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CHAPTER:1INTRODUCTION
Process costing is a form of operations costing which is used where standardized homogeneous
goods are produced. This costing method is used in industries like chemicals, textiles, steel,
rubber, sugar, shoes, petrol etc. Process costing is also used in the assembly type of industries
also. It is assumed in process costing that the average cost presents the cost per unit. Cost of
production during a particular period is divided by the number of units produced during that
period to arrive at the cost per unit.
Meaning:
Process costing is a method of costing under which all costs are accumulated for each stage of
production or process, and the cost per unit of product is ascertained at each stage of production
by dividing the cost of each process by the normal output of that process.
Process costing is an accounting methodology that traces and accumulates direct costs, and
allocates indirect costs of a manufacturing process. Costs are assigned to products, usually in a
large batch, which might include an entire month's production. Eventually, costs have to be
allocated to individual units of product. It assigns average costs to each unit, and is the opposite
extreme of Job costing which attempts to measure individual costs of production of each unit.
Process costing is usually a significant chapter.
Process costing is a type of operation costing which is used to ascertain the cost of a product at
each process or stage of manufacture. CIMA defines process costing as "The costing method
applicable where goods or services result from a sequence of continuous or repetitive operations
or processes. Costs are averaged over the units produced during the period". Process costing is
suitable for industries producing homogeneous products and where production is a continuous
flow. A process can be referred to as the sub-unit of an organization specifically defined for cost
collection purpose.
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Definition:
CIMA London defines process costing as “that form of operation costing which applies where
standardize goods are produced”
Features of Process Costing:
(a) The production is continuous
(b) The product is homogeneous
(c) The process is standardized
(d) Output of one process become raw material of another process
(e) The output of the last process is transferred to finished stock
(f) Costs are collected process-wise
(g) Both direct and indirect costs are accumulated in each process
(h) If there is a stock of semi-finished goods, it is expressed in terms of equalent units
(i) The total cost of each process is divided by the normal output of that process to find out cost
per unit of that process.
The importance of process costing:
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. Understanding these costs is
the first step in being able to control them. 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. So, a lot
of companies prefer to use process-costing system.
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When process costing is applied?
Process costing is appropriate for companies that produce a continuous mass of like units
through series of operations or process. Also, when one order does not affect the production
process and a standardization of the process and product exists. However, if there are significant
differences among the costs of various products, a process costing system would not provide
adequate product-cost information. Costing is generally used in such industries such as
petroleum, coal mining, chemicals, textiles, paper, plastic, glass, and food.
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CHAPTER:2
ADVANTAGE & DISADVANTAGES OF PROCESS COSTING
Advantages of process costing:
The primary advantage of process costing is the ease and simplicity of accounting. Process
Costing is a simple and direct method of cost ascertainment that collects the overall costs from
each department and ignores costs related to specific jobs within a department. This reduces the
volume of data, and makes data collection easy and quick. The analysis is likewise simple and
straightforward, and does not require any specialized skills other than normal accounting skills.
Process costing:
Allows budgeting of uniform output and usage costs as standard costs, making it possible to
track deviations from such standard costs with ease. It becomes possible to track the inefficiency
or discrepancy to a specific process or department without checking each department or process.
Facilitates easy and accurate tracking of inventory.
Process costing makes it easy to obtain and predict the average cost of a product, allowing
accurate estimates to customers.
Compared to other costing methods, such as activity based costing, process costing is
inexpensive and does not drain the organization's time and resources.
1. Costs are be computed periodically at the end of a particular period
2. It is simple and involves less clerical work that job costing
3. It is easy to allocate the expenses to processes in order to have accurate costs.
4. Use of standard costing systems in very effective in process costing situations.
5. Process costing helps in preparation of tender, quotations
6. Since cost data is available for each process, operation and department, good managerial
control is possible.
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Disadvantages of Process Costing:
Process costing is ideally suited for homogeneous products, and fails to provide an accurate
estimate of product costs when a single process produces many items or different versions of a
same item. It also remains suitable only for bulk process works and not for customized orders.
Apportionment of joint costs to diverse products may lead to irrational pricing decisions in such
cases.
While process costing enables budgeting standard costs, the costs obtained are historic and not
current, and their use for managerial decision-making remains limited.
