INTRODUCTION

Process costing is one of the basic techniques of management accounting .

However, without a thorough understanding of its underlying principles process
costing calculations may present difficulties for students. This article attempts to
provide a brief but comprehensive review of process costing and assist students in
their approach to answering examination questions. First, a brief description of
process costing is provided including key terms used in process costing. Next, a
basic approach to answering process costing questions is suggested. Finally, a
simple example demonstrates how each process costing method may be applied.
Process costing is used when identical items are continuously mass produced and
manufacturing involves one or more processes. Examples of products requiring
process costing include paint, food, chemicals and beer. Process costing systems
typically have the following characteristics: - Costs are accumulated by cost centre
with no attempt made to assign costs to specific batches. - Costs are accumulated
based on a time period rather than a particular job. - Process accounts are
maintained for each department or cost centre. - Completed costs from each
department or cost centre become the raw materials for the subsequent department
or cost centre. Typically, all materials are input at the start of a manufacturing
process while labour and overhead costs (conversion costs) incurred to convert the
materials into outputs occur uniformly throughout the process until goods are
complete. The outputs from the process may comprise completed and uncompleted
units and there may also be spoiled units some of which are expected to arise from
the process (normal loss) and others which are not anticipated (abnormal loss).
Sometimes it is possible to sell spoiled units of production to generate a small
income or scrap value. The key terms used in process costing are summarised in
Figure 1. The difficulties associated with process costing relate to the allocation of
costs incurred to the outputs obtained. As mentioned above outputs may include
closing work in progress, normal loss, abnormal loss or abnormal gain and
completed units which may incorporate opening work in progress that was
completed during the period. How each of these outputs is accounted for using
process costing is considered below: Closing work in progress (Closing WIP)
Units of product that are not fully finished at the end of the process will usually be
complete in terms of materials but require further conversion costs to finish them.
In this situation, the degree of completion may be established in terms of finished
1

units (e.g. 100 units 40% complete; stating these incomplete units in terms of
finished units 40 equivalent finished units) and costs may be allocated to the
incomplete units based on the equivalent number of finished units. Page 2 of 6
Normal loss Where units of product are expected to be spoiled as part of the
production process (even though the manufacturing process is operating
efficiently) no cost is allocated to these units. The cost of the spoiled units is thus
absorbed into the cost of unspoiled units representing a normal occurrence in the
production process. Abnormal loss/gain If the number of units that are spoiled
during the production process is higher or lower than expected (i.e. higher or lower
than the normal loss) both materials and conversion costs are allocated to these
units in the same way as for completed units and work in progress. This is done to
highlight the abnormal loss or gain so that the cause may be investigated and the
production process may be improved. Opening work in progress (Opening WIP)
Partially completed units at the start of a period have costs attached to them from
the previous period. There are two methods of accounting for these costs, weighted
average costing (WA) and first in first out costing (FIFO). The difference between
the two methods is in the treatment of opening WIP. Under WA the opening WIP
costs are added to the costs of the period under review and spread across all
production. The advantages of WA are that all units completed during the period
are assigned the same cost and the method itself is easier to understand and use
than FIFO. With FIFO the opening WIP costs are kept separate from the costs
incurred during the period under review and are added to the cost of units
completed and transferred from the process. The FIFO method is considered to
provide more accurate information about cost behaviour than WA. Figure 1 - Key
terms used in process costing Conversion cost: this comprises both labour and
overhead costs. Work in progress (WIP): units of product that are not fully
completed and which degree of completion may be calculated with some degree of
accuracy. Equivalent units: work in progress units that, using the degree of
completion of the units, may be stated in terms of finished units e.g. 100 units that
are 40% complete are considered equivalent to 40 units (100 x 40%) that are 100%
complete. Normal loss: this is a loss or reduction in output that is inherent in the
production process that cannot be eliminated e.g. liquids that evaporate. As this
loss occurs under efficient operating conditions it is unavoidable or uncontrollable.
Abnormal loss: this is a loss that is not inherent in the production process; it is not
expected to occur under efficient operating conditions e.g. improper mixing of
2

materials. This loss arises due to inefficiency and so is avoidable or controllable.

