PROCESS COSTING
Process costing method is applicable where products result from continuous
flow of operations or repetitive processing and products are identical and
cannot be segregated.
Some of the industries which apply process costing include oil refining,sugar
production, manufacturers of textiles, paint, soap, cement, timber.
FEATURES OF PROCESS COSTING
1. The output consists of products which are homogeneous.
2. Production is carried on in different stages, each of which is called a process,
having a continuous flow.
3. Production takes place continuously except in cases where the plant and
machinery are shut down for maintenance etc. Output is uniform and all
units are identical during each process.
4. The input will pass through two or more processes before it takes the shape
of the output. The output of each process becomes the input for the next
process until the final product is obtained.
5. The output of a process is transferred to the next process generally at cost to
the process. It may also be transferred at market price to enable checking
efficiency of operations in comparison to the market conditions.
6. Normal losses, abnormal losses and abnormal gains may arise in the
processes
7. The output of any processing stage may also be saleable in which case the
process may generate some profit.
8. The input of any process may be acquired from the outside sources or from
a preceding processing stage.
COMPONENTS OF COSTS IN PROCESS COSTING
The following are the main elements/components of costs involved in the
manufacturing process where process costing method is adopted.
(a) Direct Materials
There are two types of materials in process costing.
i. Primary Material (or Input)
Materials which are introduced in the initial processing stage and passed on
to the next processing stage which becomes a part of output after completion
of processing.
ii. Secondary Material (or added material)
These materials which are introduced in the first or subsequent processing
stages in addition to the main material introduced in the initial processing
stage.
1
(b) Direct Labour
The direct labour cost is generally incurred at every processing stage.
Identification of direct labour cost is also relatively easy in process costing
industry.
(c) Direct Expenses
Expenses in addition to direct material and labour expenses which can be
directly attributable to a particular process. These are costs relevant to specific
processing stages.
(d) Production Overheads
The overhead expenses are generally spread over all the processes involved in
production. These are to be apportioned over the various processes.
PROCESS LOSSES
Losses occur in process costing because the output is not always equal to the
input. The main causes of such losses could be evaporation, contamination or
spillage.
1. Normal loss
This is the loss of input whose occurrence is inevitable and occurs on account
of normal reasons. It is expected or standard loss in any process. It is usually
expressed as a percentage of input.
Valuation: Normal loss is valued at its market price or the net realisable value
2. Abnormal loss
This is a loss of input whose occurrence can be avoided because it occurs on
account of abnormal reasons like low quality materials, unskilled labour or
inefficient machinery. It can be interpreted as the magnitude of actual loss
that is incurred in excess of normal loss.
Valuation: It is valued at cost or its full value which is the cost of normal
output.
3. Abnormal gain
This is the extent to which actual loss is less than the expected or normal loss.
Valuation: Abnormal gain is valued at normal cost of expected output.
FORMS OF LOSS
Losses can also be classified based on their physical appearance or form:
(a) Loss without physical presence
Loss resulting in the reduction of output due to evaporation
(b) Loss with physical presence
Loss available in a physical form either in the same form as the input or
transformed on processing. This loss can have a resale, scrap value or a
disposal cost.
2
Valuation of Output
Where there is no work in progress the calculation of cost per unit is required
for the valuation of finished units or transfers. The following formula is used:
Cost per unit = total process costs – scrap value of normal loss
expected output
Where expected output = Input - normal loss
PRACTICE QUESTION I
The manufacturing of product VH passes through three distinct processes
and the following information is available:
Process I Process II Process III
Materials (10,000 units)K’000 8,000
Direct wages (K’000) 12,000 14,750 16,000
Production overheads(K’000) 3,575 6,821.55 8,817
Normal loss (% of input) 7.5% 10% 20%
Scrap value per unit (MK) 600 1,905 2,500
Actual output 9,100 8,300 6,552
Required:
Prepare all ledger accounts to record costs for output.
WORK IN PROGRESS AND EQUIVALENT UNITS OF PRODUCTION
In order to allocate costs when inventories of partially finished goods exist, all
units,(opening work-in-process inventory and closing work-in-process
inventory), must be expressed in terms of completed units.
This is done by means of a common denominator, known as equivalent units
of production or equivalent production. Equivalent units are notional whole
units which are used to apportion costs between work in process and
completed output.
Separate equivalent production computations are usually needed for each
cost element such as direct materials, added materials and direct labour and
factory overhead, collectively known as conversion costs.
3
PRACTICE QUESTION II
Suppose the following information is available for Process DD-10088 for
Week 32.
Materials - 8,000 units - K5,005,000
Labour and overhead - K3,315,000
Finished goods - 7,500 units
Closing WIP - 500 units
Degree of completion
Materials
Finished output - 100%
WIP - 40%
Labour and overhead
Finished output - 100%
WIP - 60%
PRACTICE QUESTION III
Suppose the following information is available for Process NZ for Week 18.
