BBA211 Vol7 ProcessCosting

BBA211 Managerial Accounting
PROCESS COSTING
Definition
Process costing is a costing method used when cost units are passed through a series of
clearly defined processes before the final product is completed.
Process costing refers to a type of costing procedure adopted by manufacturing firms where
there is continuous or mass production and costs are accumulated on a continuous basis.
Under process costing, there is a finished product at each stage which becomes the raw
material of the subsequent stage or next process till the final stage of completion.
Process costing method is generally employed in industries like;
 Chemicals
 Distilled products
 Canned products
 Processed food products
 Oil refineries
 Edible oils
 Soap
 Paper
 Textiles
 Erasers, etc.
Distinct features between Job and Process costing.
Point of Distinction Job order costing system Process costing system
1) Cost allocation Allocates costs by job. Allocates costs by process.
2) Company type Used by companies that manufacture Used by companies manufacturing
unique products or provide specialized identical units or homogeneous products.
services.
3) Separate products Work consists of separate projects or A process is one of the steps in
contract jobs. manufacturing production.
4) Record keeping A Job cost sheet is maintained for each A production cost report is maintained for
job each process or department.
5) Cost transfers Costs are transferred when each job is Costs are transferred at the end of the
completed accounting period.
Important terms to understand under process costing

In a manufacturing process the number of units of inputs may not necessarily be the same as
the number of units of output. There may be a loss.
Normal loss
This is the term used to describe normal expected wastage under usual operating conditions.
This may be due to reasons such as evaporation, testing or rejects.
Abnormal loss
This is when a loss occurs over and above the normal expected loss. This may be due to
reasons such as faulty machinery, errors by laborers, natural catastrophes etc.
Abnormal gain
This occurs when the actual loss is lower than the normal loss. This could, for example, be
due to greater efficiency from newly-purchased machinery.
Work in progress (WIP)
This is the term used to describe units that are not yet complete at the end of the period.
Opening WIP is the number of incomplete units at the start of a process and closing WIP is
the number at the end of the process.
Scrap value
Sometimes the outcome of a loss can be sold for a small value. For example, in the production
of screws there may be a loss such as metal wastage. This may be sold to a scrap merchant for
a fee.
Equivalent units
It Measures the amount of materials added to or work done on partially completed units
during a period.
They are expressed in terms of fully completed units of output
EU refers to a conversion of part-completed units into an equivalent number of wholly-
completed units. For example, if 1,000 cars are 40% complete then the equivalent number of
completed cars would be 1,000 x 40% = 400 cars. Note: If 1,000 cars are 60% complete on
the painting, but 40% complete on the testing, then equivalent units will need to be
established for each type of cost.
Conditions favorable for the use of process costing
The following five conditions are favorable for the use of process costing:
(1) Production of a single output in a plant.
(2) Division of a plant into different processes and departments.
(3) Processing a single product for a Scheduled time, followed by successive runs of other
products. Here costs are calculated separately for each run.
(4) Production of several products being produced simultaneously from the same process.
(5) Division of a factory into separate operations, each performing standard operation.
(6). Costs are calculated process-wise.
Computation of unit cost under process costing system
 The computation of unit costs for the work performed during a period is a key part of the
production report.
 This might seem easy — just divide the total cost by the number of units produced.
 However, the presence of work in process inventories causes problems.
 You cannot calculate the total output of the period by just taking the sum of completed
units and work in process (ending inventory).
 Because units in the work in the process inventory are not 100% complete.
 This problem is handled through the concept of equivalent units of production.
The process costing procedure can be explained by means of the following examples:
Example 1
A product passes through three processes, Process A, Process B and Process C, to completion.
The production of the commodity was 1,000 tonnes. The costs were as follows:
Process A Process B Process C
$ $ $
Materials 3,000 1,500 1,500
Labour 1,500 3,000 5,250
Manufacturing overheads 1,500 4,500 5,250
Assume that there was no work-in-progress either at the beginning or at the end. Required;
Show the process costs for each process and the total cost of the finished product.
Solution
Process A, account
Particulars Unit cost ($) Amount ($) Particulars Unit cost Amount ($)
($)
Materials 3.0 3,000 Transferred to 6.0 6,000
process B
Labour 1.5 1,500
Manufacturing OHs 1.5 1,500
Total 6.0 6,000 6.0 6,000
Cost per Unit = Cost of input / Output
= $6,000 / 1,000 tonnes
= $6 per tonne
Process B, account
Particulars Unit cost Amount ($) Particulars Unit cost Amount
($) ($) ($)
From process A, account 6.0 6,000 Transferred to process C 15 15,000
Materials 1.5 1,500
Labour 3.0 3,000
Total 15 15,000 15 15,000
Cost per unit = $15,000 / 1,000 tonnes = $15 per tonne
Process C, account
Particulars Unit cost Amount ($) Particulars Unit cost Amount
($) ($) ($)
From process B, account 15 15,000 Transferred to finished goods 27 27,000
account
Materials 1.5 1,500
Labour 5.25 5,250
Total 27 27,000 27 27,000
Cost per unit = $27,000 / 1,000 tonnes = $27 per tonne
Finished goods, account

