UNIT 4

PROCESS COSTING

4.1 LEARNING OBJECTIVES

After studying this chapter you should able to understand

• The meaning of Process Costing and its importance
• The distinction between job costing and process costing
• The accounting procedure of process costing including normal loss abnormal loss

(or) gain

• The valuation of work-in-progress, using FIFO, LIFO average and weighted average

Methods

• The steps involved in inter process transfer

4.2 INTRODUCTION:

Process costing is a form of operations costing which is used where standardized homogeneous goods are produced. This costing method is used in industries like chemicals, textiles, steel, rubber, sugar, shoes, petrol etc. Process costing is also used in the assembly type of industries also. It is assumed in process costing that the average cost presents the cost per unit. Cost of production during a particular period is divided by the number of units produced during that period to arrive at the cost per unit.

4.3 MEANING OF PROCESS COSTING

Process costing is a method of costing under which all costs are accumulated for each stage of production or process, and the cost per unit of product is ascertained at each stage of production by dividing the cost of each process by the normal output of that process.

Definition:

CIMA London defines process costing as “that form of operation costing which applies where standardized goods are produced”

Features of Process Costing:

(a)   The production is continuous

(b)  The product is homogeneous

(c)   The process is standardized

(d)  Output of one process become raw material of another process

(e)  The output of the last process is transferred to finished stock

(f)    Costs are collected process-wise

(g)  Both direct and indirect costs are accumulated in each process

(h)  If the revise stock of semi-finished goods, it is expressed in terms of equal units

(i)    The total cost of each process is divided by the normal output of that process to find out cost per unit of that process.

Advantages of process costing:

1. Costs are be computed periodically at the end of a particular period
2. It is simple and involves less clerical work that job costing
3. It is easy to allocate the expenses to processes in order to have accurate costs.
4. Use of standard costing systems in very effective in process costing situations.
5. Process costing helps in preparation of tender, quotations etc.
6. Since cost data is available for each process, operation and department, good

Managerial control is possible.

Limitations:

1. Cost obtained at each process is only historical cost and are not very useful for effective

Control.

2.      Process costing is based on average cost method, which is not that suitable for performance analysis, evaluation and managerial control.

3.      Work-in-progress is generally done on estimated basis which leads to inaccuracy in total

Cost calculations.

4.      The computation of average cost is more difficult in those cases where more than one

Type of products is manufactured and a division of the cost element is necessary.

5.      Where different products arise in the same process and common costs are prorated to

Various costs units. Such individual products costs may be taken as only approximation and hence not reliable.

4.4 DISTINCTION BETWEEN JOB COSTING AND PROCESS COSTING

Job order costing and process costing are two different systems. Both the systems are used for cost calculation and attachment of cost to each unit completed, but both the systems are suitable in different situations. The basic difference between job costing and process costing are:

4.5 COSTING PROCEDURE

For each process an individual process account is prepared.

Each process of production is treated as a distinct cost center.

Items on the Debit side of Process A/c:

Each process account is debited with –

a)      Cost of materials used in that process.

b)     Cost of labor incurred in that process.

c)      Direct expenses incurred in that process.

d)     Overheads charged to that process on some pre-determined.

e)     Cost of ratification of normal defectives.

f)       Cost of abnormal gain (if any arises in that process)

Items on the Credit side of Process A/c.:

Each process account is credited with

a)      Scrap value of Normal Loss (if any) occurs in that process.

b)     Cost of Abnormal Loss (if any occurs in that process)

Cost of Process:

The cost of the output of the process (Total Cost less Sales value of scrap) is transferred to the next process. The cost of each process is thus made up to cost brought forward from the previous process and net cost of material, labor and overhead added in that process after reducing the sales value of scrap. The net cost of the finished process is transferred to the finished goods account. The net cost is divided by the number of units produced to determine the average cost per unit in that process. Specimen of Process Account when there is normal loss and abnormal loss.

Dr. Process I A/c.           Cr.

Process Losses:

In many process, some loss is inevitable. Certain production techniques are of such a nature that some loss is inherent to the production. Wastages of material, evaporation of material is unavoidable in some process. But sometimes the Losses are also occurring due to negligence of Laborer, poor quality raw material, poor technology etc. These are normally called as avoidable losses. Basically process losses are classified into two categories

(a) Normal Loss (b) Abnormal Loss

1. Normal Loss:

Normal loss is an unavoidable loss which occurs due to the inherent nature of the materials and production process under normal conditions. It is normally estimated on the basis of past experience of the industry. It may be in the form of normal wastage, normal scrap, normal spoilage, and normal defectiveness. It may occur at any time of the process.