Abnormal gain: this is a gain that is not inherent in the production process; similar
to the abnormal loss, it is not expected to occur under efficient operating conditions
It arises when the actual loss in a process is less than expected. Scrap value: this is
the income obtained by selling any spoiled units of production i.e. any normal or
abnormal losses. Page 3 of 6 Suggested approach to answering process costing
questions (1) Prepare a statement reconciling total units input to the process with
the total outputs from the process in terms of closing work in progress, completed
units, normal loss, abnormal loss or abnormal gain. (2) For total outputs from the
process, calculate equivalent units for each of the categories: previous process
costs (where applicable), materials and conversion costs (labour and overheads).
(3) Set out costs corresponding to each equivalent unit category at (2) above based
on costing approach adopted (i.e. WA or FIFO). (4) Calculate cost per equivalent
unit for each cost category: previous process costs (where applicable), materials
and conversion costs (labour and overheads). (5) Allocate costs to each ouput:
closing WIP, abnormal loss or abnormal gain and completed units using cost per
equivalent unit calculated at (4) above and based on costing approach adopted (i.e.
WA or FIFO. (6) Prepare a T account for the process showing both units and
value columns. Include the units input and costs given in the question, and the
output in units and costs as calculated at (2) and (5) above. The inputs and outputs
both in terms of units and costs should balance the process account.

MEANING & DEFINITION

3

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
Meaning
Process costing is a method of costing used to ascertain the cost of production of
each process, operation or stage of manufacture where processes are carried on
having one or more of the following features:
(i) Where the product of one process becomes the material of another process or
operation,
(ii) Where there is simultaneous production at one or more process of different
products, with or without by product,
(iii) Where, during one or more processes or operations of a series, the products or
materials are not distinguishable from one another, as for instance, when finished
products differ finally only in shape or form.
There are a number of industries where process costing is followed:
(i) The final product emerges only after two or more process such as paperthe
raw material, bamboo or sabai grass or any other, is made into pulp: pulp is made
into paper and then it is finished, glazed etc. for sale;
(ii) The product of one process becomes the raw material of another process or
operation (for example, refined groundnut oil is the material for making vegetable
ghee) and

(iii) Different products may have a common prior process (for example, brass
goods will require melting of brass commonly for all goods). Another example is
petroleum products produced by the same refinery.
A common feature is that production goes on without interruption and, normally,
special production is not arranged for meeting any particular order. In a steel mill,
for example, when a customer orders a certain quantity, no special arrangements
will be made for himhis order will be executed out of the quantity produced in
general. Thus, 100 tonnes of steel sheets of a certain size cannot be distinguished
from the remaining quantity of steel sheets of that size.
Further, often important by-products are produced automatically at the end of each
process. These by-products may have an importance almost equal to that of the
main product. Consider kerosene oil, diesel oil, naphtha and petrol which all are
produced from the same crude oil, in addition to a host of smaller products.
In such industries the method of cost accounting used is known as Process
Accounts. It may be possible to find out the total cost without distinguishing the
cost of each process but it is not desirable to do so. Wastage and by-products of
different nature may arise out of each operation or process. Each process is likely
to entail different types of expenses. It would thus be advisable to find out the cost
of each process or operation separately.
Sometimes it is possible to either process the materials ourselves or buy them
ready for use in the next process. For instance, if one wants to market perfumed
castor oil, one can buy castor seed and carry out all the processescrushing,
refining and finishingor one can buy refined castor oil and add the necessary
perfume and colour and bottle it and market it. The decision will depend upon the
5