Particulars Unit cost Amount ($) Particulars Unit cost Amount ($)
($) ($)
From process C, account 27 27,000 Balance c/d 27 27,000
Total 27 27,000 27 27,000
Example 2
The manufacturer of product ‘Ghee’ required three distinct processes numbered 1, 2 & 3. On
completion, the product is passed through three processes to finished goods stock. The
following information was obtained in respect of product ‘Ghee for the month of July.
(i) 3000 units of raw materials @ $25 per unit were issued to process 1 and costs
incurred are given below.
Process
Type of cost 1 2 3
$ $ $ Total ($)
Direct material 5,000 12,000 18,000 35,000

Direct labour 30,000 20,000 10,000 60,000
Direct expenses 2,800 5,200 2,000 10,000
Production overhead ---- ----- ----- 90,000
(ii) Production overhead is absorbed by each process at 150% of direct labour.
(iii) There was no stock of raw material or work-in-progress either at the beginning or
at the end of the period.
Required;
Prepare the process accounts for product “Ghee”.
Process 1, account
Particulars Cost/unit Amount Particulars Cost/unit Amount
($) ($) ($) ($)
Units introduced $25 $75,000 Transferred to $52.6 $157800
process 2
Direct material 1.66 5,000
Direct labour 10 30,000
Direct expenses 0.93 2,800
Production OHs 15 45,000
Total $52.6 $157,800 $157,800
Process 2, account
($) ($) ($) ($)
From process 1 $52.6 $157,800 Transferred to $75 $225,000
process 3
Direct material 4 12,000
Direct labour 6.7 20,000
Total $75 $225,000 $75 $225,000
Process 3, a/c
Particulars CPU Amount Particulars CPU Amount
($) ($) ($) ($)
From process 2 $75 $225,000 Transferred to finished goods $90 $270,000
account
Direct material 6 18,000
Direct labour 3 10,000
Total $90 $270,000 $90 $270,000
FINISHED GOODS STOCK ACCOUNT