Process costing makes it easy to offer estimates or quotations, it deviates from the standard
product, or allowing options for any value-added service. Process costing also helps to fix
standard costs of production, the accumulation of all costs and transferring them to units as
average costs raise the possibility of concealment of inefficiencies in process. Process costing
makes evaluation of the efficiency of individual processes or productivity of an individual
worker difficult.
This review of the advantages and disadvantages of process costing indicates that process costing
is a useful management accounting tool for large companies such as Coca Cola that mass
produce homogeneous products.
1. Cost obtained at each process is only historical cost and are not very useful for effective
control.
2. Process costing is based on average cost method, which is not that suitable for
performance analysis, evaluation and managerial control.
3. Work-in-progress is generally done on estimated basis which leads to inaccuracy in total
cost calculations.
4. The computation of average cost is more difficult in those cases where more than one
type of products is manufactured and a division of the cost element is necessary.
5. Where different products arise in the same process and common costs are prorated to
various costs units. Such individual products costs may be taken as only approximation
and hence not reliable.
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CHAPTER:3
OBJECTIVES
After studying this chapter you should able to understand
• the meaning of Process Costing and its importance
• the distinction between job costing and process costing
• the accounting procedure of process costing including normal loss abnormal loss (or)
gain
• the valuation of work-in-progress, using FIFO, LIFO average and weighted average
methods
• the steps involved in inter process transfer
Reasons for use
Companies need to allocate total product costs to units of product for the following reasons:
A company may manufacture thousands or millions of units of product in a given period of time.
Products are manufactured in large quantities, but products may be sold in small quantities,
sometimes one at a time (automobiles, loaves of bread), a dozen or two at a time (eggs, cookies),
etc.
Product costs must be transferred from Finished Goods to Cost of Goods Sold as sales are made.
This requires a correct and accurate accounting of product costs per unit, to have a proper
matching of product costs against related sales revenue.
Managers need to maintain cost control over the manufacturing process. Process costing
provides managers with feedback that can be used to compare similar product costs from one
month to the next, keeping costs in line with projected manufacturing budgets.
A fraction-of-a-cent cost change can represent a large dollar change in overall profitability, when
selling millions of units of product a month. Managers must carefully watch per unit costs on a
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daily basis through the production process, while at the same time dealing with materials and
output in huge quantities.
Materials part way through a process (e.g. chemicals) might need to be given a value, process
costing allows for this. By determining what cost the part processed material has incurred such as
labor or overhead an "equivalent unit" relative to the value of a finished process can be
calculated.
Process cost procedures
There are four basic steps in accounting for Process cost:
Summarize the flow of physical units of output.
Compute output in terms of equivalent units.
Summarize total costs to account for and Compute equivalent unit costs.
Assign total costs to units completed and to units in ending work in process inventory.
Operation cost in batch manufacturing
Batch costing is a modification of job costing. When production is repetitive nature and consists
of a definite number of articles, batch is used. In batch costing, the most important problem is to
determine the optimum size of the batch that follows the fact that production of two elements of
costs:
Set up costs which are generally fixed per batch.
Carrying costs which vadetermination of batch quantity requires considerations of some factors:
setting up costs per batch.
cost of manufacturing such as (direct materials cost + direct wages + direct overhead) per piece.
cost of storage.
rate of interest on the capital invested in product and rate of demand for product.
Process Costing Overview
Process costing is used in situations where job costing cannot be used; that is, for the mass
production of similar products, where the costs associated with individual units of output cannot
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be differentiated from each other. In other words, the cost of each product produced is assumed
to be the same as the cost of every other product.
Examples of the industries where this type of production occurs include oil refining, food
production, and chemical processing. For example, how would you determine the precise cost
required to create one gallon of aviation fuel, when thousands of gallons of the same fuel are
gushing out of a refinery every hour? The cost accounting methodology used for this scenario is
process costing.
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.
Cost Flow in Process Costing
The typical manner in which costs flow in process costing is that direct material costs are added
at the beginning of the process, while all other costs (both direct labor and overhead) are
gradually added over the course of the production process. For example, in a food processing
operation, the direct material (such as a cow) is added at the beginning of the operation, and then
various rendering operations gradually convert the direct material into finished products (such as
steaks).
Conversion Costs:
Conversion costs are those costs required to convert raw materials into finished goods that are
ready for sale.
