MAF 201

CHAPTER 2

Process
Costing
 Learning objectives
• Define and describe the definition of
and the important terms in process
costing

• Explain the objectives and

characteristics of process costing

• Prepare process, normal loss,

abnormal loss, and abnormal gain
accounts

• Prepare statement of equivalent unit,

statement of cost and statement of
evaluation

• Calculate joint cost and by-product cost

• Allocate joint cost to joint products

using the physical, net realizable value,
or selling price method at the split off
point

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 Introduction to
Process Costing
Definition
• Process costing is a costing system that
is used in industries where the products
are homogeneous (i.e. more or less
identical/uniform).

• It is used in mass production that

produce identical units continuously, and
each unit of product receives the same
treatment.

• Process costing system is widely used in

industries that convert raw material into
homogeneous products on a continuous
basis, such as manufacturing of canned
food and drinks, paper, shoes, clothes,
personal computers, and televisions.

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The application of process
costing

Manufacturing industries
Manufacturing Paper, petroleum, chemical, textile,
lumber and food processing industries
commonly use process costing.
Assembly industries
Assembly
Bicycles, television, radio and these are
some examples of assembling
industries that use process costing

Services Services industries

Retail banking, Postal delivery, Credit
card etc. uses process costing method.

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 Process Costing Systems
In a process costing system, products are produced in a department called processing
department where material, labour and overhead costs are added to the product.

There are two types of process costing system, which are sequential and parallel
processing.

SEQUENTIAL PROCESSING PARALLEL PROCESSING

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 Sequential Processing

In this department, the manufacturing of a product is organized in a sequential pattern

where each unit produced flow in sequence from one department to another ( e.g from
process A to process B to process C)

Basic input Processing Processing Processing

(material, Finished
Department Department Department
labour and Goods
overhead) A B C

Note: Additional material, labour and overhead can be part of the input for
Department B and Department C besides the input from the previous department.

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 Parallel Processing
Manufacturing can also be in a form of parallel processing where, after certain points,
some manufactured units need to go through different processing department (e.g from
process A to process B to Process C, whereas the other parallel processing is from
process A to process D to Process E).

Basic input Processing

Processing Processing
(material, Department Finished
labour and Department Department Goods
overhead) A B C

Processing Processing
Department Finished
Department Goods
D E

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 CHARACTERISTIC AND DIFFERENCES BETWEEN JOB AND PROCESS COSTING

JOB COSTING PROCESS COSTING

1. Used in industries where many different Used in industries where the products are
jobs are produced at the end of the homogeneous (i.e. more or less
production. identical/uniform).

2. Many different jobs are worked on during Products are produced in a continuous basis.
each period. Product is recognized by job or Flow of units is more or less continuous.
batch.

3. Units of product are distinguishable. Units are indistinguishable as all units

produced are identical.

4. Costs are accumulated by individual job. Costs are accumulated by departments /

processes.

5. Use job cost sheet. Use department production report.

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 Terms you need to know
3 1
Work in Progress
Direct Labour and (WIP)
Production Overhead
1. Opening Work in
is known as conversion Progress (OWIP)
cost 2. Closing Work in
Progress (CWIP)

Input and Output

1. Material Added
2. Transferred-in
3. Transferred-out
4. Finished Goods
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Scenarios of Process Costing
System

WHEN THERE IS A
WHEN THERE’S NO CLOSING WIP BUT NO
PROCESS LOSS OPENING WIP

WHEN THERE IS WHEN THERE IS

OPENING AND
PROCESS LOSS OR
CLOSING WIP / ONLY
GAIN BUT NO WIP OPENING WIP

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 SITUATION
When there is no process loss
• Units of output will be the same as
units of input
• In order to calculate the value of
output, cost per unit (CPU) will
have to be determined.
• The formula to compute CPU is:
Input cost
Expected output

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SITUATION 1: WHEN THERE IS NO PROCESS LOSS

CPU = Input cost

Expected output

PROCESS A/C
Particulars Qty CPU RM Particulars Qty CPU RM
Input: Output xx xx xxx
Material xx xx xxx
Labour xxx
OH xxx
xxx xxx

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ILLUSTRATION 1
Product M passes through two processes i.e 1 and 2. The following information
relates to the production of M. Overhead is absorbed based on 100% of labour
cost.
Prepare the accounts of Process 1 and 2.

PROCESS 1 2
RM RM
Direct cost incurred:
Material 6,000 4,000
Labour 1,000 2,000
Direct expenses 2,000 3,000
Input 500 kilos 200 kilos
Output 500 kilos 700 kilos

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SOLUTION
PROCESS 1 A/C
Particulars Qty CPU RM Particulars Qty CPU RM
Input: Output 500 20 10,000
Material 500 12 6,000
Labour 1,000
Direct expenses 2,000
OH 1,000
500 10,000 500 10,000

CPU = Input cost

Expected output
= 10,000
500
= 20

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 PROCESS 2 A/C
Particulars Qty CPU RM Particulars Qty CPU RM
Input: Output 700 30 21,000
Input from P1 500 20 10,000
Material 200 20 4,000
Labour 2,000
Direct expenses 3,000
OH 2,000
700 21,000 700 21,000