No of units of normal loss: Input x Expected percentage of Normal Loss.

The cost of normal loss is a process. If the normal loss units can be sold as a crap then the sale value is credited with process account. If some rectification is required before the sale of the normal loss, then debit that cost in the process account. After adjusting the normal loss the cost per unit is calculated with the help of the following formula:

Cost of Good units = Total Cost – Scrap value of Normal goods / Input – Normal Loss

2.      Abnormal Loss:

Any loss caused by unexpected abnormal conditions such as plant breakdown, substandard material, carelessness, accident etc. such losses are in excess of pre-determined normal losses. This loss is basically avoidable. Thus abnormal losses arrive when actual losses are more than expected losses. The units of abnormal losses in calculated asunder:

Abnormal Losses = Actual Loss – Normal Loss

The value of abnormal loss is done with the help of following formula:

Value of Abnormal Loss:

Total Cost increase – Scrap Value of normal Loss x Units of abnormal loss

Input units – Normal Loss Units

Abnormal Process loss should not be allowed to affect the cost of production as it is caused by abnormal or unexpected conditions. Such loss representing the cost of materials, labour and overhead charges called abnormal loss account. The sales value of the abnormal loss is credited to Abnormal Loss Account and the balance is written off to costing P & L A/c.

Dr. Abnormal Loss A/c.         Cr.

3.      Abnormal Gains:

The margin allowed for normal loss is an estimate (i.e. on the basis of expectation in process industries in normal conditions) and slight differences are bound to occur between the actual output of a process and that anticipates. This difference may be positive or negative. If it is negative it is called ad abnormal Loss and if it is positive it is Abnormal gain i.e. if the actual loss is less than the normal loss then it is called as abnormal gain. The value of the abnormal gain calculated in the similar manner of abnormal loss. The formula used for abnormal gains:

Abnormal Gain

Total Cost incurred – Scrap Value of Normal Loss x Abnormal Gain Unites

Input units – Normal Loss Units

The sales values of abnormal gain units are transferred to Normal Loss Account since it arrive out of the savings of Normal Loss. The difference is transferred to Costing P & L A/c. As a Real Gain.

Dr. Abnormal Gain A/c.      Cr.

4.6 INTER PROCESS PROFITS:

Normally the output of one process is transferred to another process at cost but sometimes at a price showing a profit to the transfer process. The transfer price may be made at a price corresponding to current wholesale market price or at cost plus an agreed percentage. The advantage of the method is to find out whether the particular Process is making profit (or) loss. This will help the management whether to process the product or to buy the product from the market. If the transfer price is higher than the cost price then the process account will show a profit. The complexity brought into the accounting arises from the fact that the inter process profits introduced remain a part of the prices of process stocks, finished stocks and work-in-progress. The balance cannot show the stock with profit. To avoid the complication a provision must be created to reduce the stock at actual cost prices. This problem arises only in respect of stock on hand at the end of the period because goods sold must have realized the internal profits. The unrealized profit in the closing stock is eliminated by creating a stock reserve. The amount of stock reserve is calculated by the following formula.

Stock Reserve = Transfer Value of stock x Profit included in transfer price

Transfer Price

4.7 VALUATION OF WORK-IN-PROGRESS

Meaning of Work-in-Progress:

Since production is a continuous activity, there may be some incomplete production at the end of an accounting period. Incomplete units mean those units on which percentage of completion with regular to all elements of cost (i.e. material, labour and overhead) is not 100%. Such incomplete production units are known as Work-in-Progress. Such Work-in-Progress is valued in terms of equivalent or effective production units.

Meaning of equivalent production units:

This represents the production of a process in terms of complete units. In other words, it means converting the incomplete production into its equivalent of complete units. The term equivalent unit means a notional quantity of completed units substituted for an actual quantity of incomplete physical units in progress, when the aggregate work content of the incomplete units is deemed to be equivalent to that of the substituted quantity. The principle applies when operation costs are apportioned between work in progress and completed units.

Equivalent units of work in progress = Actual no. Of units in progress x Percentage of work completed

Equivalent unit should be calculated separately for each element of cost (viz. Material, labour and overheads) because the percentage of completion of the different cost component may be different.

Accounting Procedure:

The following procedure is followed when there is Work-in-Progress

1. Find out equivalent production after taking into account of the process losses, degree of completion of opening and / or closing stock.
2. Find out net process cost according to elements of costs i.e. material, labour and overheads.
3. Ascertain cost per unit of equivalent production of each element of cost separately by dividing each element of costs by respective equivalent production units.
4. Evaluate the cost of output finished and transferred work in progress

The total cost per unit of equivalent units will be equal to the total cost divided by effective units and cost of work-in- progress will be equal to the equivalent units of work-in- progress multiply by the cost per unit of effective production. In short the following from steps an involved.

