Process Costing

Areas to be covered:
 Process costing
 Some important concepts
 Concepts of equivalent units
 Losses during the process
 Closing Work In Progress in the process
 5- Steps to solve question
Process Costing
Process costing is a costing method which is applicable in industries

producing homogenous products in large quantities. The purpose of

process costing is a typical one for example stock valuation.

Features Of Process Costing
• Homogenous production (Large Quantities) identical products.

• Production is continuous (2 or 3 or more processes) like oil

refining, paper making and chemical manufacturing.

Important Terms And Concepts:
• If finished products are produced by more than one process then output

of first process becomes the input of the next process.

• There might be some incomplete products at the end of the period; they

are called work in progress units.

• Work in progress might not be complete with respect to all the cost so

equivalent units should be calculated.

Important Terms And Concepts:
• Conversion cost = Direct labour cost + Direct expenses + Production

overheads.

• During production process, some units might get lost, and if the loss is not

more than the expected loss then it is called as normal loss ignored in the

calculation.
Important Terms And Concepts:
• Loses might have a certain resale value, that value is called the “Scrap

Value”.

• Losses might have to dispose off at some cost to company, that cost is

called “disposal cost”.

Concept Of Equivalent Units
A process is continuous in nature and at the end of a period there

may be some units, which have been started but have not been

completed. These partially completed units are known as work-in

progress.
Concept Of Equivalent Units
The existence of work-in-progress gives a problem in computing the

average cost per unit as production units will be at different degree

of completions, therefore we cannot simply take total cost divided

by total output. It becomes more complicated if the degree of

completions varies for various cost elements. To solve this problem,

we use equivalent unit.

Concept Of Equivalent Units
Equivalent unit refers to a notional quantity of completed units

substituted for an actual quantity of incomplete physical units in

progress.
Losses During The Process
Normal Loss:

Normal Loss is an expected loss of the process and its units are

ignored while calculating equivalent units. It is charge at scrap value.

If normal loss has a scrap value, the scrap value is set off against the

cost of production usually material.

5 - Steps To Solve Question
1. Prepare a process account.

2. Calculate equivalent units.

3. Calculate the cost of an equivalent unit.

4. Find the cost of finished goods.

5. Calculate the cost of Closing Work-In-Progress

Format
Process cost is calculated in process accounts. Process account
contains the following:

PROCESS ACCOUNT
Units $ Units $
Opening WIP x x Finished Goods 4,500
Direct Material 5,000 20,000 Closing WIP 300
Direct Labour 12,000 Normal Loss
Factory 8,000 Scrap value: $2/- 200
Overheads

5,000 40,000 5,000

Formulas:
 Equivalent Units: Output units + (Closing WIP unit x % of completion)

 Cost per unit: ($ Total input cost – $ Normal loss scrape Value) /

Equivalent units

 Cost of Output: Output units x cost per unit

 Cost of Closing WIP: (Closing WIP x % of completion) x cost per unit

Example:
Alpha Ltd a liquid chemical compound is manufactured as result of two
processes. Details of Process 2 for November are as follows:
Opening W-I-P Nil
Material transferred from Process 1 $49,875 (50,000 liters)
Labour cost 500 hours @ $5/-hour
Overheads 60% of labour cost
Output transferred to finished goods 45,000 liters
Quality control checks at the end of the process of manufacture and normally
leads to a rejection rate of 10% of input materials.

Required: Prepare the Process 2 account for Alpha Ltd.

Solution:
Process Account
Units $ Units $
Direct Material Finished goods
Direct Labour Closing WIP
Factory Overheads Normal Loss

Equivalent units:

Cost per unit:

Cost of Finished Goods:

Cost of Closing WIP:

Example: 1, 2 & 3: Home Assignment
Formulas:
If work-in-progress have different degrees of completion:

For example, closing WIP is 100% compete for material, 80% for Labour & 60%
for FOH, than:

Equivalent Units:

• Mat: Output units +(Closing WIP x 100%) = M units

• Lab: Output units + (Closing WIP x 80%) = L units

• FOH: Output units + (Closing WIP x 60%) = F units

Formulas:
Cost per unit:

• Mat: [Total input cost of material – Normal loss ($)] / Equivalent

units of material

• Lab: Total input cost of labour / Equivalent units of labour

• FOH: Total input cost of FOH / Equivalent units of FOH

Cost of Output = Output units x Total cost per unit

Formulas:
• Cost of Closing WIP:

• Mat: (Closing WIP x 100%) x Cost per unit of material =X

• Lab: (Closing WIP x 80%) x Cost per unit of labour =Y

• FOH: (Closing WIP x 60%) x cost per unit of FOH =Z

Total XYZ
Example 2:
Bravo Ltd a liquid chemical compound is manufactured as result of two
processes. Details of Process 2 for November are as follows:
Opening W-I-P Nil
Material transferred from Process 1 $49,875 (50,000 units)
Labour cost 500 hours @ $5/-hour
Overheads 44% of labour cost
Output transferred to finished goods 42,500 liters
Closing W-I-P 5,000 liters
Quality control checks at the end of the process of manufacture and normally
leads to a rejection rate of 5% of input materials, which can be scrapped at
$0.5 per unit. Closing W-I-P is 100% completed for materials and 50% for labour
& Factory OHs.
Required: Prepare the Process 2 account for Alpha Ltd.
Solution:
Process Account
Units $ Units $
Opening WIP Finished goods
Direct Material Closing WIP
Conversion cost Normal Loss

Equivalent units:
Material:

Conversion:

Cost per unit:

Material:

Conversion:
Cost of Finished Goods:

Cost of closing WIP:

Material:

Conversion:
Example 1, 2, 3, 4, 5, 6, 7 & 8: Home Assignment
Practice Questions: Home Assignment