cost and the price prevailing in the market. This is another reason why cost of each
process should be ascertained.
Definitions:
A Dictionary for Accounts, Eric L. Kohler defines process as:
1. Any unbroken series of acts, steps, or events or any unchanging persisting
condition.
2. Hence, the sequence of operations.
3. Making up a plan of production, as on an assembly line; and continuous system
involving an unbroken chain of activities
4. And a more or less continuous operation on constant output, as distinguished
from a job order system of production.
Process costing has been defined by Kohler as:
A method of accounting whereby costs are charged to processes or operations and
averaged over units produced; it is employed principally where a finished product
is the result of a more or less continuous operation, as in paper mills, refineries,
canneries and chemical plants; distinguished from job costing, where costs are
assigned to specific orders, lots or units.
Accounts can be kept, if desired, to show the cost of each job or order. It is
possible, if it is insisted upon, to find out the cost of producing, say, 100 tonnes of
oil ordered by somebody, rather than the cost of the bulk of the oil produced in a
period. This involves the issue of requisition slips when the materials for the
6

particular order are drawn, allocating the time of the direct workers for the
particular order and allocating a proper share of the indirect expenses.
However, since the oil produced against one order is not likely to be different from
the bulk, it is unnecessary to ascertain the cost of each order. Accounts are
maintained only to show the cost of the output as a whole.
The method is useful in the case of Process cost:
(i) Metallurgical industries (like steel and aluminum);
(ii) Chemical industries (like plastics and drugs);
(iii) Food processing industries (like cheese, chocolates, etc.) and
(iv) Any other industry where there is continuous output involving two or more
processes.
Method for determining the total unit cost of the output of a continuous
production run (such as in food processing, petroleum, and textile industries) in
which a product passes through several processes (or cost centers). It involves the
following steps: (1) the 'total cost per process' is computed by estimating the
number of products passing through each process in a given period; (2) the 'unit
cost per process' is computed by dividing the 'total cost per process' by the number
of units passing through the process in the given period; (3) the 'unit cost per
process' is charged to each unit as it passes through each process so that, at the end
of the production cycle, each product will have received an appropriate charge for
each process through which it has passed.

What Are the Advantages & Disadvantages of Process Costing?

Many companies use some type of system to determine the minimum value of
produced products. Process costing is an allocation system companies use to
allocate cost for homogeneous items produced by a company. Homogeneous
products represent items that are very similar or indistinguishable from each other.
Lumber, soda pop and chemical products are a few examples of homogeneous
products. Process costing provides companies with a few advantages and
disadvantages.
Easy to Use
Process costing is an easier system to use when costing homogenous products
compared to other cost allocation methods. Business owners allocate business costs
according to the number of processes each good travels through in the production
system. Each process applies direct materials, labor and manufacturing overhead to
the production cost total. Management accountants take the total number of goods
leaving the process and divide the total process cost by this number. This creates a
simple average cost for each item produced.
Flexible
Business owners use process costing because it creates a flexible production
process. Companies needing to refine their process can simply add or remove a
process as necessary. This also allows companies to lower their production cost for
each good. Business owners typically look for ways to refine a production process
to increase cost savings. Eliminating redundant processes often achieves this goal.
Adding a process allows companies to produce slightly different goods or improve
product quality.
Management accountants may review the amount of materials and labor used in
each process to determine if any costing savings is available in the productions
system. This flexibility ensures companies can produce at the most competitive
cost in the economic marketplace.
8

DISADVANTAGES OF PROCESS COSTING

Cost Errors
Process costing can create cost errors in the production system. Production cost
errors often represent a significant disadvantage for cost accounting systems.
Process costing does not use direct allocation to apply business costs to individual
goods. Direct allocation costing applies a specific amount of raw materials,
production labor and manufacturing overhead to goods or services. Process costing
may allow non-production costs to be included in the total process cost. Including
non-production costs will arbitrarily increase each items cost; this also increases
the consumer product price. Management accountants may also leave out
production costs and create under-coste products. Under-costed products usually
result in lower business profits because goods are actually more expensive than
actually reported.
Equivalent Units
Management accountants must calculate equivalent units in the process costing
system. Equivalent units represent the amount of unfinished goods left in a process
at the end of an accounting period. This calculation may only be a best guess or an
estimate by management accountants. This information is reported as the work-inprocess on a companys balance sheet. Inaccurate work-in-process accounts may
also result in distorted finished good totals. This creates a difficult process for
managing inventory and determining how many products the company has to sell
in the open marketplace

