Process Costing by Taha Popatia

Process Costing by Taha Popatia
Process Costing
It is a method for determining the total unit cost of the output of a continuous production process in which a
product passes through a sequence of operations. This method used where it is not possible to identify separate
units of production, or jobs, usually because of the continuous nature of the production processes involved. It
may also be associated with the continuous production of large volumes of low-cost items, such as cans and tins.
Some examples of continuous production are as follows:
 Oil refining
 Drinks
 Cars etc.
Process costing is applicable on homogeneous units.
Example of Process accounts

Process 1 Account
Units £ Units £
Materials 1000 5,000 Transferred to Process 2 1000 15000
Labour 8,000
Overheads 2,000
1000 15000 1000 15000
Process 2 Account
Units £ Units £
Received from Process 1 1000 15,000 Transferred to Process 3 1000 27400
Materials 7,000
Labour 4,200
Overheads 1,200
1000 27400 1000 27400
Process 3 Account
Units £ Units £
Received from Process 2 1000 27,400 Transferred to Finished Goods 1000 50400
Materials -
Labour 11,000
Overheads 12,000
1000 50400 1000 50400
Some important terms
 Normal loss: It is an inherent loss that is expected to rise under normal operating conditions. This loss is
unavoidable. No cost is charged on this loss therefore, the cost of producing these units is borne by the
finished goods.
 Abnormal loss: This loss is occurred when actual loss exceeds the normal loss due to inefficient operations.
This loss is avoidable. Cost is charged to units of abnormal loss.
 Abnormal Gain: It occurs when actual loss is less than normal loss. Cost is charged to units of abnormal gain
and it is treated as a negative cost.
 Average cost / unit: It is calculated as follows
Average cost/unit = Total Production cost incurred
Expected output
If Scrap value is given then,
1|P ag e AR TT BUSIN ESS SCH OOL SIR TAHA POPATIA

Average cost/unit = Total Production cost incurred - (Units of normal loss x Scrap value/unit)
Expected output
Steps for developing solution
1. Calculate normal loss units.

2. Calculate expected output.
3. Calculate abnormal loss/gain units.
4. Calculate average cost/unit.
5. Prepare Process account.
Process Account
Units $ Units $
Materials xxx xxx Normal loss xxx xxx
Labour xxx Actual output xxx xxx
Overheads xxx Abnormal loss xxx xxx
Abnormal Gain xxx xxx
xxx xxx xxx xxx
Case # 1: Process account with normal loss
Example 1
Input units 2000 units
Normal loss 20%
Material $ 4800
Labour $ 9600
Overheads $ 19200
Actual output 1600 units
Solution:
Step 1: Calculate normal loss units
Input unit’s x Normal loss %
= 2000 x 20% = 400 units
Step 2: Calculate expected output
Input units – Units of normal loss
= 2000 – 400 = 1600 units
Step 3: Calculate abnormal loss/gain units
Expected output – Actual output
= 1600 – 1600 = 0 unit
Step 4: Calculate average cost/unit
Average cost/unit = 4800 + 9600 + 19200 = 21
1600
Step 5:
Process Account
Units $ Units $
Materials 2000 4,800 Normal loss 400
Labour 9,600 Actual output 1600 33,600 [1600 x 21]
Overheads 19,200
2000 33,600 2000 33,600

Case # 2: Process account with normal loss + scrap
Example 2
Normal loss 20%
Material $ 32,000
Labour $ 16,000
Overheads $ 9600
Scrap value $ 2/unit
Solution:
Input units x Normal loss %
= 4000 x 20% = 800 units
= 4000 – 800 = 3200 units
= 3200 – 3200 = 0 unit
Average cost/unit = (32,000 + 16,000 + 9600) – (800 x 2) = 17.5
3200
Step 5:
Process Account
Units $ Units $
Materials 4000 32,000 Normal loss 800 1600 [800 x 2]
Labour 16,000 Actual output 3200 56,000 [3200 x 17.5]
Overheads 9600
4000 57,600 4000 57,600
Case # 3: Process with abnormal loss
Example 3
Normal loss 30%
Material $ 21,000
Labour $ 42,000
Overheads $ 4200
Solution:
= 3000 x 30% = 900 units
= 3000 – 900 = 2100 units
= 2100 – 1900 = 200 units
Average cost/unit = 21,000 + 42,000 + 4200 = 32
2100
Step 5:
Process Account
Units $ Units $
Materials 3000 21,000 Normal loss 900 -
Overheads 4200 Abnormal loss 200 6400 [200 x 32]
3000 67,200 3000 67,200
Case # 4: Process account with abnormal loss + scrap
Example 4
Normal loss 10%
Material $ 18,000
Labour $ 36,000
Overheads $ 47,500
Scrap value $ 5/unit
Solution:
= 5000 x 10% = 500 units
= 5000 – 500 = 4500 units
= 4500 – 4300 = 200 units
Average cost/unit = (18,000 + 36,000 + 47,500) – (500 x 5) = 22
4500
Step 5:
Process Account
Units $ Units $
Materials 5000 18,000 Normal loss 500 2500 [500 x 5]
Overheads 47,500 Abnormal loss 200 4400 [200 x 22]
5000 101,500 5000 101,500