Materials - 10,000 units - K5,000,000
Conversion costs - K195,000
Finished goods - 9,000 units
Closing WIP - 1,000 units
Degree of completion
Materials
Finished output - 100%
WIP - 100%
Conversion costs
Finished output - 100%
WIP - 75%
4
VALUING OPENING WORK IN PROGRESS: FIFO METHOD
PRACTICE QUESTION IV
The information relates to process I of a two-stage production process of HG
Ltd for January 2024.
Opening inventory 800 units: degree of completion 70%
Cost to date K4,900,000
Costs incurred in January 2024
MK’000
Direct materials (4,600 units introduced) 23,200
Direct labour 8,600
Production overhead 11,600
43,400
Closing inventory 900 units: degree of completion 60%
There was no loss in the process.
Required:
Prepare the process I account for January, 2024.
VALUING OPENING WORK IN PROGRESS: WEIGHTED AVERAGE
COST METHOD
PRACTICE QUESTION V
BT Ltd produces an item which is manufactured in two consecutive processes.
Information relating to process II during January 2024 is as follows.
Opening inventory 2,800 units
degree of completion MK’000
Process 1 materials 100% 34,238
Added materials 40% 2,333.75
Conversion costs 30% 4,000
40,571. 75
During January 2024, 7,000 units were transferred from process I at a
valuation of K46,710,000. Added materials cost K17,500,000 and conversion
costs were K26,281,250.
5
Closing inventory at 31 January 2024 amounted to 2,300 units which were
100% complete with respect to process I materials and 75% complete with
respect to added materials. Conversion cost work was 25% complete.
BT Ltd uses a weighted average cost system for the valuation of output and
closing inventory.
Required:
Prepare Process II Account for January 2024.
JOINT AND BY- PRODUCTS
In some production processes, particularly in agriculture and natural
resources, two or more products undergo the same process up to a split-off
point, after which one or more of the products may undergo additional
processing.
Examples:
(a) An oil company drills for oil and obtains both crude oil and natural gas.
(b) A forest is harvested and timber of various grades is milled.
(c) A dairy company processes milk into various products such as cream
and yoghurt. Some of these products then constitute raw materials in the
manufacture of other products such as butter and cheese.
The following are some important terms associated with joint and
by-products:
Joint Products: Two or more products originating from the same input or
common
process having sufficiently high saleable value.
By Product: a product which is produced incidentally alongside a main
product having
some saleable value.
Split-off point: Joint products acquire separate identities. Costs incurred
prior to this point are common costs, and any costs incurred after this point
are separable costs.
Common costs: Costs that cannot be identified with a particular joint product.
Common costs are available until products reach split-off point.
Separable costs: These costs can be identified with a particular joint product.
These costs are incurred for a specific product, after the split-off point.
6
REASONS FOR ALLOCATING COMMON COSTS
1. The production process cannot be changed and hence the quantities of joint
products obtained. Therefore the preference of one product over another is
relevant.
2. Sales price of joint products does not depend on common costs. The
decision to sell a joint product at split-off or to process it further depends only
on the incremental costs and revenues of the additional processing, not on the
common costs. Common costs can be considered as sunk at the time the
additional processing decision is made. Pricing of joint products will depend
on other factors like producers being price-takers.
3. Common costs do not inform the manager that the entire production
process is unprofitable and should be terminated. The operation should be
viewed in its entirety.
Bases for Sharing Common Costs to Joint Products
a) Physical measurement or units basis
The ratio of weight or the volume at split-off point. The challenge comes in if
a common measure cannot be used. For example, crude oil and natural gas
are by products which cannot be measured using same units.
b) Sales value at split-off:
If a market price can be established for the products that are obtained at
split-off, common costs can be allocated in proportion to the sales value of the
products at split-off.
PRACTICE QUESTION VI
Marsh Ltd produces three products K, L and M in a single process. There is a
normal loss in the process of 10% of input, and the products emerge in the
ratio of K 5: L 3: M 2.
For a typical month, the following budgeted figures are available:
Material input 100,000 kilos MK3 per kilo
Labour 5,000 hours MK8 per hour
Variable overhead 5,000 hours MK4 per hour
Fixed overhead is absorbed at 50% of labour cost.
There is no abnormal loss. The normal loss is sold for scrap at MK2 per kilo,
this being credited to the process account. There was no opening or closing
work-in-progress.
7
The products sell for: K - MK6 per kilo
L - MK5 per kilo
M - MK7.5 per kilo
REQUIREMENTS:
(a) Calculate separately the cost of each of K, L and M, using the following
methods to apportion the joint processing costs (working to the nearest MK):
(i) Relative weight of output
(ii) Sales value of output
(c) Each of K, L and M can be converted by a further process into KK, LL and
MM respectively. The selling prices would be KK - MK7 per kilo, LL - MK7
per kilo and MM - MK8.2 per kilo. The further processing would cost MK0.5
per kilo input. There would be a normal loss in the further processing of 10%
of material input, which would have no sales value. State with supporting
figures which (if any) of the products K, L and M should be converted into
KK, LL and MM.
