the following particulars using First in First out Method

A] Opening work in progress – 900 units @ Rs.4500, degree of completion, material –100%, labor and
overheads – 60%
B] Input of materials: 9100 units @ Rs.27300, expenses: Labor Rs.12, 300, overheads Rs.8, 200
C] Finished units transferred to next process – 7,800
D] Normal scrap – 10% of input, scrap realization @ Rs.3 per unit
E] Units scrapped- 1,200 units, degree of completion: material 100%, labor and overheads: 70%
F] Closing work in progress – 1000 units, degree of completion: material 100%, labor and overheads
80%