Case # 5: Process account with abnormal gain
Example 5
Normal loss 20%
Material $ 40,000
Labour $ 20,000
Overheads $ 1600
Solution
= 1000 x 20% = 200 units
= 1000 – 200 = 800 units
= 800 – 840 = (40) units Abnormal gain
Average cost/unit = (40,000 + 20,000 + 1600) = 77
800
Step 5:
Process Account
Units $ Units $
Materials 1000 40,000 Normal loss 200 -
Overheads 1600
Abnormal gain [40 x 77] 40 3080
1040 64,680 1040 64,680
Case # 6: Process account with abnormal gain + Scrap
Example 6
Normal loss 20%
Material $ 24,000
Labour $ 12,000
Overheads $ 20,400
Scrap value $ 2.5/unit
Solution:
= 6000 x 20% = 1200 units
= 6000 – 1200 = 4800 units
= 4800 – 5100 = (300) units Abnormal gain
Average cost/unit = (24,000 + 12,000 + 20,400) – (1200 x 2.5) = 11.125
4800
Step 5:
Process Account
Units $ Units $
Materials 6000 24,000 Normal loss 1200 3000 [1200 x 2.5]
Labour 12,000 Actual output 5100 56,737.5 [5100 x 11.125]
Overheads 20,400
Abnormal gain [300 x 11.125] 300 3337.5
6300 59,737.5 6300 59,737.5
Abnormal losses/gains Account

Abnormal losses/gains are transferred from process account to their respective accounts and then transferred to
income statement at the value given in the process a/c.
If there is Scrap then,
 In case of abnormal loss credit the abnormal loss a/c and then transfer the remaining balance to the
income statement.
 In case of abnormal gain debit the abnormal gain a/c and then transfer the remaining balance to the
income statement.
Losses with disposal cost

i. Increase process cost by the cost of disposal of normal loss and the resulting cost/unit will be use to
value actual output and abnormal loss/gain.
ii. No value will be assign to normal loss units in the process a/c.
iii. Show the disposal cost on the debit side of the process a/c.
iv. Include the disposal cost of abnormal loss in the abnormal loss a/c.
Work – In – Progress
 Opening WIP: These are the units which were unfinished at the end of the previous period.
 Closing WIP: These are the units which were started in the current period and remains unfinished till the
the end of the current period.
When there is a continuous production process, it is difficult to measure the quantity of work-in-process at the
end of a financial period. Process costing provides a method of measuring and costing incomplete WIP.
Concept of Equivalent Production Units (EPU)

These are notional whole units which represent incomplete work, and which are used to apportion costs
between work in process and completed output.
Steps for developing solution
1. Calculate EPU of Material and Conversion cost separately.

2. Calculate Cost/EPU
3. Assign Value to FGS and WIP
4. Prepare Process A/C

Note: Conversion cost is the cost incurred to convert raw material into FGS (usually sum of Labour and
Overheads).
Case # 7: Process account with Closing WIP
Example 7
Material $ 21,000
Conversion cost $ 24,750
Closing WIP 500 units
Degree of Completion
Material 50%
Conversion cost 30%
Solution
Step 1: Calculate EPU
i. Material equivalent units
Finished units + Closing WIP units x % of work done in current period
= (2000 – 500) + (500 x 0.5) = 1750 units
ii. Conversion cost equivalent units
= (2000 – 500) + (500 x 0.3) = 1650 units
Step 2: Cost/EPU
i. Material cost/EPU
21,000 = 12
1750
ii. Conversion cost/EPU
24,750 = 15
1650
Step 3: Valuation
i. FGS
Material = 1500 x 12 = 18,000
Conversion cost = 1500 x 15 = 22,500
40,500
ii. Closing WIP
Material = 250 x 12 = 3,000
5,250
Step 4: Process A/C
Process Account
Units £ Units £
Materials 2000 21,000 Finished Goods 1500 40,500
Conversion cost - 24,750 Closing WIP 500 5,250
2000 45,750 2000 45,750

