Process Costing

                                                               

Meaning

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

Definition-

i) According to ICMA, London Process Costing is “that form of operation costing which applies where standardized goods are produced”

ii) Kohler defines Process Costing as “a method of costing whereby costs are charged to processes or operations and averaged over units produced”.

Applicability –

It is suitable for

1. Cotton, wool jute textile mill

2. Sugar Industry

3. Food processing Industry

4. Cement industry

5. Chemical plants

6. Mining industries such as coal and oil 

Features of Process Costing

1.      Each plant is divided into a number of process cost centers or departments.

2.      Output of one process becomes the input of the next process.

3.      It is not possible to distinguish finished products while they are in the stage of processing.

4.      Cost incurred in the earlier process are transferred to the later process along with the output

5.      Each process is treated as a separate cost center.

6.      Under process costing method every process is treated as a cost unit.

7.      Total cost of the finished product in the last process is cumulative i.e.  It comprises of costs of all processes.

8.      The cost of normal loss is included in the cost of the total units produced.

9.      Due to continuous nature of production, work in progress is a regular feature of process costing 

10.  Production of one article may give rise to two or more by-products or joint products.

11.  The finished products are homogeneous in all respect such as shape, size, color, weight etc

 

Process Loss

Process Losses and wastages are usually of two types viz. Normal Process Loss and Abnormal Process Loss.

The term process loss may be defined as “the difference between the input quantity of raw material and the output quantity.

ICMA defines ‘waste and scrap from the recovery point of view as follows-

Waste: “Discarded substances having no value”.

Scrap:  Discarded material having some recovery value which is usually disposed of without further treatment or re-introduced into the production process in the place of raw material”

Normal Loss:

Normal loss is the loss which is expected under normal conditions

Because of nature of the raw material, some loss is inherent and unavoidable. This is known as normal wastage or normal loss.

 Features-

1. Normal loss is unavoidable.

2. Normal loss arises under efficient operating conditions.

3. Normal loss consists of losses that are inherent in the production process.

4. It is caused by the factors such as evaporation, chemical change, and withdrawals for test or testing, unavoidable spoilage, due to the nature of raw material    

5. Normal loss can be estimated in advance

6. Normal loss is recorded in terms of quantity.

7. Normal loss is generally calculated at a certain percentage of the input of units introduced in the respective process.

8. The normal loss cost is borne by the good units produced.

Accounting treatment of normal loss

The units of normal loss are recorded on the credit side of a process account in the quantity column only. The value of the normal loss, if any, should be included in the amount column on the credit side of the process account as a realizable value. This reduces the cost of normal output.

Example 1 (Normal loss without scrap value)

The cost of production of 40 units consisting of material Rs 1500; labor Rs 1300 and overhead Rs 164 the normal waste is 5% of input.  Show process Account

Process Account

	Units	Amount		Units	Amount
To material To Labour  To overhead	40     40	1500 1300 164 2964	By normal loss By Final product @ Rs 78	2   38 40	-   2964 2964

 

Per Unit Rate = 2964 

                         (40-2)

= Rs 78

 

Example 2 (Normal loss with scrap value)

Material (200 units)          Rs 4000

Labour                               Rs 3000

Indirect Expenses              Rs 2000

Normal wastage is 5% of the input. One unit of wastage is sold at Rs 16.50. Prepare Process Account.

Process Account

	units	Amount		Units	Amount
To material To labor To indirect expenses	200         200	4000 3000 2000     9000	By normal loss By Next process Rs 46.50	10   190     200	165   8835     9000

 

When the normal wastage has a scrap value, good unit rate is calculated as follows

Rs 9000-165=8835

8835/190=46.50

Abnormal Loss

 Any loss exceeding the normal loss is called abnormal loss. Where the loss is caused by unexpected or abnormal conditions and if it is beyond the limit, it is called an abnormal loss. eg use of defective material, carelessness, fire, machine breakdown, power failure, strike, accidents, natural calamities like floods, fire, cyclone, etc.

Features   

1. Abnormal loss is avoidable.

2. It can be controlled by management action.

3. The difference between normal output and actual output is termed abnormal loss

4. Abnormal loss is valued just like good units and transferred to separate an account called abnormal loss   

Accounting Treatment of Abnormal Loss

The amount of abnormal loss is credited to a process account. A separate Abnormal Loss Account is opened and scraps value, if any, is credited to Abnormal Loss Account and balance on it transferred to costing profit loss Account.

Value of Abnormal Loss is calculated as follows –

Step 1. Cost per unit =    Normal cost of Normal Output                                                                                                                

Normal Output     

 

Step 2.        Value of Abnormal Loss = Cost P U × unit of Abnormal loss

 

·         Normal Output = Input – Normal Loss

·         Normal Cost   = Total Process Cost – scrap value of Normal loss if any    

 

Normal Loss and abnormal loss with no scrap value

Prepare Process Account from the following

Material issued 1000 kg @ Rs 125

Wages       Rs 28000

Overheads Rs 8000

Normal loss 5% of input

Output 900 kg          

Process Account

	Units	Amount		Units	Amount
To material To wages To overheads	1000 (input)       1000	1,25,000 28,000 8000     1,61,000	By normal loss(5% of Input ) By Abnormal loss By Next Process c.p.u = 169.47	50   50 900   1000	----   8474 1,52,526   1,61,000

 

 

Note – Normal output = 1000 kg -50 kg = 950 kg

Actual Output = 900 units

Unit of Normal Loss = 5% of 1000 =50 kg

Unit of abnormal loss = normal output – actual output

                                                950kg -900 kg

                                                = 50 kg

Normal cost of Normal output = 1, 61,000-nil = 1, 61,000

Cost per unit = 161000/950= 169.47

Value of abnormal loss= unit of abnormal loss × cost per unit

Amount of Good units = actual output × cost per unit

                                                900× 169.47= 1, 52,526