Since conversion activities involve labor and manufacturing overhead, the calculation of
conversion costs is:
Conversion costs = Direct labor + Manufacturing overhead
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Thus, conversion costs are all manufacturing costs except for the cost of raw materials.
Examples of costs that may be considered conversion costs are:
Direct labor and related benefits
Equipment depreciation
Equipment maintenance
Factory rent
Factory supplies
Machining
Inspection
Production utilities
Production supervision
Small tools charged to expense
If a business incurs unusual conversion costs for a specific production run (such as reworking
parts due to incorrect tolerances on the first pass), it may make sense to exclude these extra costs
from the conversion cost calculation, on the grounds that the cost is not representative of day-to-
day cost levels.
Absorption Costing:
Absorption costing, which is also known as full absorption costing or full costing, is a method
for accumulating fixed and variable costs associated with the production process and
apportioning them to individual products.
Thus, a product must absorb a broad range of costs. The key costs assigned to products are:
Direct materials. Those materials that are included in a finished product.
Direct labor. The factory labor costs required to construct a product.
Fixed manufacturing overhead. The costs to operate a manufacturing facility, which vary with
production volume. Examples are supplies and electricity for production equipment.
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Variable manufacturing overhead. The costs to operate a manufacturing facility, which do not
vary with production volume. Examples are rent and insurance.
Because many costs are absorbed into inventory, they are not recognized as expenses in the
month when an entity pays for them. Instead, they remain in inventory as an asset until such time
as the inventory is sold; at that point, they are charged to cost of goods sold.
Generally Accepted Accounting Principles require that an entity use absorption costing to record
the value of inventory in its financial statements. Direct costing does not require the allocation of
overhead to a product, and so may be more useful than absorption costing for incremental pricing
decisions.
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CHAPTER:4
TYPES OF PROCESS COSTING
There are three types of process costing, which are:
Weighted average costs. This version assumes that all costs, whether from a preceding period
or the current one, are lumped together and assigned to produced units. It is the simplest version
to calculate.
Standard costs. This version is based on standard costs. Its calculation is similar to weighted
average costing, but standard costs are assigned to production units, rather than actual costs; after
total costs are accumulated based on standard costs, these totals are compared to actual
accumulated costs, and the difference is charged to a variance account.
First-in first-out costing (FIFO). FIFO is a more complex calculation that creates layers of
costs, one for any units of production that were started in the previous production period but not
completed, and another layer for any production that is started in the current period.
There is no last in, first out (LIFO) costing method used in process costing, since the underlying
assumption of process costing is that the first unit produced is, in fact, the first unit used, which
is the FIFO concept.
Why have three different cost calculation methods for process costing, and why use one version
instead of another? The different calculations are required for different cost accounting needs.
The weighted average method is used in situations where there is no standard costing system, or
where the fluctuations in costs from period to period are so slight that the management team has
no need for the slight improvement in costing accuracy that can be obtained with the FIFO
costing method. Alternatively, process costing that is based on standard costs is required for
costing systems that use standard costs. It is also useful in situations where companies
manufacture such a broad mix of products that they have difficulty accurately assigning actual
costs to each type of product; under the other process costing methodologies, which both use
actual costs, there is a strong chance that costs for different products will become mixed
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together. Finally, FIFO costing is used when there are ongoing and significant changes in
product costs from period to period – to such an extent that the management team needs to know
the new costing levels so that it can re-price products appropriately, determine if there are
internal costing problems requiring resolution, or perhaps to change manager performance-based
compensation. In general, the simplest costing approach is the weighted average method, with
FIFO costing being the most difficult.
How to calculate cost per unit:
The cost per unit is derived from the variable costs and fixed costs incurred by a production
process, divided by the number of units produced.
Variable costs, such as direct materials, vary roughly in proportion to the number of units
produced, though this cost should decline somewhat as unit volumes increase, due to greater
purchasing discounts. Fixed costs, such as building rent, should remain unchanged no matter
how many units are produced, though they can increase as the result of additional capacity being
needed (known as a step cost, where the cost suddenly steps up to a higher level once a specific
unit volume is reached). Within these restrictions, then, the cost per unit calculation is:
(Total fixed costs + Total variable costs) / Total units produced
The cost per unit should decline as the number of units produced increases, primarily because the
total fixed costs will be spread over a larger number of units (subject to the step costing issue
noted above). Thus, the cost per unit is not constant.