Opening WIP
There are two methods for the valuation of opening WIP

i. AVCO
ii. FIFO
Case 8: Process A/C with opening WIP (AVCO)
Example 8
Opening Stock 500 units
Material $3000 30% Complete
Conversion cost $5000 40% Complete

Material $52,440
Conversion cost $29,650

Degree of completion
Material 40%
Conversion cost 50%
Solution
= (500 + 3000 – 700) + (700 x 0.4) = 3080 units
= (500 + 3000 – 700) + (700 x 0.5) = 3150 units
Step 2: Cost/EPU
3000 + 52,440 = 18
3080
5000 + 29,650 = 11
3150
Step 3: Valuation
i. FGS
Material = 2800 x 18 = 50,400
81,200
ii. Closing WIP
Material = 280 x 18 = 5,040
8,890
Step 4: Process A/C
Process Account
Units £ Units £
Opening 500 Finished Goods 2800 81,200
Material 3,000 Closing WIP 700 8,890
Conversion cost 5,000
Input 3000
Material 52,440
3500 90,090 3500 90,090
Case 9: Process A/C with opening WIP (FIFO)
Example 9
Opening Stock 1000 units
Material $8000 30% Complete
Conversion cost $3000 40% Complete

Material $25,800
Conversion cost $35,400

Degree of completion
Material 60%
Conversion cost 20%
Solution
Work done on opening WIP [1000 x 70%] 700
Unit Stated and finished in current period [2000 - 300] 1700
Work done on closing WIP [300 x 60%] 180
2580

Work done on opening WIP [1000 x 60%] 600
Unit Stated and finished in current period [2000 - 300] 1700
Work done on closing WIP [300 x 20%] 60
2360
Step 2: Cost/EPU
25,800 = 10
2580
35,400 = 15
2360
Step 3: Valuation
i. Opening Stock
Previous cost = 8000 + 3000 = 11,000
Material = 700 x 10 = 7,000
Conversion cost = 600 x 15 = 9,000 27,000

ii. Units started and finished in the current period
Material = 1700 x 10 = 17,000
Conversion cost = 1700 x 15 = 25,500 42,500
FGS 69,500
iii. Closing WIP
Material = 180 x 10 = 1,800
Conversion cost = 60 x 15 = 900
2,700
Step 4: Process A/C
Process Account
Units £ Units £
Opening 1000 Finished Goods 2700 69,500
Material 8,000 Closing WIP 300 2,700
Input 2000
Material 25,800
3000 72,200 3000 72,200
Note: In exam if degree of completion of each element in opening inventory is given but cost element is not
given then, use FIFO method. If cost element is given but degree of completion is not given then, use AVCO
method.
Joint and By Products
 Joint - Products: Joint products are two or more products generated by a single production process at the
same time. It is the primary product having significant sales value.
 By – Products: An incidental product made in the manufacture or synthesis of something else. It is non-
primary product having insignificant sales value.
 Split – off point: The point at which several products emerge from a common process.
 Joint – cost: It is the collective cost incurred up to the split – off point.
Split - off point

Product X
Raw Material Process
Product Y
By - Product A
Methods for Joint – cost apportionment
1. Physical method
Share of Joint - cost of X or Y = Joint - cost x Units of X or Y
Total number of units
2. Market/Sales value method
Share of Joint - cost of X or Y = Joint - cost x Market value of X or Y
Total market value
10 | P a g e A R T T B U S I N E S S S C H O O L SIR TAHA POPATIA

Example 10
Joint Cost $ 150,000
Joint Products # of units Market Value

A 6000 units $120,000
B 5000 units $160,000
C 4000 units $120,000
Calculate the cost and the profit of each product under physical and market value method.
Solution
Physical method
Share of Joint - cost of A = 150,000 x 6000 = 60,000
15,000
Share of Joint - cost of B = 150,000 x 5000 = 50,000

15,000
Share of Joint - cost of C = 150,000 x 4000 = 40,000

15,000
A B C
Sales 120,000 160,000 120,000
Cost (60,000) (50,000) (40,000)
Profit 60,000 110,000 80,000
Market value method
Share of Joint - cost of A = 150,000 x 120,000 = 45,000
400,000
Share of Joint - cost of B = 150,000 x 160,000 = 60,000

