CHAPTER TWO: PROCESS COSTING
A process costing system is used in those industries where masses of similar products or services
are produced. Products are produced in the same manner and consume the same amount of direct
costs and overheads. It is therefore unnecessary to assign costs to individual units of output.
Instead the average cost per unit of output is calculated by dividing the total costs assigned to a
product or service for a period by the number of units of output for that period.
Industries where process costing is widely used include chemical processing, oil refining, food
processing and brewing. In contrast, job costing relates to a costing system where each unit or
batch of output is unique. This creates the need for the cost of each unit to be calculated
separately.
The objective of this chapter is to examine the cost accumulation procedure that is required for
inventory valuation and profit measurement for a process costing system.
Flow of production and costs in a process costing system
The flow of production and costs in a process costing system is as illustrated below:
Process costing
Work in progress stock
Process A Process C
Process B Finished
Input Output goods stock
Input Output Input Output
- Finished goods consists of stock of like units valued at average unit cost of production
- No attempt is made to allocate costs to individual units of production. Direct costs and
factory overhead costs are allocated to process A, Process B, and so on. When units are
completed, they are transferred to finished goods stock at average unit cost
Job costing
Work in progress stock
Job A Job B Job C
Finished goods stock
1
, -Finished goods consists of stock of unlike units
-Direct costs and factory overheads are allocated to individual units of production
In the case of process costing, control accounts are established for each process (or department)
and direct and indirect costs are assigned to each process.
Process costing when all output is fully complete
Throughout this section it is assumed that all output within each process is fully complete. We
shall examine the following situations:
1. No losses with no scrap value
2. Normal losses with no scrap value
3. Abnormal losses with no scrap value
4. Normal losses with a scrap value
5. Abnormal losses with a scrap value
6. Abnormal gains with no scrap value
7. Abnormal gains with a scrap value
The information shown in the following example will be used to illustrate the accounting entries.
To simplify the presentation it is assumed that the product is produced within a single process.
ABC Ltd produces a liquid fertilizer within a single production process. During the month of
May the input into the process was 12 000 litres at a cost of Ksh 120 000. There were no
opening or closing inventories and all output was fully complete. We shall prepare the process
account and calculate the cost per litre of output for thr single process for each of the following
seven cases:
Case Input Output Normal loss Abnormal Abnormal Scrap value of spoilt
(litres) (litres) (litres) loss (litres) gain (litres) output (Ksh per litre)
1 12 000 12 000 0 0 0 0
2 12 000 10 000 2 000 (1/6) 0 0 0
3 12 000 9 000 2000 (1/6) 1000 0 0
4 12 000 10 000 2 000 (1/6) 0 0 5
5 12 000 9 000 2000 (1/6) 1000 0 5
6 12 000 11 000 2 000 (1/6) 0 1000 0
7 12 000 11 000 2000 (1/6) 0 1000 5
2
, No losses within the process
To calculate the cost per unit (i.e. litre) of output for case 1 we merely divide the total cost
incurred for the period of Ksh 120 000 by the output for the period ( 12 000 litres). The cost per
unit of output is Ksh 0. In practice the cost per unit is analyzed by the different cost categories
such as direct materials and conversion cost which consists of the sum of direct labour and
overhead costs.
Normal losses in process with no scrap value
Certain losses are inherent in the production and cannot be eliminated. For example, liquid must
evaporate, part of the cloth required to make a suit may be lost and losses occur in cutting wood
to make furniture. These are referred to as normal or uncontrollable losses. Where normal
losses apply the cost per unit of output is calculated by dividing the costs incurred for a period by
the expected output from the actual input for that period. In our example, the normal loss is one
sixth of the input. Therefore for an input of 12 000 litres the expected ouput is 10 000 litres so
that the cost per unit of output is Ksh 12 (Ksh 12 000/10 000 litres). Actual output is equal to the
expected output so there is neither an abnormal loss nor gain. Compared with case 1 the unit
cost has increased by Ksh 2 per unit because the cost of the normal loss has been absorbed by the
good production. Our objective is to calculate the cost of normal production under normal
efficient operating conditions.
Abnormal losses in process with no scrap value
In addition to losses that cannot be avoided, there are some losses that are not expected to occur
under efficient operating conditions, for example improper mixing of ingredients, the use of
inferior materials and the incorrect cutting of cloth. These losses are not an inherent part of the
production process, and are referred to as abnormal or uncontrollable losses. Because they are
not an inherent part of the production process and arise from inefficiencies they are not included
in the process costs. Instead, they are removed from the appropriate process account and reported
separately as an abnormal loss. The abnormal loss is treated as a period cost and written off in
the profit statement at the end of the accounting period. This ensures that abnormal losses are not
incorporated in any inventory valuations.