Step1 – Prepare statement of Equivalent production

Step2 – Prepare statement of cost per Equivalent unit

Step3 – Prepare of Evaluation

Step4 – Prepare process account.

The problem on equivalent production may be divided into four groups.

1. When there is only closing work-in-progress but without process losses
2. When there is only closing work-in-progress but with process losses
3. When there is only opening as well as closing work-in- progress without process losses
4. When there is opening as well as closing work-in- progress with process losses.

Situation I: Only closing work-in-progress without process losses:

In this case, the existence of process loss is ignored. Closing work-in-progress is converted into equivalent units on the basis of estimates on degree of completion of materials, labour and production overhead. Afterwards, the cost per equivalent unit is calculated and the same is used to value the finished output transferred and the closing work-in-progress.

Situation II: When there is closing work-in-progress with process loss or gain.

If there are process losses the treatment is same as already discussed in this chapter. In case of normal loss nothing should be added to equivalent production. If abnormal loss is there, it should be considered as good units completed during the period. If units scrapped (normal loss) have any reliable value, the amount should be deducted from the cost of materials in the cost statement before dividing by equivalent production units. Abnormal gain will be deducted to obtain equivalent production.

Situation III: Opening and closing work-in-progress without process losses.

Since the production is a continuous activity there is possibility of opening as well as closing work-in-progress. The procedure of conversion of opening work-in-progress will vary depending on the method of apportionment of cost followed via, FIFO, Average cost Method and LIFO.

Let us discuss the methods of valuation of work-in-progress one by one.

(a)               FIFO Method: The FIFO method of costing is based on the assumption of that the opening work-in-progress units are the first to be completed. Equivalent production of opening work-in-progress can be calculated as follows:

Equivalent Production = Units of Opening WIP x Percentage of work needed to finish the units

(b)               Average Cost Method: This method is useful when price fluctuate from period to period. The closing valuation of work-in-progress in the old period is added to the cost of new period and an average rate obtained. In calculating the equivalent production opening units will not be shown separately as units of work-in-progress but included in the units completed and transferred.

(c)               Weighted Average Cost Method: In this method no distinction is made between completed units from opening inventory and completed units from new production. All units finished during the current accounting period are treated as if they were started and finished during that period. The weighted average cost per unit is determined by dividing the total cost (opening work-in-progress cost + current cost) by equivalent production.

(d)               LIFO Method: In LIFO method the assumption is that the units entering into the process is the last one first to be completed. The cost of opening work-in-progress is charged to the closing work-in-progress and thus the closing work-in- progress appears cost of opening work-in-progress. The completed units are at their current cost.

(1)   Format of statement of Equivalent Production:

(2)   Statement of cost per Equivalent Units:

(3)   Statement of Evaluation

4.8 SOLVED EXAMPLES

Q.1. (Normal / Abnormal Loss)

Prepare a Process Account, Abnormal Loss Account and Normal Loss Account from the following information.

Solution:

Dr. Process – I A/c.                 Cr.

Dr. Abnormal Loss A/c.       Cr.

Dr. Normal Loss A/c.       Cr.

Working Notes:

Cost Per Unit of Process 1:

= Total Cost increased – Sales value of Scrap

Input units – Normal Loss Units

= 36200–400 = Rs 37.68 per unit

1000 – 50

Note: It has been assumed that units of abnormal loss have also been sold at the same rate i.e. of Normal Scrap.

Q.2. (Normal / Abnormal Loss and Abnormal Gain)

The product of a company passes through 3 distinct process. The following information is obtained from the accounts for the month ending January 31, 2008.

3000 units @ Rs. 3 each were introduced to process – I. There was no stock of materials or work in progress. The output of each process passes directly to the next process and finally to finished stock A/c.

The following additional data is obtained:

Prepare Process Cost Account, Normal Cost Account and Abnormal Gain or Loss Account.

Solution:

Dr. Process – A A/c.       Cr.

Cost Per Unit of Process A:

= Total Cost – Sales value of Scrap

Input units – Normal Loss Units

= 28800–300 = Rs 10 per unit

3000– 150

Dr. Process –B A/c.       Cr.

Cost Per Unit of Process B:

= Total Cost – Sales value of Scrap

Input units – Normal Loss Units

= 52400–1140 = Rs 20 per unit

3000– 285

Dr. Process – C A/c.       Cr.