For example, ABC Company has total variable costs of $50,000 and total fixed costs of $30,000
in May, which it incurred while producing 10,000 widgets. The cost per unit is:
($30,000 Fixed costs + $50,000 variable costs) / 10,000 units = $8 cost per unit
In the following month, ABC produces 5,000 units at a variable cost of $25,000 and the same
fixed cost of $30,000. The cost per unit is:
($30,000 Fixed costs + $25,000 variable costs) / 5,000 units = $11/unit
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Fixed Cost:
A fixed cost is a cost that does not vary in the short term, irrespective of changes in production or
sales levels.
Examples of fixed costs are:
Amortization
Depreciation
Insurance
Interest expense
Property taxes
Rent
Over the long term, few (if any) costs are truly fixed. For example, a thirty-year lease can be
eliminated after the thirtieth year, so the expense is actually variable if viewed over a 31-year
time period.
Companies with a high proportion of fixed costs have a high breakeven point, above which they
earn outsized profits. Companies with a low proportion of fixed costs have a low breakeven
point, above which they earn more modest profits.
Companies with high fixed costs have a greater incentive to engage in price wars to gain some
additional incremental revenue, because they can recognize the bulk of these additional revenues
as profit.
Variable Cost:
A variable cost is a cost that varies in relation to either production volume or services provided.
If there is no production or no services are provided, then there should be no variable costs.To
calculate total variable costs, the formula is:
Total quantity of units produced x Variable cost per unit = Total variable cost
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Direct materials are considered a variable cost. Direct labor may not be a variable cost if labor is
not added to or subtracted from the production process as production volumes change. Most
types of overhead are not considered a variable cost.
The sum total of all manufacturing overhead costs and variable costs is the total cost of products
manufactured or services provided.
If a company has a large proportion of variable costs in its cost structure, then most of its
expenses will vary in direct proportion to revenues, so it can weather a business downturn better
than a company that has a high proportion of fixed costs.
An example of a variable cost is the resin used to create plastic products. The resin is the key
component of a plastic product, and so varies in direct proportion to the number of units
manufactured.
Overhead:
Overhead is those costs required to run a business, but which cannot be directly attributed to any
specific business activity, product, or service.
Thus, overhead costs do not directly lead to the generation of profits. Overhead is still necessary,
since it provides critical support for the generation of profit-making activities. For example, a
high-end clothier must pay a substantial amount for rent (a type of overhead) in order to be
located in an adequate facility for the sale of clothes. The clothier must pay overhead to create
the proper sale environment for its customers.
Fixed Overhead:
Fixed overhead is a set of costs that do not vary as a result of changes in activity. These costs are
needed in order to operate a business. One should always be aware of the total amount of fixed
overhead costs that a business has, so that management can plan to generate a sufficient amount
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of contribution margin from the sale of products and services to at least offset the amount of
fixed overhead.
Since fixed overhead costs do not change substantially, they are easy to predict, and so should
rarely vary from the budgeted amount. These costs also rarely vary from period to period, unless
a change is caused by a contractual modification that alters the cost. For example, building rent
remains the same until a scheduled rent increase alters it.
Examples of fixed overhead costs that can be found throughout a business are:
Rent
Insurance
Office expenses
Administrative salaries
Depreciation
Examples of fixed overhead costs that are specific to a production area (and which are usually
allocated to produced goods) are:
Factory rent
Utilities
Production supervisory salaries
Normal scrap
Materials management compensation
Depreciation on production equipment
Insurance on production equipment, facilities, and inventory
Fixed overhead is allocated to products using the following steps:
Assign all expenses incurred in the period that are related to factory fixed overhead to a cost
pool.
Derive a basis of allocation for applying the overhead to products, such as the number of direct
labor hours incurred per product, or the number of machine hours used.
Divide the total in the cost pool by the total units of the basis of allocation used in the period. For
example, if the fixed overhead cost pool was $100,000 and 1,000 hours of machine time were
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used in the period, then the fixed overhead to apply to a product for each hour of machine time
used is $100.
Apply the overhead in the cost pool to products at the standard allocation rate. Ideally, this
means that some of the allocated overhead is charged to the cost of goods sold (for goods
produced and sold within the period) and some is recorded in the inventory (asset) account (for
goods produced and not sold within the period).
Fixed overhead can change if the activity level changes substantially outside of its normal range.
