PROCESS COSTING CHAPTER - 1

Chapter outcomes  Meaning and nature of process costing  Application of process costing  Fundamental principles of process costing  Advantages & limitations of process costing  Limitations of cost accounting  Elements of production costs  Process losses  Practical exercises

PROCESS COSTING - Meaning Process costing is that form of operation costing which is used to ascertain the cost of the produce at each process or stage of manufacturing, where process are carried out one or more of the following features:  Production is done having a continuous flow of identical products.  Clearly defined process cost centres and the accumulation of all costs by the cost centre.  The maintenance of accurate records of the units and part units produced and cost incurred by each process.  The finished product of one process becomes the raw-material of the next process or operation and so on until the final product is obtained.  Avoidable and unavoidable losses usually arise at different stages of manufacture for various reasons.

APPLICATION OF PROCESS COSTING The industries in which process costs may be used are many. A process costing system can usually devised in all industries except where job, batch or unit operation costing is necessary. The following are examples of industries where process costing is applied: Textile companies, chemical works, soap making, food products, canning factory, paint, ink, paper mills, biscuit works, oil refining, milk diary, meat products factor and so on.

FUNDAMENTAL PRINCIPLES  Cost of materials, wages and overhead expenses are collected for each process or operation in a period of time.  Adequate records in respect of output and scrap of each process or operation during the period are kept.  The cost per finished output of each process is obtained by dividing the total cost incurred during a period by the number realised from sale of scrap.  The finished product along with its cost is transferred from one process to the next process just like raw materials of that process.

ADVANTAGES OF PROCESS COSTING  It is possible to determine process costs periodically at short intervals. Unit cost can be computed weekly or even daily if overhead rates are used on predetermined basis.  It is simple and less expensive to find out the process cost.  It is possible to have managerial control by evaluating the performance of each process.  It is easy to allocate the expenses to processes in order to have accurate costs.  It is easy to quote the prices with standardisation of process. Standard costing can be established easily in process type of manufacture.

DISADVANTAGES OF PROCESS COSTING  Costs obtained at the end of the accounting period are only of historical values and are not very useful for effective control.  Work in progress is required to be ascertained at the end of the accounting period for calculating the cost of continuous process. Valuation of work in progress is generally done on estimated basis which in total cost.  Where different products arise in the same process and a common costs are allocate to various cost units. Such individual products’ costs may be taken as only approximation and hence not reliable but may be taken as the best.  There is a wide scope of errors while calculating average costs. An error in one average cost will be carried through all processes to the valuation of work in process and finished goods.  The computation of average cost is more difficult in those cases where more than one type of products are manufactured and a division of the cost element is necessary.

ELEMENTS OF PRODUCTION COST MATERIALS – It generally in processing costing, all the material required for production is issued to the first process, where after processing it is passed to the next process and so on. Some operation on the material is performed in each process which has been passed from the first process. In other words, material is performed in each process which has been passed from the first process. In some other cases, material may pass from the first process to the second process, where extra or new materials are added, then more material is added in the next process. This may continue until the completion of the whole processes.

LABOUR – The cost of direct labour is very small part of the cost of production in industries adopting process costing. The direct labour element becomes smaller and smaller while the overhead element increases with the introduction of more and more automatic machinery. The recording and allocating of time spent on production is relatively easy as compared with job costing. PRODUCTION OVER-HEAD – The overhead element of total cost is generally very high in process costing. To more care is required to ensure that each process is charged with a reasonable share of production overhead. The actual overheads are debited to each process account.

PROCESS LOSSES In many processes, some loss is unavoidable. It is essential that accurate records are maintained to enable control of the items to be affected. The cost department must be kept well informed through the medium of scrape, material credit notes and loss reports etc. It should be pointed out to the supervisors and foremen that any loss as scrape should be measured and recorded, otherwise production costs will increase during the production. Materials which have been processed and are then found to be defective and scrapped have incurred their share of labour and variable overheads up to the point of rejection, it understood the loss to the firm increases with each stage of production. Process losses classified as follows:  Normal loss  Abnormal loss

NORMAL LOSS It is the loss which is unavoidable on account of inherent nature of production processes. Such loss can be estimated in advance on the basis of past experience or data. The normal loss is recorded only in items of quantity and the cost per unit of usable production is increased accordingly. Where scrap possesses some value as a waste product or as raw material for an earlier process, the value thereof is credited to the process account. This reduces the cost of normal output, process loss is shared by usable units.

ABNORMAL LOSS Any loss caused by unexpected or abnormal conditions such as plant break down, sub-standard materials, carelessness, accident etc. or loss in excess of the margin anticipated for normal loss should regarded as abnormal loss. The units of abnormal loss are calculated as under: Abnormal loss = Actual loss – Normal loss The calculation of abnormal loss should be done with the following formula: The value of abnormal loss = Normal cost of Normal output x Units of Abnormal loss Normal Output