Process Costing in Manufacturing: Definition, Types, and Example

The chemical industry uses process costing to calculate the cost of producing chemicals. This industry produces chemicals in large quantities with a consistent manufacturing process, making process costing a suitable technique. Using a process costing system provides better cost control, allowing manufacturers to identify the cost of each process in producing a product.

What is Accounting Equation? Example, Procedure of Forming

• Process costing is a system best suited to mass production environments where the products are similar and require similar manufacturing processes.
• Hybrid process costing combines elements of both single and multiple process costing.
• Process Costing, also called job-order costing, assigns total manufacturing costs to the units being produced.
• However, it does not precisely identify which a lot of raw material is taken for production and its procurement rate.
• Accountants will calculate the total overhead cost of each month and separate them to each finished product at the month-end.
• Manufacturers can use the information provided by process costing to make informed decisions about expanding their production capacity, introducing new products, or investing in new technology.
• The finished material of one process constitutes the raw material of the next.

Process cost allows an organisation to assigns the cost to different steps in the production phase. The organisation can use this method to identify the relevant costs (i.e., direct and indirect costs) for each process, and no abnormal expenses are charged to any process. Process costing is a method of cost accounting used to calculate the cost of producing a product or service in a manufacturing environment where products are made in large quantities and indistinguishable. It is commonly used in chemical manufacturing, oil refining, and food processing industries. A process cost system (process costing) accumulates costs incurred to produce a product according to the processes or departments it goes through on its way to completion.

The process costing method is in contrast to other costing methods, such as product costing, job costing, or operation costing systems. If the output products are homogeneous, that is, the units of output are relatively indistinguishable from one another, it may be beneficial to use process costing. If the output products are of low value, meaning each individual unit of output is not worth much, it may be beneficial to use process costing. And if it is difficult or infeasible to trace production costs directly to individual units of output, it may be beneficial to use the process costing method. Each process or department collects its own costs incurred during production.

• This costing method is used in industries like chemicals, textiles, steel, rubber, sugar, shoes, petrol, etc.
• To the extent of loss of income, the abnormal gain is transferred to a normal loss account, and the balance of abnormal gain is transferred to the costing profit and loss account.
• These costs include expenses such as utilities, maintenance, depreciation of machinery, and factory rent.
• The good units produced bear the cost of the units representing normal loss.
• Process costing is particularly useful in industries where a large volume of identical or similar products are produced, as it provides an efficient way of calculating the cost of each unit.

Steps of Process Costing

Manufacturers can use the data generated by the system to evaluate the profitability of different products and decide which products to produce and which to discontinue. They can use this information to identify areas where the manufacturing process can be improved, leading to higher efficiency and productivity. Process costing is the only reasonable approach to determining product costs in many industries. It uses most of the same journal entries found in a job costing environment, so there is no need to restructure the chart of accounts to any significant degree. This makes it easy to switch over to a job costing system from a process costing one if the need arises, or to adopt a hybrid approach that uses portions of both systems. While it has advantages, such as providing accurate cost information and helping to determine the selling price of a product, it also has disadvantages, such as complexity and the need for accurate cost data.

Effective communication is critical to the success of process costing implementation. Companies must ensure all stakeholders understand the process and the importance of accurate cost calculations. This can be challenging, especially if the company has a large workforce or multiple locations. Companies must develop an effective method for allocating overhead costs to the appropriate cost centers to accurately calculate the production cost. This can make it difficult to get a complete picture of the business’s cost structure. This article will explore the definition and types of process costing, its importance in manufacturing, and its advantages and disadvantages.

Disadvantages of using a process costing system in manufacturing:

Costing is an important process that many companies engage in to keep track of where their money is being spent in the production and distribution processes. It is very important that a company chooses the appropriate type of costing system for their product type and industry. One type of costing system that is used in certain industries is process costing that varies from other types of costing (such as job costing) in some ways. In process costing unit costs are more like averages, the process-costing system requires less bookkeeping than does a job-order costing system. The cost flows are tracked using a cost of production report, which tracks the costs incurred in each process and the number of units produced. The prices are then accumulated and allocated to the units produced based on a predetermined allocation method.

Job-order costing focuses on a specific product or service produced for a given customer. Process costs represent a higher level of accuracy than job-order costing, but they are also more complex and time consuming to develop. A process costing system accumulates the costs of a production process and assigns them to the products that the business outputs.

Textile Industry

Manufacturing companies use a cost accounting technique to track and allocate the costs of producing a product or service. In simple words, process costing is a cost accounting technique, in which the costs incurred during production are charged to processes and averaged over the total units manufactured. For this purpose, process accounts are opened in the books of accounts, for each process and all the expenses relating to the process for the period is charged to the respective process account. Process Costing is the cost accounting method in which production overhead is equally allocated to each product due to their similarity and mass production.

Process Costing refers to a method of accumulating cost of production by process. It represents a method of cost procedure applicable to continuous or mass production industries producing standard products. Costs are compiled for each process or department by preparing a separate account for each process. Process costing is suitable for some businesses, which produces similar products, such as a footwear manufacturing. Besides that, It is also applicable to manufacturing that has many processes which cannot identify the cost of each production process. Mobile applications can be used to track production costs on the go, allowing supervisors and managers to monitor production costs from anywhere.

The first in first out (FIFO) method of costing is used to introduce the subject of materials costing. The FIFO method of costing issued materials follows the principle that materials used should carry the actual experienced cost of the specific units used. Learn about process costing, its components, procedure, types, benefits, and challenges in manufacturing operations for efficient process costing definition cost management.

Under this method, weighted average is computed and used in valuation of the incomplete units. Costs follow the production process, i.e., costs incurred in one process are transferred to the next process along with the output. In March 202X, this department has incurred a cost of direct labor USD 50,000, overhead cost USD 30,000. As a result, they have completed 8,000 pairs of shoes and pass the next stage. First, they start from the Designing and Cutting department where shoes are designed to fit with the trending market, and fabric will be cut to fit with each design. In March 200X, the Design and Cutting department incur the cost of direct material USD 100,000, direct labor cost of USD 150,000 and USD 80,000 of overhead cost.