For example, if a company needs to add onto its existing production facility in order to meet a
large increase in demand, this will result in a higher rent expense, which is normally considered
part of fixed overhead. Thus, fixed overhead costs do not vary within a company's normal
operating range, but can change outside of that range.
If fixed overhead is allocated to a cost object (such as a product), the allocated amount is
considered to be fixed overhead absorbed.
The other type of overhead is variable overhead, which varies in proportion to changes in
activity. The amount of fixed overhead is usually substantially greater than the amount of
variable overhead.
Variable Overhead:
Variable overhead is those manufacturing costs that vary roughly in relation to changes in
production output.
Thus, variable overhead remains approximately constant on a per-unit basis. Examples of
variable overhead are:
Production supplies
Equipment utilities
Materials handling wages
For example, Kelvin Corporation produces 10,000 digital thermometers per month, and its total
variable overhead is $20,000, or $2.00 per unit. Kelvin ramps up its production to 15,000
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thermometers per month, and its variable overhead correspondingly rises to $30,000, resulting in
the variable overhead remaining at $2.00 per unit.
Variable overhead tends to be small in relation to the amount of fixed overhead. Since it varies
with production volume, an argument exists that variable overhead should be treated as a direct
cost and included in the bill of materials for products.
Variable overhead is analyzed with two variances, which are:
Variable overhead efficiency variance. This is the difference between the actual and budgeted
hours worked, which are then applied to the standard variable overhead rate per hour.
Variable overhead spending variance. This is the difference between the actual spending and the
budgeted rate of spending on variable overhead.
Manufacturing Overhead:Manufacturing overhead is all of the costs that a factory incurs, other than direct materials and
direct labor.
Examples of costs that are included in the manufacturing overhead category are:
Depreciation on equipment used in the production process
Rent on the factory building
Salaries of maintenance personnel
Salaries of manufacturing managers
Salaries of the materials management staff
Salaries of the quality control staff
Supplies not directly associated with products (such as manufacturing forms)
Utilities for the factory
Wages of building janitorial staff
Since direct materials and direct labor are considered to be the only costs that directly apply to a
unit of production, manufacturing overhead is (by default) all of the indirect costs of the factory.
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When you create financial statements, both generally accepted accounting principles and
international financial reporting standards require that you assign manufacturing overhead to the
cost of products, both for reporting their cost of goods sold (as reported on the income
statement), and their cost within the inventory asset account (as reported on the balance sheet).
The method of cost allocation is up to the individual company - common allocation methods are
based on the labor content of a product or the square footage used by production equipment.
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CHAPTER:5DISTINCTION BETWEEN JOB COSTING AND PROCESS
COSTING
Job order costing and process costing are two different systems. Both the systems are used for
cost calculation and attachment of cost to each unit completed, but both the systems are suitable
in different situations. The basic difference between job costing and process costing are
Sr. no. Basis ofDistinction
Job order costing Process costing
1. Specific order Performed againstspecific orders
Production isContentious
2. Nature Each job many bedifferent.
Product ishomogeneous andstandardized.
3. Cost determination Cost is determined foreach job separately.
Costs are complied foreach process fordepartment on timebasis i.e. for a givenaccounting period.
4. Cost calculations Cost is complied whena job is completed.
Cost is calculated atthe end of the costperiod.
5. Control Proper control iscomparatively difficultas each product unit isdifferent and theproduction is notcontinuous.
Proper control iscomparatively easieras the production isstandardized and ismore suitable.
6. Transfer There is usually nottransfer from one jobto another unlessthere is some surpluswork.
The output of oneprocess is transferredto another process asinput.
7. Work-in-Progress There may or may notbe work-in-progress.
There is always somework-in-progressbecause of continuousproduction.
8. Suitability Suitable to industries where production is intermittent and customer orders can be identified in the value of production.
Suitable, where goodsare made for stock andproductions iscontinuous.
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CHAPTER:6
COSTING PROCEDURE
For each process an individual process account is prepared. Each process of production is
treated as a distinct cost centre.
Items on the Debit side of Process A/c.