($) ($) ($) ($)
From process 3 $90 $270,000 Balance c/d $90 $270,000
Example 3
Normal loss example
Mr. Bean’s chocolate Wiggly bars passes through two processes. The data for the month just
ended are:
$ Kg
Process 1:
Ingredients 5,000 4,000
Labour & overheads 6,000
Process 2:
Packaging 10,000
Labour & overheads 9.000
Additional information
(i) Mr. Bean allows the staff to eat 5% of the chocolate as they work on Process 1.
(ii) There was no work in progress at the month end.
Required;
Prepare the two process accounts and calculate the cost per kg.
Solution
Process 1
Particulars Units Amount Particulars Units Amount
($) ($)
Ingredients 4,000 5,000 Normal loss 200
Labour & overheads 6,000 Transferred to process 2 3,800 11,000
Total 4,000 11,000 4,000 11,000
Workings
(1) The staff normally eat 5% of the chocolate, so the normal loss is 4,000 x 5% = 200kg.
There is no work in progress or scrap value or abnormal losses or gains, so we can now
balance the account to obtain the amounts transferred to Process 2.
(2) Number of kg transferred = kg input less normal loss = 4,000 – 200 = 3,800kg
Total cost
Cost per kg =
No . of expected units
11,000
= = $2.89
3,800
Process 2
($) ($)
From process 1 3,800 11,000 Transferred to finished goods a/c 3,800 30,000
Packaging 10,000
Total 3,800 30,000 3,800 30,000
Total cost
Cost per kg =
30,000
= = $7.89
3,800
Finished goods a/c
($) ($)
From process 2 3,800 30,000 Balance c/d 3,800 30,000
Total 3,800 30,000 3,800 30,000
Example 4
Abnormal gain example
Consider Mr. Bean in example 3. There is a heatwave and staff have eaten less chocolate. At
the end of Process 13,810 units are transferred to Process 2.
Process 1
($) ($)
Ingredients 4,000 5,000 Normal loss 200
Labour & overheads 6,000 Transferred to process 2 3,810 11,029
Abnormal gain 10 29
Total 4,010 11,029 4,010 11,029
Workings
(1) As the T account should balance, the abnormal gain = 4,010kg – 4,000kg = 10kg
Total cost
(2) Cost per kg =
11,000
= = $2.89
3,800
Cost of units transferred to Process 2 = $2.89 3,810 = $11,029 (using $2.894736842 to avoid
rounding differences). Cost of abnormal gain = $2.89 10 = $29. [Remember to open an
abnormal gain T account and credit it with $29]
Process 2
Particulars UnitsAmount Particulars Units Amount
($) ($)
From process 1 3,810 11,029 Transferred finished goods a/c 3,810 30,029
Packaging 10,000
Total 3,810 30,029 3,810 30,029
Total cost
Cost per kg =
30,029
= = $7.88
3810
Finished goods a/c
($) ($)
From process 2 3,810 11,029 Balance c/d 3,810 30,029
Total 3,810 30,029 3,810 30,029
Example 5
Expo company ltd makes a chemical that passes through three production processes 1, 2 and
3. In the month of August, 6000 litres of the basic raw material priced at shs. 240,000 were
introduced into process 1, subsequently, the following costs were incurred.
Element of cost Total Process
1 2 3
Shs. Shs. Shs. Shs.
Direct material (additional) 87,500 30,000 40,000 17,500
Direct labour 110,000 4,0000 50,000 20,000
Direct expenses 16,900 6,000 1,600 9,300
Additional information
(i) Total loss per process was estimated as:
 Process 1 10%
 Process 2 5%
 Process 3 8%
(ii) Output of each process was
 Process 1 5300 litres
(iii) The loss in each process represented scrap which could be sold of the following
values:
 Process 1 -shs 20 per unit
(iv) There were no stocks of materials or work-in- progress at the beginning or end
of the month. The output of each process passes directly to the next process and
finally to finished stock.
(v) Production overhead is absorbed by each process on a basis of 50% the cost of
direct labour
Required:
a) Prepare separate process accounts for each of the three processes.
b) Prepare abnormal loss and abnormal gain accounts.
ANSWER
Process 1
Particulars Units CPU Amount Particulars Units CPU Amount
(shs) (shs) (shs) (shs)
Direct material - basic 6,000 40 240,000 Normal loss 600 20 12,000
Direct material 1 5 30,000 Abnormal loss 100 60 6,000
Direct labour 6.7 40,000 Units transferred to 5,300 60 318,000
process 2
Direct expenses 1 6,000
Production overhead 3.3 20,000
Total 6,000 56 336,000 6,000 336,000
Workings
Total cost−normal loss
Cost per kg =
No. of expected units
336,000−12,000
= = shs 60
5400
Process 1
 Normal loss = 10% of 6,000 units = 600 units
 Expected production = 6000 - 600 units = 5400 units
 Actual production = 5300 units
 Abnormal loss = 5400 – 5300 = 100 units
 Scrap value of normal loss = 600 x shs 20 = shs12, 000
shs 336,000−shs 12,000
 Cost per unit of abnormal loss =
5400 units
shs 324,000
= =shs 60
5400units
Process 2
From process 1 5,300 60 318,000 Normal loss 265 44 11,660
Direct material 7.54 40,000 Abnormal loss 35 84 2,940
Direct labour 9.43 50,000 Units transferred to 5,000 84 420,000
process 3
Production overhead 4.72 25,000
Total 5,300 82 434,600 6,000 434,600
Workings, process 2
Total cost−normal loss
Cost per kg =
No. of expected units
434,600−11,660
= = shs 84
5,035
 Normal loss = 5% of 5300 = 265 units
 Expected production = 5300 - 265 = 5035 units
 Actual production = 5000 units
 Abnormal loss = 5035 - 5000 = 35 units
 Scrap value of normal loss =265 x shs 44
= shs 11,660
shs 434,600−sh 11,660
 Cost per unit of abnormal loss =
5,035 units
= shs. 84
Process 3
From process 2 5,000 84 420,000 Normal loss 400 65 26,000
Direct material 17,500 Transferred to finished 4,700 98 460,600
goods a/c
Direct labour 20,000
Direct expenses 9,300
Production overhead 10,000
Subtotal 5,000 476,800
Abnormal gain 100 98 9,800
Total 5,100 486,600 5100 486,600
Workings, process 3
 Normal loss = 8% of 5000 units = 400 units
 Expected production =5000 - 400 = 4600 units
 Actual production =4700 units
 Abnormal gain =4700 – 4600 =100 units
 Scrap value of normal loss = 400 x shs 65 =shs 26000
shs 476800−sh 26000
 Cost per unit of abnormal gain = =shs 98
4600 units
Finished goods a/c

From process 3 4,700 98 460,600 Balance c/d 4,700 98 460,600
Total 4,700 460,600 4,700 460,600
Abnormal loss a/c

Particulars Units CPU (shs) Amount Particulars Units CPU Amount
(shs) (shs) (shs)
Process 1 100 60 6,000 Scrap 100 20 2,000
Process 2 35 84 2,940 Debtors 35 44 1,540
Process 1 and 2 P & 5,400
L a/c
Total 135 8,940 135 8,940
Abnormal gain a/c

Scrap sales a/c 100 65 6,500 Process 3 100 98 9,800
Process 3, P & L a/c 3,300
Total 100 9,800 100 9,800
Scrap Debtors Account

Shs Shs
Process 1: Process 3:
Normal loss 12,000 Abnormal Gain 6,500
Abnormal loss 2,000 Balance c/d 46,700
Process 2:
Normal loss 11,660
Abnormal loss 1,540
Process 3:
Normal loss 26,000
53,200 53,200
Balance b/d 46,700
End

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BBA211 Managerial Accounting

Important terms to understand under process costing

Finished goods, account

Direct material 5,000 12,000 18,000 35,000

FINISHED GOODS STOCK ACCOUNT

Total 3,800 30,000 3,800 30,000

Finished goods a/c

Abnormal loss a/c

Abnormal gain a/c

Total 100 9,800 100 9,800

Scrap Debtors Account

Balance b/d 46,700

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