3
A process costing system is used in those industries where masses of similar products or services
are produced. Products are produced in the same manner and consume the same amount of direct
costs and overheads. It is therefore unnecessary to assign costs to individual units of output.
Instead the average cost per unit of output is calculated by dividing the total costs assigned to a
product or service for a period by the number of units of output for that period.
Industries where process costing is widely used include chemical processing, oil refining, food
processing and brewing. In contrast, job costing relates to a costing system where each unit or
batch of output is unique. This creates the need for the cost of each unit to be calculated
separately.
The objective of this chapter is to examine the cost accumulation procedure that is required for
inventory valuation and profit measurement for a process costing system.
Flow of production and costs in a process costing system
The flow of production and costs in a process costing system is as illustrated below:
Process costing
Work in progress stock
Process A Process C
Process B Finished
Input Output goods stock
Input Output Input Output
- Finished goods consists of stock of like units valued at average unit cost of production
- No attempt is made to allocate costs to individual units of production. Direct costs and
factory overhead costs are allocated to process A, Process B, and so on. When units are
completed, they are transferred to finished goods stock at average unit cost
Job costing
Work in progress stock
Job A Job B Job C
Finished goods stock
1
, -Finished goods consists of stock of unlike units
-Direct costs and factory overheads are allocated to individual units of production
In the case of process costing, control accounts are established for each process (or department)
and direct and indirect costs are assigned to each process.
Process costing when all output is fully complete
Throughout this section it is assumed that all output within each process is fully complete. We
shall examine the following situations:
1. No losses with no scrap value
2. Normal losses with no scrap value
3. Abnormal losses with no scrap value
4. Normal losses with a scrap value
5. Abnormal losses with a scrap value
6. Abnormal gains with no scrap value
7. Abnormal gains with a scrap value
The information shown in the following example will be used to illustrate the accounting entries.
To simplify the presentation it is assumed that the product is produced within a single process.
ABC Ltd produces a liquid fertilizer within a single production process. During the month of
May the input into the process was 12 000 litres at a cost of Ksh 120 000. There were no
opening or closing inventories and all output was fully complete. We shall prepare the process
account and calculate the cost per litre of output for thr single process for each of the following
seven cases:
Case Input Output Normal loss Abnormal Abnormal Scrap value of spoilt
(litres) (litres) (litres) loss (litres) gain (litres) output (Ksh per litre)
1 12 000 12 000 0 0 0 0
2 12 000 10 000 2 000 (1/6) 0 0 0
3 12 000 9 000 2000 (1/6) 1000 0 0
4 12 000 10 000 2 000 (1/6) 0 0 5
5 12 000 9 000 2000 (1/6) 1000 0 5
6 12 000 11 000 2 000 (1/6) 0 1000 0
7 12 000 11 000 2000 (1/6) 0 1000 5
2
, No losses within the process
To calculate the cost per unit (i.e. litre) of output for case 1 we merely divide the total cost
incurred for the period of Ksh 120 000 by the output for the period ( 12 000 litres). The cost per
unit of output is Ksh 0. In practice the cost per unit is analyzed by the different cost categories
such as direct materials and conversion cost which consists of the sum of direct labour and
overhead costs.
Normal losses in process with no scrap value
Certain losses are inherent in the production and cannot be eliminated. For example, liquid must
evaporate, part of the cloth required to make a suit may be lost and losses occur in cutting wood
to make furniture. These are referred to as normal or uncontrollable losses. Where normal
losses apply the cost per unit of output is calculated by dividing the costs incurred for a period by
the expected output from the actual input for that period. In our example, the normal loss is one
sixth of the input. Therefore for an input of 12 000 litres the expected ouput is 10 000 litres so
that the cost per unit of output is Ksh 12 (Ksh 12 000/10 000 litres). Actual output is equal to the
expected output so there is neither an abnormal loss nor gain. Compared with case 1 the unit
cost has increased by Ksh 2 per unit because the cost of the normal loss has been absorbed by the
good production. Our objective is to calculate the cost of normal production under normal
efficient operating conditions.
Abnormal losses in process with no scrap value
In addition to losses that cannot be avoided, there are some losses that are not expected to occur
under efficient operating conditions, for example improper mixing of ingredients, the use of
inferior materials and the incorrect cutting of cloth. These losses are not an inherent part of the
production process, and are referred to as abnormal or uncontrollable losses. Because they are
not an inherent part of the production process and arise from inefficiencies they are not included
in the process costs. Instead, they are removed from the appropriate process account and reported
separately as an abnormal loss. The abnormal loss is treated as a period cost and written off in
the profit statement at the end of the accounting period. This ensures that abnormal losses are not
incorporated in any inventory valuations.
3