Each process account is debited with –
a) Cost of materials used in that process.
b) Cost of labour incurred in that process.
c) Direct expenses incurred in that process.
d) Overheads charged to that process on some pre determined.
e) Cost of ratification of normal defectives.
f) Cost of abnormal gain (if any arises in that process)
Items on the Credit side:
Each process account is credited with
a) Scrap value of Normal Loss (if any) occurs in that process.
b) Cost of Abnormal Loss (if any occurs in that process)
Cost of Process:
The cost of the output of the process (Total Cost less Sales value of scrap) is transferred to the
next process. The cost of each process is thus made up to cost brought forward from the previous
process and net cost of material, labour and overhead added in that process after reducing the
sales value of scrap. The net cost of the finished process is transferred to the finished goods
account. The net cost is divided by the number of units produced to determine the average cost
per unit in that process. Specimen of Process Account when there are normal loss and abnormal
losses.
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Dr. Process I A/c. Cr.
Particulars Units Rs. Particulars Unit
s
Rs.
To Basic Material xx xx By Normal Loss xx Xx
To Direct Material Xx By Abnormal Loss xx Xx
To Direct Wages xx By Process II A/c. xx Xx
To Direct Expenses xx (outputtransferred to Next
process)
ToProduction Overheads
xx
ToCost of Rectification ofNormal Defects
xx By Process I Stock A/c. xx Xx
To Abnormal Gains xx
xx xxx xx Xx
Process Losses:
In many process, some loss is inevitable. Certain production techniques are of such a nature that
some loss is inherent to the production. Wastages of material, evaporation of material is un
avoidable in some process. But sometimes the Losses are also occurring due to negligence of
Labourer, poor quality raw material, poor technology etc. These are normally called as avoidable
losses. Basically process losses are classified into two categories
(a) Normal Loss (b) Abnormal Loss
1. Normal Loss:
Normal loss is an unavoidable loss which occurs due to the inherent nature of the materials and
production process under normal conditions. It is normally estimated on the basis of past
experience of the industry. It may be in the form of normal wastage, normal scrap, normal
spoilage, and normal defectiveness. It may occur at any time of the process.
No of units of normal loss: Input x Expected percentage of Normal Loss.
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The cost of normal loss is a process. If the normal loss units can be sold as a crap then the sale
value is credited with process account. If some rectification is required before the sale of the
normal loss, then debit that cost in the process account. After adjusting the normal loss the cost
per unit is calculates with the help of the following formula:
Cost of good unit : Totalcost increased−SaleValue of Scrap
Input−Normal Loss units
2. Abnormal Loss:
Any loss caused by unexpected abnormal conditions such as plant breakdown, substandard
material, carelessness, accident etc. such losses are in excess of pre-determined normal losses.
This loss is basically avoidable. Thus abnormal losses arrive when actual losses are more than
expected losses. The units of abnormal losses in calculated as under:
Abnormal Losses = Actual Loss – Normal Loss
The value of abnormal loss is done with the help of following formula:
Value of Abnormal Loss:
TotalCost increase−ScrapValue of normal LossInput units−Normal LossUnits
×Units of abnormal loss
Abnormal Process loss should not be allowed to affect the cost of production as it is caused by
abnormal (or) unexpected conditions. Such loss representing the cost of materials, labour and
overhead charges called abnormal loss account. The sales value of the abnormal loss is credited
to Abnormal Loss Account and the balance is written off to costing P & L A/c.
Dr. Abnormal Loss A/c. Cr.
Particulars Units Rs. Particulars Units Rs.
To Process A/c. xx xx By Bank xx Xx
By Costing P & LA/c.
xx Xx
xx xxx xx Xx
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Abnormal Gains:
The margin allowed for normal loss is an estimate (i.e. on the basis of expectation in process
industries in normal conditions) and slight differences are bound to occur between the actual
output of a process and that anticipates. This difference may be positive or negative. If it is
negative it is called ad abnormal Loss and if it is positive it is Abnormal gain i.e. if the actual
loss is less than the normal loss then it is called as abnormal gain. The value of the abnormal gain
calculated in the similar manner of abnormal loss.
The formula used for abnormal gain is:
Abnormal Gain
TotalCost incurred−Scrap Value of Normal LossInput units−Normal LossUnits
× AbnormalGainUnites
The sales values of abnormal gain units are transferred to Normal Loss Account since it arrive
out of the savings of Normal Loss. The difference is transferred to Costing P & L A/c. as a Real
Gain.
Dr. Abnormal Gain A/c. Cr.
Particulars Units Rs. Particulars Units Rs.