Cost Per Unit of Process C:

= Total Cost – Sales value of Scrap

Input units – Normal Loss Units

= 87390–1890 = Rs 38 per unit

2520– 378

Dr. Abnormal Gain A/c.       Cr.

Dr.     Normal Loss A/c.       Cr.

Q.3. A product passes through three processes before its completion. The output of each process s charged to the next process at a price calculated to give a profit of 20% on transfer price. The output of Process III is transferred to finished stock account on a similar basis. There was no work-in-progress at the beginning of the years. Stock in each process has been valued at prime cost of the process. The following data is available at the end of 31st March, 2009.

From above information prepare:

1. Process Cost Account showing the profit at each stage
2. Actual realized profit and
3. Stock Valuation as would appear in the balance sheet

Solution:

Dr. Process –I A/c.                          Cr.

Dr. Process –II A/c.      Cr.

Dr.     Process III A/c        Cr.

Dr.     Finished Stock A/c        Cr.

Calculation of profit on closing stock

Profit included in stock = Profit included in transfer price x Value of stock

Transfer price

Process I = No profit

Process II = 10000 x 20000 = 2000

100000

Process III   = 28000 x 30000= 5600

150000

Finished stock = 52400x15000 = 5240

150000

Q.4. A product process through three process A, B and C. The details of expenses incurred on the three processes during the year 2008 were as under:

Management expenses during the year were Rs. 80000 and selling were Rs. 5000. There are not allocable to the processes. Actual output of the three process were A – 9300 units, B – 5400 units and C 2100 units. Two-thirds of the output of process A and one half of the output of process B was passed on to the next process A and one-half of the output of process B was passed on to the next process and the balance was sold. The entire output of process C was sold.

The normal losses of the three process, calculated on the input of every process was: Process A – 5%, B – 15% and C – 20%. The loss of process A was sold @ Rs. 3 per unit, that of B @ Rs. 5 per unit and of process C @ Rs. 10 per unit.

Prepare process A, B and C account and the Profit and Loss Account.

Solution:

Dr. Process A A/c.   Cr.

Dr.  Process B A/c.   Cr.

Dr. Process C A/c.  Cr.

Dr. Profit &Loss A/c. Cr.

Dr.                                          Abnormal Loss A/c.   Cr.

Dr.                                       Abnormal Gain A/c   Cr.

Q.5. Mahesh Ltd process a material which passes through three processes. Figures relating to production for the first 6 months of 2009 are as follows.

Management expenses were Rs. 10,500 selling expenses Rs. 8,000 and interest on borrowed capital Rs. 2,000. Two third of process I and one half of process 2 are passed on to the next process and the balance are sold.

Prepare Process Account, Process Stock Account and Costing Profit & Loss A/c.

Solution

Dr.   Process No.1 A/c.    Cr.

Dr. Process No. 1 Stock A/c. Cr.

Dr. Process No.2 A/c.   Cr.

Dr. Process No. 2 Stock A/c.   Cr.

Dr. Process No.3 A/c.   Cr.

Dr. Process No. 3 Stock A/c.   Cr.

Dr. Costing Profit &Loss A/c.   Cr.

Q.6

Prepare a statement of equivalent production, statement of cost, process account from the following information using average costing method.

During the period 1,50,000 units were completed and transferred to Process II.

Closing stock 1,00,000 units. Degree of completion.

Solution:

Statement of Equivalent Production

Statement of Cost:

Statement of Apportionment of Cost

Dr. ProcessIA/c. Cr.

Q.7. From the following information relating to KKN Company Ltd, prepare Process Cost Account for Process III for the year 2008.

Opening Stock in Process III 5000 units of Rs.36,000

Transfer from Process II 2,13,000 units of Rs.8,27,000

Direct Material added in Process III Rs. 4,01,800

Direct Wages Rs.1,98,100

Production Overhead Rs.99,050

Units Scrap 11,000 units

Transferred to Process IV 1,89,000 units

Closing Stock 18,000 units

There was a normal loss of 5% production and unit scraped were sold at Rs. 1.50

Solution:

Note  : Units Produced: Opening stock + units introduced – closing stock

: 5000 +213000 – 18000 = 200000

Normal Loss : 5 % of 200000 = 10000 units

Statement of Cost

Statement of Apportionment of Cost

Dr.                                             Process III A/c.     Cr.

Q.8. GH & Co. Manufactures a product. The process costing is followed and work-in-progress stocks at the end of each month are valued at FIFO basis.

At the beginning of the month of June, the inventory of work- in-progress showed 400 units, 40% complete, valued as follows: