Process Costing [Guideline]

Process costing is related to a continuous & uninterrupted process of production of the same or similar goods, for instance, chemical production and oil refining. Hence the items is uniform, there is no need or require to determine the costs of different groups of goods and each and every processing department becomes a cost center. This post simply demonstrates simple way to understand topic of the process costing. Through a case instance presented here, you will learn how to determine it. Enjoy!

Process costing computations can be divided into the five steps:

1.Visualize the physical flow of units of production
2. To determine the equivalent units of production
3. Compute costs to allocate
4. Find out unit costs
5. Assign total costs to: (a) Ending work in process (b) Gods Completed

Note that the 5 steps above can be memorized using the acronym: PECUA (P- Physical Flow, E- Equivalent Units of Production, C- Costs to Allocate, U- Unit Costs, A-  Allocate Costs) which are described in brief.

Physical Flow of Units

The cost flow figure shown under Section B in this module is the similar for process costing other than there will typically be several WIP accounts (i.e., 1 for every department). When solving a process costing issue, it is very helpful to visualize the physical flow of units, as illustrated in the figure below.

The units in the BWIP means beginning work-in-process are either finished or become spoiled. Units started during the period but incompleted become the EWIP  means ending work-in-process.

EUP – Equivalent Units of Production

An Equivalent Units of Production is the amount of work equivalent to finishing one unit from start to end. In a process costing system, products are allocated costs regularly [generally monthly]. At any one moment few units are not complete which makes the Equivalent Units of Production calculations necessary to assign manufacturing costs between:

• product finished during the period (cost of goods manufactured)
• finishing work in process

The two primary Equivalent Units of Production methods used for process costing are FIFO i.e. [ first-in, first-out ] and WA [ weighted average ]. Under the weighted average approach, current costs are combined with prior period costs, & all units are carried at an average cost of production. Importantly, the method suppose that all units finished during a period are started and finaled during that period. As a outcome, the percentage of work done last time period on the initial work in process inventory is skip.

Process Costing Case Example

The Ascension Suppliers Company uses a weighted-average [WA] process cost system to collect costs. information relevant to 2009 production is given below. Consider we begin with 800 units 25% finish for labor and overhead (conversion costs), and 100% finish for materials because they are familiar with at the start of the process. We start 4,200 units. 4,000 units are finished, while 1,000 remain in Ending WIP (20% final for labor and overhead and 100% final for materials). No spoilage exists.

The costs are summarized in the given below T-account:

 Step 1: The physical flow of business units is accounted is given below

Step 2: The units finished and ending work in process are converted to equivalent units

Notes:

* These units are 100 percentage complete with respect to materials because materials are introduced at the start of the process.
** These units are 100 percentage complete with respect to conversion because all units completed are considered to be started and completed during the period.

Step 3 and 4: Determine costs to assign and equivalent unit costs

Notes:

* Notice the resulting costs are averages: $ 5,100 / 5,000 equivalent units = $1.02.
** $ 14,532 / 4,200 equivalent units = $ 3.46.

Step 5: Assign total costs to goods finished and ending work in process

The assign is accomplished by multiplying the individual equivalent unit figures by the unit costs.

Equivalent Unit production for Material

In the above instance, material was considered to be added at the starting of the production process. Material can also be added at different points in the process (e.g., 10 percent, 70 percent) or gradually during the process.

First-in, First-out Work in Process Assumption

With first-in, first-out, the first batch into production (i.e., the beginning work in process inventory) is considered to be the first batch finial. This batch is treated as a separate, distinct layer—separate from product that are started and finished during the period.

The weighted-average [WA] assumption (all goods are considered to be started and completed during the period) no longer holds for first-in, first-out. Thus, any work done last period on the starting work in process inventory should be taken into consideration. After all is said & done, the equivalent unit diagrams reflect the work completed during the current accounting period. Also, the only difference between the 2 methods is the treatment of the starting work in process inventory.
The equivalent-unit calculations for Ascension Suppliers Company follow:

Notes:
* All material was introduced last period.
** 75 percent of the work was necessary this period to finish the units.
*** 100 percent of the materials and conversions were introduced this period.

Spoilage (Scrap) in Process Costing

The following terms are generally used:

• Spoilage (scrap)—Inferior goods either sold or discarded for disposal value
• Defective units—Inferior goods sold and reworked as normal product

A major distinction is made between abnormal and normal spoilage:

• Normal spoilage is the funs of spoiled units caused by the nature of the manufacturing process (i.e., which occur due to the under efficient operating conditions). Normal spoilage is a important cost in the production process and is, hence, a product cost. It is a period cost (e.g., “loss on abnormal spoilage”).
• Abnormal spoilage is the cost of spoiled units which were spoiled through some not necessary act, event, or condition. It is costs must not be involved in cost of goods sold.

Spoilage must be considered in Equivalent Unit production calculations. For instance: if spoilage is discovered at the 60 percent point in processing and 100 units of abnormal spoilage are discovered, 60 Equivalent Unit production have occurred. The amount of abnormal loss would be the cost of 60 Equivalent Unit production (processing) plus the materials added to 100 units of production up to the 60 percent point. In against, if the spoilage was assumed normal in nature, the spoilage cost would be treated as a goods cost and simply added to the cost of the good units work done.