400,000
Share of Joint - cost of C = 150,000 x 120,000 = 45,000

400,000
A B C
Sales 120,000 160,000 120,000
Cost (45,000) (60,000) (45,000)
Profit 75,000 100,000 75,000
3. Net Realizable Value method

Split - off point
Product X Further processing @ $ 20,000 MV will be 240,000
Raw Material Process Product Y Further processing @ $ 50,000 MV will be 300,000

Share of Joint – cost of X or Y = Joint - cost x NRV of X or Y
Total NRV
Example 11
Joint – Cost 120,000

Market value after further processing
A $ 635,000
B $ 375,000
Further processing cost
A $ 35,000
B $ 75,000
Calculate joint – cost and profit of each product by NRV method.
Solution
NRV of A = 635,000 - 35,000 = 600,000
NRV of B = 375,000 - 75,000 = 300,000
Total NRV 900,000
Share of Joint - cost of A = 120,000 x 600,000 = 80,000

900,000
Share of Joint - cost of B = 120,000 x 300,000 = 40,000

900,000
A B
Sales 635,000 375,000
Cost (80,000) (40,000)
Further processing cost (35,000) (40,000)
Profit 555,000 335,000
By – Product Accounting
Following are the accounting treatment of by product
i. No share of joint cost is allocated to by product.
ii. By – Product revenue can be added to sales of the main product (i.e. Credited to Sales A/C).
iii. By – Product revenue can be used to reduce joint – cost (i.e. Credited to Process A/C). (most common
treatment)
iv. By – Product revenue can be treated as other income.
v. If By – Product has unknown value at the split – off point but does have a value after further processing
then, the net reliable value of the by – product is used to reduce the process costs.
Process Account for Joint and By Products

 Credit process account and debit by – product account by the sales value of by – product.
 By – Product units will be treated as units of normal loss therefore, reduce the number of units output.
 Cost can be calculated as follows
Cost = Material + Labour + Overheads - Scrap value of normal loss - By-product revenue
Input units - Units of normal loss - Units of by-product

Process Costing by Taha Popatia

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Process Costing by Taha Popatia

Example of Process accounts

1000 15000 1000 15000

1|P ag e AR TT BUSIN ESS SCH OOL SIR TAHA POPATIA

1. Calculate normal loss units.

Case # 1: Process account with normal loss

2000 33,600 2000 33,600

2|P ag e AR TT BUSIN ESS SCH OOL SIR TAHA POPATIA

4000 57,600 4000 57,600

Case # 3: Process with abnormal loss

3000 67,200 3000 67,200

Case # 4: Process account with abnormal loss + scrap

5000 101,500 5000 101,500

4|P ag e AR TT BUSIN ESS SCH OOL SIR TAHA POPATIA

Case # 6: Process account with abnormal gain + Scrap

Abnormal losses/gains Account

Losses with disposal cost

Concept of Equivalent Production Units (EPU)

Steps for developing solution

1. Calculate EPU of Material and Conversion cost separately.

6|P ag e AR TT BUSIN ESS SCH OOL SIR TAHA POPATIA

Case # 7: Process account with Closing WIP

2000 45,750 2000 45,750

7|P ag e AR TT BUSIN ESS SCH OOL SIR TAHA POPATIA

Case 8: Process A/C with opening WIP (AVCO)

Input units 3000 units

Closing WIP 700 units

3500 90,090 3500 90,090

Case 9: Process A/C with opening WIP (FIFO)

Input units 2000 units

Closing WIP 300 units

ii. Conversion cost equivalent units

9|P ag e AR TT BUSIN ESS SCH OOL SIR TAHA POPATIA

3000 72,200 3000 72,200

Joint and By Products

Split - off point

10 | P a g e A R T T B U S I N E S S S C H O O L SIR TAHA POPATIA

Joint Products # of units Market Value

Share of Joint - cost of B = 150,000 x 5000 = 50,000

Share of Joint - cost of C = 150,000 x 4000 = 40,000

Share of Joint - cost of B = 150,000 x 160,000 = 60,000

Share of Joint - cost of C = 150,000 x 120,000 = 45,000

3. Net Realizable Value method

11 | P a g e A R T T B U S I N E S S S C H O O L SIR TAHA POPATIA

Joint – Cost 120,000

Share of Joint - cost of A = 120,000 x 600,000 = 80,000

Share of Joint - cost of B = 120,000 x 300,000 = 40,000

Process Account for Joint and By Products

12 | P a g e A R T T B U S I N E S S S C H O O L SIR TAHA POPATIA

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