To Normal Loss A/c. XX XX By Process A/c. XX XX
To Costing P & L A/c. XX XX
XX XX XX XX
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CHAPTER:7
INTER PROCESS PROFITS:
Normally the output of one process is transferred to another process at cost but sometimes at a
price showing a profit to the transfer process. The transfer price may be made at a price
corresponding to current wholesale market price or at cost plus an agreed percentage. The
advantage of the method is to find out whether the particular process is making profit (or) loss.
This will help the management whether to process the product or to buy the product from the
market. If the transfer price is higher than the cost price then the process account will show a
profit. The complexity brought into the accounting arises from the fact that the inter process
profits introduced remain a part of the prices of process stocks, finished stocks and work-in-
progress. The balance cannot show the stock with profit. To avoid the complication a provision
must be created to reduce the stock at actual cost prices. This problem arises only in respect of
stock on hand at the end of the period because goods sold must have realized the internal profits.
The unrealized profit in the closing stock is eliminated by creating a stock reserve. The amount
of stock reserve is calculated by the following formula.
Stock Reserve: The unrealised profit in closing stock is estimated by creating a stock reserve in
respect of the stock lying in a process / stores. The amount of stock reserve is calculated by the
following formula:
Stock Reserve = Profit included∈transfer price
Transfer Price ×Transfer Value of Stock
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CHAPTER:8
VALUATION OF WORK-IN-PROGRESS
Meaning of Work-in-Progress:
Since production is a continuous activity, there may be some incomplete production at the end of
an accounting period. Incomplete units mean those units on which percentage of completion with
regular to all elements of cost (i.e. material, labour and overhead) is not 100%. Such incomplete
production units are known as Work-in-Progress. Such Work-in-Progress is valued in terms of
equivalent or effective production units.
Meaning of equivalent production units :
This represents the production of a process in terms of complete units. In other words, it means
converting the incomplete production into its equivalent of complete units. The term equivalent
unit means a notional quantity of completed units substituted for an actual quantity of incomplete
physical units in progress, when the aggregate work content of the incomplete units is deemed to
be equivalent to that of the substituted quantity. The principle applies when operation costs are
apportioned between work in progress and completed units.
Equivalent units of work in progress
= Actual no. of units in progress X Percentage of work completed
Equivalent unit should be calculated separately for each element of cost (viz. material, labour
and overheads) because the percentage of completion of the different cost component may be
different.
Equivalent units of production is a term applied to the work-in-process inventory at the end of an
accounting period. It is the number of completed units of an item that a company could
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theoretically have produced, given the amount of direct materials, direct labor, and
manufacturing overhead costs incurred during that period for the items not yet completed. In
short, if 100 units are in process but you have only expended 40% of the processing costs on
them, then you are considered to have 40 equivalent units of production.
Equivalent units of production are usually stated separately for direct materials and all other
manufacturing expenses, because direct materials are typically added at the beginning of the
production process, while all other costs are incurred as the materials gradually work their way
through the production process. Thus, the equivalent units for direct materials are generally
higher than for other manufacturing expenses.
When you assign a cost to equivalent units of production, you typically assign either the
weighted average cost of the beginning inventory plus new purchases to the direct materials, or
the cost of the oldest inventory in stock (known as the first in, first out, or FIFO, method). The
simpler of the two methods is the weighted average method. The FIFO method is more accurate,
but the additional calculations do not represent a good cost-benefit trade off. Only consider using
the FIFO method when costs vary substantially from period to period, so that management can
see the trends in costs.
Equivalent units is a cost accounting concept that is used in process costing for cost calculations.
It has no relevance from an operational perspective.
Example of Equivalent Units of Production
ABC International has a manufacturing line that produces large amounts of green widgets. At the
end of the most recent accounting period, ABC had 1,000 green widgets still under construction.
The manufacturing process for a green widget requires that all materials be sent to the shop floor
at the start of the process, and then a variety of processing steps are added before the widgets are
considered complete. At the end of the period, ABC had incurred 35% of the labor and
manufacturing overhead costs required to complete the 1,000 green widgets. Consequently, there
were 1,000 equivalent units for materials and 350 equivalent units for direct labor and
manufacturing overhead.
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Accounting Procedure:
The following procedure is followed when there is Work-in-Progress
1) Find out equivalent production after taking into account of the process losses, degree of
completion of opening and / or closing stock.
