PROCESS COSTING SYSTEM:Data Collection, Cost of Completed Output

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Cost & Management Accounting (MGT-402)

LESSON# 19

PROCESS COSTING SYSTEM

(An introduction)

Definition

Process costing system applies when standardised goods are produced tom a series of inter-

connected operations.

In some industries, the output produced emerges from a continuous process. An example might be

an oil refinery; Oil in a raw state is input and subjected to a process of purification. Refined oil

emerges at the end of the process.

Problems that arise in such situations include the attribution of materials costs and conversion

costs to units of finished output and the occurrence of losses during the process (spoilt or lost

production).

The characteristics and application of process costing

Continuous production

In the job order costing, costs were directly allocated to a particular job. When standardised goods

or services result from a sequence of repetitive and continuous operations, it is useful to work out

the cost of each operation. Then because every unit produced may be assumed to have involved

the same amount of work, costs for a period are charged to processes or operations, and unit costs

are ascertained by dividing process costs by the quantity of output units produced This is know n

as process costing.

Series of interconnected operations

Process costing applies when standardised goods are produced from a series of interconnected

operations. Process costing system is employed by industries possessing following characteristics:

1. There is mass production of a single product or two or more products in successive runs

of scheduled duration e.g., vegetable canning or fruit juice bottling.

2. All units of output are exactly similar and are produced by the same manufacturing

process.

3. Entire manufacturing process is divided into departments or processes, each performing a

specific set of operations.

4. Completed output of each department, except the last one, is the raw materials for the next

department.

5. Manufacturing operations may result in production of joint products or by products.

6. Production is not in response to customers' orders but in anticipation of demand.

Examples of industries using Process Costing include:

Bottling, Pharmaceuticals, Cement, Paint, Coal, Distilleries Electricity, Ice, Soap, Sugar, Canning,

Chemicals, Cooking oil, Electric appliances, Flour, Natural gas, Petroleum Products, Rubber, Steel,

Textile. Under process costing, for the purpose of cost control, each department involved in

manufacturing process is regarded as a cost centre and product costs are accumulated separately

for each department. Cost Centre means a division or segment for which an individual is made responsible

.for the incurrence of cost

Departmental costs are passed through department work in process accounts and not through a

single work in process control account as in job costing. As all units are produced from the same

raw materials and by same manufacturing operations, therefore, it is assumed that same cost is

chargeable to each unit. Instead of accumulating cost of individual units, an average unit cost is

computed by dividing total cost by total output of the period. Cost is associated only with

departments and not with jobs. It reduces clerical efforts for accumulation and analysis of cost. In

this way process costing is less expensive, as compared with job costing.

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Cost & Management Accounting (MGT-402)

The Process Cost Sheet also called Cost of Production Report is the basic document in process

costing. This document is prepared for each department and shows the quantities processed, total

and unit cost, and cost of work transferred out, and still in process. .

Following table is meant to make the difference between the two costing systems more clear.

Job order costing system

Process costing system

Where different products

Application

Where single standard

having peculiar

product is produced or

specifications are produced

two or more standard

against customers' orders

products are produced in

successive runs.

Production is for stock

and in anticipation of

demand.

In order to determine cost

Accumulation of Cost

of each job, costs are

Costs are associated only

compiled job wise. At the

same time, to evaluate

with departments

efficiency of departmental

management cost are also

compiled department wise

Unit cost is computed on

completion of job. The job

may itself be a single cost

Cost per unit

unit e.g. a machine or it may

An average unit cost is

be a multi unit

computed at the end of

costing period by dividing

total cost by units of output

Only one work in process

of the period.

control account is

maintained

A separate work in process

control

account

More clerical efforts are

Work in process a/c

maintained

for

each

needed to accumulate costs

producing department

by jobs and by departments,-

therefore, the system is more

Cost accumulation is simple

expensive

as costs are accumulated only

Cost of operating the system

by departments; therefore,

the system is comparatively

less expensive.

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Cost & Management Accounting (MGT-402)

Process costing procedures

In process costing industries standard products are produced in accordance with production

budget. Therefore, it becomes unnecessary to issue a production order. Production Planning and

Control Department communicates production targets to departmental heads by means of written

letters. Data of quantities produced by each department are collected and compared with budgeted

quantities for control purposes. These information are collected by departmental supervisors or

quality inspectors may recording these data. Each producing department is a cost centre because

for the purpose of cost control management is interested in ascertaining departmental costs.

In process costing, generally, a separate work in process account is maintained for each producing

department.

Data Collection

Collection of departmental cost figures of direct materials, direct labor and factory overhead is

based on similar procedure as for, job order costing. However, the source documents used for the

data collection are comparatively simple. These documents identify costs only with departments

and not with jobs as well.

Direct Materials:

Production people secure materials by issuing properly authorised Materials Requisitions. At the

end of each month, these requisitions are sorted and a Materials Requisition Summary indicating

cost of direct and indirect materials issued to each department is prepared. Monthly totals of

direct and indirect materials issued are debited to departmental work in process control accounts

and factory overhead control account respectively and credited to materials control account.

Direct Labor:

Instead of using Job Time Tickets, labor cost data are accumulated on Clock Cards and Daily

Time Sheets. These documents show labor time utilized by each department and classification of

labor cost as direct and indirect. At the end of each month, labor cost data accumulated on these

source documents are summarised in Labor Cost Analysis Sheet indicating direct and indirect

labor cost for each department. Monthly totals of direct labor are debited to departmental work in

process accounts and indirect labor is debited to factory overhead control account.

Factory Overhead:

Factory overhead costs, other than indirect materials and indirect labor discussed earlier, are

accumulated in Voucher Register and in General Journal by means of adjusting entries for

depreciation, expired insurance etc, Monthly total, are debited to factory overhead control

account.

Factory overhead is charged to production through predetermined departmental factory overhead

applied rates. Some industries using process costing charge actual factory overhead to

departments. This method gives satisfactory results if production is stable from month to month,

But if there are fluctuations in production volume, charge of actual factory overhead is

unsatisfactory especially when considerable portion of factory overhead is a fixed cost,

Cost of Completed Output:

Cost of completed output of each production department is calculated in Cost of Production

Report. Cost of units completed and transferred out is credited to work in process control account

of the respective department and debited to work in process control account of the department

receiving the units. Cost transferred out by the last department is, however, debited to finished

goods control account

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Cost & Management Accounting (MGT-402)

Cost of Production Report

In process costing Cost of Production Report also called Process Cost Sheet is the key

document. At the end of costing period, generally a month, a Cost of Production Report is

prepared. It summarizes the data of quantity produced and cost incurred by each producing

department. It also serves as a source document for passing accounting entries at the end of

costing period.

Cost of production report is divided into five sections. Each section is meant to provide specific

information. A brief description of these sections is presented below:

Quantity schedule.

Cost accumulated in the department/process.

Calculation of equivalent units produced.

Calculation of cost per unit.

Accounting treatment / apportionment of the accumulated cost

Quantity Schedule:

The first section Quantity Schedule contains input and output data in terms of quantities. The

information is presented in the following order.

(i)

Units in process at the beginning of costing period.

(ii)

Units started in process or received from preceding department during the period.

(Total of (i) and (ii) constitutes total units to be accounted for)

(iii)

Units completed and transferred to next department or to finished goods.

(iv)

Units completed but still in the department.

(v)

Units in process at the end of the period and their degree of completion.

(vi)

Units lost in process during the period indicating whether normal loss or abnormal loss.

The stage of completion at which the loss occurs is also specified.

(Total of (iii) , (iv) , (v) and (vi) is again the total units to be accounted for)

The quantity schedule assists management to look at a glance production performance of

departments as well as it provides necessary data for preparing remaining sections of the report.

Cost accumulated in the department/process.

The second section Cost Accumulated to Departments shows total cost for which the

departments are accountable. Total costs include cost of beginning work in process inventory,

cost transferred in from the preceding department and cost of direct materials, direct labor and

factory overhead added by the department. If there is normal loss of units, unit cost received

from preceding department requires adjustment. This adjustment for lost units is also shown in

this section. This section provides data for debiting work in process control accounts of the

departments.

Calculation of equivalent units produced.

In order to arrive at cost per unit of output, total of each cost element is divided by the number of

units produced, For this purpose, where at the end of costing period, there are some partially

completed units in process, these units must be stated in terms of equivalent completed units, For

example, if 4,000 units. are in process at the end of month estimated as 50% complete, these will

be equivalent to 2,000 completed units. These equivalent units are added to units completed by

the department to arrive at equivalent production. Then total cost is divided by this equivalent

production figure to calculate unit cost.

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Cost & Management Accounting (MGT-402)

Calculation of cost per unit

In process costing, costs are averaged over the units produced. The costs accumulated to a process

for a period are collected and divided by the number of units equally produced during the period.

Accounting treatment / apportionment of the accumulated cost

The last section presents a summary to the explaining the accounting treatments of the costs

incurred in the department. This includes

(i)

Adjustment for lost units for normal loss, if any.

(ii)

Cost transferred out.

(iii)

Cost of abnormal loss, if any.

(iv)

Cost of work in process ending inventory and

(v)

Any other accounting adjustment, if necessary to present.

Cost of production report is generally presented to management with supplementary reports of

usage of materials, labor and factory overhead.

Standard format of a simple

Cost of Production Report

I- Quantity Schedule:

Units put into the process

***

Units completed in this process & transferred

to next department.

***

Units not yet completed at the end of the

Period.

***

***

II- Cost Accumulated In The Department / Process:

Direct Material Cost

***

Direct Labor

***

Factory Overhead (Applied)

***

***

III- Calculation of Equivalent Units Produced

100% of completed units + % completed of the in process units

IV- Calculation Of Per Unit Cost

Total Cost

Equivalent Units Produced

V-

Accounting Treatment

1- Finished goods

2- Closing Work in process

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Cost & Management Accounting (MGT-402)

Problem Questions

Q. 1

Heera Manufacturing Company manufactures a product. Production made and manufacturing

costs incurred in the first department during the month of October .are given below:

10,000 units were started in process out of which 9,400 units were transferred to next department

and remaining 600 units were 1/2 complete as to materials, labor and overhead. Direct materials

Rs. 19,400, direct labor Rs. 24,250 and factory overhead Rs. 14,550 was charged to production.

Required: Cost of production report for the month.

Q. 2

Production and cost data of first production department of Excellent Manufacturing Company for

the month of March 2006 are as follow:

Units started in process were 5,000. Units completed and transferred to second department were

4,500. Remaining units were in process estimated to be 50%, 40%, 60% completed as to materials,

labor and factory overhead respectively. Costs of materials, labor and overhead were Rs. 50,000,

Rs. 60,000 and Rs. 40,000 respectively.

Required: Cost of production report.

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