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Process costing is an accounting methodology that traces and accumulates direct costs, and allocates indirect costs of a manufacturing process. Costs are assigned to products, usually in a large batch, which might include an entire month's production. Eventually, costs have to be allocated to individual units of product. It assigns average costs to each unit, and is the opposite extreme of Job costing which attempts to measure individual costs of production of each unit. Process costing is usually a significant chapter. Process costing is a type of operation costing which is used to ascertain the cost of a product at each process or stage of manufacture. CIMA defines process costing as "The costing method applicable where goods or services result from a sequence of continuous or repetitive operations or processes. Costs are averaged over the units produced during the period". Process costing is suitable for industries producing homogeneous products and where production is a continuous flow. A process can be referred to as the sub-unit of an organization specifically defined for cost collection purpose.

Process Costing Types


There are three types of process costing, which are: 1. Weighted average costs. This version assumes that all costs, whether from a preceding period or the current one, are lumped together and assigned to produce units. It is the simplest version to calculate. 2. Standard costs. This version is based on standard costs. Its calculation is similar to weighted average costing, but standard costs are assigned to production units, rather than actual costs; after total costs are accumulated based on standard costs, these totals are compared to actual accumulated costs, and the difference is charged to a variance account. 3. First-in first-out costing (FIFO). FIFO is a more complex calculation that creates layers of costs, one for any units of production that were started in the previous production

period but not completed, and another layer for any production that is started in the current period. Why have three different cost calculation methods for process costing, and why use one version instead of another? The different calculations are required for different cost accounting needs. The weighted average method is used in situations where there is no standard costing system, or where the fluctuations in costs from period to period are so slight that the management team has no need for the slight improvement in costing accuracy that can be obtained with the FIFO costing method. Alternatively, process costing that is based on standard costs is required for costing systems that use standard costs. It is also useful in situations where companies manufacture such a broad mix of products that they have difficulty accurately assigning actual costs to each type of product; under the other process costing methodologies, which both use actual costs, there is a strong chance that costs for different products will become mixed together. Finally, FIFO costing is used when there are ongoing and significant changes in product costs from period to period to such an extent that the management team needs to know the new costing levels so that it can re-price products appropriately, determine if there are internal costing problems requiring resolution, or perhaps to change manager performance-based compensation. In general, the simplest costing approach is the weighted average method, with FIFO costing being the most difficult.

The importance of process costing


Costing is an important process that many companies engage in to keep track of where their money is being spent in the production and distribution processes. Understanding these costs is the first step in being able to control them. It is very important that a company chooses the appropriate type of costing system for their product type and industry. One type of costing system that is used in certain industries is process costing that varies from other types of costing (such as job costing) in some ways. In Process costing unit costs are more like averages, the process-costing system requires less bookkeeping than does a job-order costing system. So, a lot of companies prefer to use process-costing system.

When process costing is applied?


Process costing is appropriate for companies that produce a continuous mass of like units through series of operations or process. Also, when one order does not affect the production process and a standardization of the process and product exists. However, if there are significant differences among the costs of various products, a process costing system would not provide adequate product-cost information. Costing is generally used in such industries such as petroleum, coal mining, chemicals, textiles, paper, plastic, glass, and food.

Reasons for use


Companies need to allocate total product costs to units of product for the following reasons:
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A company may manufacture thousands or millions of units of product in a given period of time.

Products are manufactured in large quantities, but products may be sold in small quantities, sometimes one at a time (automobiles, loaves of bread), a dozen or two at a time (eggs, cookies), etc.

Product costs must be transferred from Finished Goods to Cost of Goods Sold as sales are made. This requires a correct and accurate accounting of product costs per unit, to have a proper matching of product costs against related sales revenue.

Managers need to maintain cost control over the manufacturing process. Process costing provides managers with feedback that can be used to compare similar product costs from one month to the next, keeping costs in line with projected manufacturing budgets.

A fraction-of-a-cent cost change can represent a large dollar change in overall profitability, when selling millions of units of product a month. Managers must carefully watch per unit costs on a daily basis through the production process, while at the same time dealing with materials and output in huge quantities.

Materials part way through a process (e.g. chemicals) might need to be given a value, process costing allows for this. By determining what cost the part processed material has

incurred such as labor or overhead an "equivalent unit" relative to the value of a finished process can be calculated.

Process cost procedures


There are four basic steps in accounting for Process cost:
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Summarize the flow of physical units of output. Compute output in terms of equivalent units. Summarize total costs to account for and Compute equivalent unit costs. Assign total costs to units completed and to units in ending work in process inventory.