2) Find out net process cost according to elements of costs i.e. material, labour and
overheads.
3) Ascertain cost per unit of equivalent production of each element of cost separately by
dividing each element of costs by respective equivalent production units.
4) Evaluate the cost of output finished and transferred work in progress
The total cost per unit of equivalent units will be equal to the total cost divided by effective units
and cost of work-inprogress will be equal to the equivalent units of work-inprogress
multiply by the cost per unit of effective production. In short the following from steps an
involved.
Step 1 – prepare statement of Equivalent production
Step 2 – Prepare statement of cost per Equivalent unit
Step 3 – Prepare of Evaluation
Step 4 – Prepare process account
The problem on equivalent production may be divided into four groups.
I. when there is only closing work-in-progress but without process losses
II. when there is only closing work-in-progress but with process losses
III. when there is only opening as well as closing work-inprogress without process losses
IV. when there is opening as well as closing work-inprogress with process losses
Only closing work-in-progress without process losses :
In this case, the existence of process loss is ignored. Closing work-in-progress is converted into
equivalent units on the basis of estimates on degree of completion of materials, labour and
production overhead. Afterwards, the cost pr equivalent unit is calculated and the same is used to
value the finished output transferred and the closing work-in-progress
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When there is closing work-in-progress with process loss or gain.
If there are process losses the treatment is same as already discussed in this chapter. In case of
normal loss nothing should be added to equivalent production. If abnormal loss is there, it should
be considered as good units completed during the period. If units scrapped (normal loss) have
any reliable value, the amount should be deducted from the cost of materials in the cost
statement before dividing by equivalent production units. Abnormal gain will be deducted to
obtain equivalent production.
Opening and closing work-in-progress without process losses.
Since the production is a continuous activity there is possibility of opening as well as closing
work-in-progress. The procedure of conversion of opening work-in-progress will vary depending
on the method of apportionment of cost followed viz, FIFO, Average cost Method and LIFO. Let
us discuss the methods of valuation of work-in-progress one by one.
(a) FIFO Method: The FIFO method of costing is based on the assumption of that the opening
work-in-progress units are the first to be completed. Equivalent production of opening
work-in-progress can be calculated as follows:
Equivalent Production = Units of Opening WIP X Percentage of work needed to finish the units
(b) Average Cost Method: This method is useful when price fluctuate from period to period.
The closing valuation of work-in-progress in the old period is added to the cost of new period
and an average rate obtained. In calculating the equivalent production opening units will not be
shown separately as units of work-in-progress but included in the units completed and
transferred.
(c) Weighted Average Cost Method: In this method no distinction is made between completed
units from opening inventory and completed units from new production. All units
finished during the current accounting period are treated as if they were started and finished
during that period. The weighted average cost per unit is determined by dividing the total cost
(opening work-in-progress cost + current cost) by equivalent production.
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(d) LIFO Method: In LIFO method the assumption is that the units entering into the process is
the last one first to be completed. The cost of opening work-in-progress is charged to the closing
work-in-progress and thus the closing work-inprogress appears cost of opening work-in-
progress. The completed units are at their current cost.
(1) Format of statement of Equivalent Production :
Input Output Equivalent ProductionParticular
sUnit Particulars Units
Material Labour Overhead% Units % Units % Units
Opening stock
xxUnits
Completedxx xx Xx xx xx
Units introduce
dxx
Normal loss
xx -- -- -- --
Abnormal loss
xx xx Xx xx xx
xxEquivalent
unitsxx xx Xx xx xx xx Xx
(2) Statement of cost per Equivalent Units :
Element of costing CostRs.
EquivalentUnits
Cost perEquivalentUnits Rs
Material Cost (Net) xx xx Xx
Labour Cost xx xx XxOverheads Cost xx xx Xx
xx Xx
(3) Statement of Evaluation
ParticularsElements of
costEquivalent
cost
Cost per Equivalent Units Rs.
Cost Rs.Total cost
Rs.
Units Completed Material Xx xx XxLabour Xx xx Xx
Overheads Xx xx Xx XxClosing WIP Material Xx xx Xx
Labour Xx xx Xx
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Overheads Xx xx Xx XxAbnormal loss Material Xx xx Xx
Labour Xx xx XxOverheads Xx xx Xx Xx
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