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CHAPTER:1 INTRODUCTION

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.

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.

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.

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.

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.

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

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

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-today 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.

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:5 DISTINCTION 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 of Distinction 1. 2. 3.


Specific order Nature

Job order costing


Performed against specific orders Each job many be different. Cost is determined for each job separately.

Process costing
Production is Contentious Product is homogeneous and standardized. Costs are complied for each process for department on time basis i.e. for a given accounting period. Cost is calculated at the end of the cost period. Proper control is comparatively easier as the production is standardized and is more suitable. The output of one process is transferred to another process as input. There is always some work-in-progress because of continuous production. Suitable, where goods are made for stock and productions is continuous.

Cost determination

4. 5.

Cost calculations

Cost is complied when a job is completed. Proper control is comparatively difficult as each product unit is different and the production is not continuous. There is usually not transfer from one job to another unless there is some surplus work. There may or may not be work-in-progress.

Control

6.

Transfer

7.

Work-in-Progress

8.

Suitability

Suitable to industries where production is intermittent and customer orders can be identified in the value of production.

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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. Particulars To Basic Material To Direct Material To Direct Wages To Direct Expenses ToProduction Overheads ToCost of Rectification of Normal Defects To Abnormal Gains xx

Process I A/c. Units xx Rs. xx Xx xx xx xx xx By Process I Stock A/c. xx Particulars By Normal Loss By Abnormal Loss By Process II A/c. (output transferred to Next process)

Cr. Units Rs. xx xx xx Xx Xx Xx

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. 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

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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 :

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:

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. Particulars To Process A/c.

Abnormal Loss A/c. Units xx Rs. xx Particulars By Bank By Costing P & L A/c. xx xxx

Cr. Units xx xx xx Rs. Xx 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

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. Particulars To Normal Loss A/c. To Costing P & L A/c.

Abnormal Gain A/c. Units XX XX XX Rs. XX XX XX XX Particulars By Process A/c.

Cr. Units XX Rs. 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-inprogress. 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 =

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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 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

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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. (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
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work-in-progress and thus the closing work-inprogress appears cost of opening work-inprogress. The completed units are at their current cost.

(1) Format of statement of Equivalent Production : Input Particulars Opening stock Units introduced Unit xx xx Output Particulars Units Completed Normal loss Abnormal loss Equivalent units Units xx xx xx xx Equivalent Production Material Labour Overhead % Units % Units % Units xx -xx xx Xx -Xx Xx xx -xx xx xx -xx xx xx Xx

xx

(2) Statement of cost per Equivalent Units : Element of costing Cost Rs. xx xx xx xx Equivalent Units xx xx xx Cost per Equivalent Units Rs Xx Xx Xx Xx

Material Cost (Net) Labour Cost Overheads Cost

(3) Statement of Evaluation Elements of cost Material Labour Overheads Material Labour Overheads Material Labour Overheads Equivalent cost Xx Xx Xx Xx Xx Xx Xx Xx Xx Cost per Equivalent Units Rs. xx xx xx xx xx xx xx xx xx Total cost Rs.

Particulars Units Completed

Cost Rs. Xx Xx Xx Xx Xx Xx Xx Xx Xx

Xx

Closing WIP

Xx

Abnormal loss

Xx

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