CPU = Input cost

Expected output
= 21,000
700
= 30

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 SITUATION
When there is process loss but no WIP
• In reality, there might be losses which might
reduce the quantity of output.
• The losses that are expected in the production
are known as Normal loss.
• Sometimes, the actual losses are more than
expected (Abnormal loss).
• If the actual loss is less than expected
(Abnormal Gain).
• The formula to compute CPU is:
Input cost - NL Scrap value
Expected output (Input units – NL units)

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Process Loss

NORMAL LOSS ABNORMAL LOSS

Losses happened in a But sometimes the
process of production. losses are also occurring
Wastages of material, due to negligence of
evaporation of material is labour, poor quality raw
unavoidable in some material, poor technology
process.
Process Loss
NORMAL LOSS
▪ Unavoidable loss
▪ Inherent nature of the
materials and production
process under normal
conditions
▪ Examples: Evaporation of
liquids and losses in the
process of wood cuttings
▪ The cost will be borne by the
customer, absorbed by the
completed production.
▪ These losses sometimes may
be sold as scrap, if so it will
have scrap value
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ABNORMAL LOSS
▪ Unexpected abnormal
conditions
▪ Basically avoidable & arises
from inefficiency conditions
▪ Examples: Accidents due to
carelessness and negligence,
plant breakdown, fire or theft
▪ The cost will not be charged to
customer but will be absorbed
by manufacturer.
▪ AL will be valued the same as
finished output.
▪ AL = Actual losses > Normal
losses
▪ AL = Actual output < Expected
output
Abnormal Gains
• Abnormal effective in the use of raw material or
efficiency in performance so it is known as abnormal
effective.
• Sometimes, due to efficiency in production, if the
actual loss is less than expected, there will be
abnormal gain.

Abnormal Gain = Actual Losses < Normal Losses

or
Abnormal Gain = Actual Output > Expected Output

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SITUATION 2: WHEN THERE IS PROCESS LOSS BUT NO WIP
ILLUSTRATION 2
Mayangsari Trading is a manufacturing business, which produces a single product that
passes through 3 processes. The information below relates to the month of July 2018.

PROCESS 1 PROCESS 2 PROCESS 3

5,000 units
Direct material @RM3 - -
400 hours 500 hours 450 hours
@RM7 per @RM6 per @RM7 per
Direct labour hour hour hour
Direct expenses RM5,200 RM4,500 RM1,548
Output 4,800 units 4,500 units 4,470 units

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SOLUTION
Determine whether there is any abnormal loss or gain:
Units
Input 5,000
Less: Output 4,800
Actual loss 200
NL (2% x5,000) 100
Abnormal loss 100

Process 1
Input Output
DM 5,000 Output 4,800
NL (2%) 100
AL 100
5,000 5,000

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 PROCESS 1 A/C
Particulars Qty CPU RM Particulars Qty CPU RM
DM 5,000 3 15,000 Output to P2 4,800 5.90 28,320
DL 2,800 NL 100 0.90 90
DE 5,200 AL 100 5.90 590
POH 6,000
5,000 29,000 5,000 29,000

CPU = Input cost - NL Scrap value

Expected output
= 29,000 - 90
5,000 - 100
= 5.90

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 Process 2
Input Output
From P1 4,800 Output 4,500
NL (5%) 240
AL 60
4,800 4,800

PROCESS 2 A/C
Particulars Qty CPU RM Particulars Qty CPU RM
Input from P1 4,800 5.90 28,320 Output to P2 4,500 9.50 42,750
DL 3,000 NL 240 - -
DE 4,500 AL 60 9.50 570
POH 7,500
4,800 43,320 4,800 43,320

CPU = Input cost - NL Scrap value

Expected output
= 43,320 - 0
4,800 - 240
= 9.50
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 Process 3
Input Output
From P2 4,500 Output 4,470
AG 15 NL (1%) 45

4,515 4,515

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Practices makes perfect

ILLUSTRATION 3 ILLUSTRATION 4
SITUATION 2: WHEN THERE IS PROCESS LOSS BUT NO WIP
ILLUSTRATION 3
Unicorn Sdn Bhd manufactures organic fertilizers by
means of two successive processes. Process A and
Process B. Below is the costs for September 2017

PROCESS 1 PROCESS 2
16,000 kg 15,500 kg
Materials @RM0.60/kg @RM0.50 /kg
300 hours 425 hours
@RM2 per @RM2 per
Direct wages hour hour
550 machine 520 machine
hours @ RM hours @ RM
Direct expenses 11/hr 10/hr
Normal loss 5% of input 400 kg
Output 15,000 kg 30,200 kg

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SITUATION 2: WHEN THERE IS PROCESS LOSS BUT NO WIP
ILLUSTRATION 4
A company within the food industry mixes powdered ingredients in
two different processes to manufacture one product. The output of
Process 1 is transferred to Process 2 before it is ready to be
distributed to retailers.
Details of the process costs are as follows:

PROCESS 1 PROCESS 2
Direct materials @
RM12/kg 3,800 kg -
Direct labour** 1800 hours 2,200 hours
Direct expenses RM2,614 RM1,455

Factory OH (absorbed
based on DLC) 80% 70%
Actual output 3,500 kg 3,100 kg
Expected output 90% of input 95% of input
Scrap value RM 0.50 per kg RM 0.40 per kg

**Workers are paid based on hours worked as follows:

- Up to 1,200 hours = RM 4.50 per hour
- From 1,201 to 3,000 hours = RM 4.80 per hour

Required: SNAAR2019