Process Costing

 

Process costing is a method of allocating manufacturing cost to products to determine an average cost per unit.  It is used by companies which mass produce identical or similar products.  Since every unit is essentially the same, each unit receives the same manufacturing input as every other unit.  Refineries, paper mills, and food processing companies are examples of businesses which use process costing. 

 

Similarities between job order and process costing include:

          Both systems have the same basic purpose—to calculate unit cost

          Both systems use the same manufacturing accounts

          The flow of costs through the manufacturing accounts is basically the

Same

 

However, there are some important differences between job order and processing costing as described below.

Job Order Costing

Process Costing

Each job is different

All products are identical

Costs are accumulated by job

Costs are accumulated by department

Costs are captured on a job cost sheet

Costs are accumulated on a department production report

Unit costs are computed by job

Unit costs are computed by department

  

Study the production flow and the cost flows of companies which use process costing in Exhibits 4-2, 4-3, and 4-4.  Note that as units are partially completed in one department they proceed onto another department for further processing.  This will require a journal entry such as:

          Work in Process – Department B

                   Work in Process – Department A

 

When the products are completed they are transferred from the final processing department to Finished Goods.  Study the model journal entries on Pages 149-150.

 

A complication arising in process costing is that not all units may be completed at the balance sheet date.  To calculate unit costs, it will be necessary to compute equivalent units of production.  Equivalent units can be defined as the product of the number of partially completed units times the percentage completion of these units.  If there are 300 of partially completed units at year-end which are 40% complete, then there are 120 equivalent units.  If say 5000 units were completed during the period, the managerial accountant would add 5000 and 120 to arrive at 5120 equivalent units completed during the period.  Then total department costs for the period (direct material, direct labor, and overhead) would be divided by the 5120 equivalent units to arrive at cost per unit.  Equivalent units can be computed in two different ways, the weighted average method and the FIFO method.  We only cover the weighted average method in this course and therefore skip Appendix 4A.

 

Companies using process costing prepare departmental production reports.  Exhibit 4-9, Page 158, is a production report for Double Diamond Skis' Shaping and Milling Department.  Note that the production report consists of three parts as follows:

    1.  A quantity schedule which shows the flow of units through the department and a
        computation of equivalent units

   2.  A computation of costs per equivalent unit

   3.  A reconciliation of all cost flows into and out of the department

 

Also note in Exhibit 4-9 that the equivalent unit totals are different for material costs and for conversion costs.  This frequently happens as all material is input at the start of the production process but the direct labor and overhead costs are incurred sometime later.