Limitations:
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.
DISTINCTION BETWEEN JOB COSTING ANDPROCESS 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
Basis of
Distinction
1. Specific order
Production is
2. Nature

3. Cost determination

Job order costing

Performed against
Each job many be

Cost is determined for

10

Process costing
specific orders
contentious
different Product
Homogeneous
and standardized.

each job separately.

Costs are complied for

each process for
department on time
basis i.e. for a given
accounting period.

4. Cost calculations
Cost is complied when
A job is completed
5. Control Proper

Cost is calculated at the

end of the cost period.

control is
Comparatively difficult
As each product unit is
different and the
production is not
continuous.

Proper control is
comparatively easier
as the production is
standardized and is
more suitable.

6. Transfer

7. Work-in-Progress

8. Suitability

There is usually not

transfer from one job
to another unless

There may or may

No To be work-in-progress.

there is some surplus

work. The output of one
aprocess is transferred to
another process input
There is always some
work-inprogress
because
of continuous
production.

Suitable to industries where

production is intermittent
and customer orders can b
identified in the value of production.

11

Suitable,
where goods
are made for stock and
productions

ENTRIES TO TRANSFER BALANCES:TRANSFER TO NEXT DEPARTMENT

At the end of the month, Tyler needs an entry to record the cost of the goods
transferred
out of the department. In this case, the transfer is to the Assembly Department,
and Tyler makes the following entry.
Work in Process Assembly
XXXXX
Work in Process Machining
XXXXX
(To record transfer of units to theAssembly Department)
TRANSFER TO FINISHED GOODS
When the Assembly Department completes the units, it transfers them to the fi
nished
goods warehouse. The entry for this transfer is as follows.
Finished Goods Inventory
XXXXX
Work in ProcessAssembly
XXXXX
(To record transfer of units to fi nished goods)
TRANSFER TO COST OF GOODS SOLD
When Tyler sells the fi nished goods, it records the cost of goods sold as follows.
Cost of Goods Sold
XXXXX
Finished Goods Inventory
XXXXX
(To record cost of units sold)

12

COSTING PROCEDURE
For each process an individual process account is prepared.
Each process of production is treated as a distinct cost centre.
1 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)
2 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)
3 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
13

that process. Specimen of

abnormal loss
Process 1
Dr
Particulars

Process Account when there are normal loss and

Cr
Units

Rs.

To
Basic Xxx
Material
To
Direct
Material

Xxx

To
Direct
Wages
To
Direct
Expenses

Xxx

ToProductio
n
Overheads
ToCost of
Rectification
of
Normal
Defects
To Abnormal
Gains

Xxx

Xxx

Xxx

Xxx

Particular Units
s
By Normal xxx
Loss
By
Abnormal
Loss
By Process
II A/c.
(output
transferred
to
Next
process)

Rs.

By Process
I
Stock A/c.

xxx

xxx
xxx

xxx

Xxx

xxx

Xxx

xxx

TOTAL
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
14

technology etc. These are normally called as avoidable losses. Basically process
losses are classified into two categories
(a) Normal Loss (b) Abnormal Loss

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 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:
Formula To Calculate Cost of goods loss unit:
Total cost increased Sale Value 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:
Formula To find ABNORMAL LOSS
Abnormal Losses = Actual Loss Normal Loss
The value of abnormal loss is done with the help of following
formula:
Value of Abnormal Loss:
15

Total Cost increase Scrap Value of normal Loss /Input units Normal Loss Units
* Unit 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

Abnormal Loss A/c.

Dr.
particular Unit
To process Xx
a/c

total

Cr.
Rs
xxx

particular Unit
By
bank xx
a/c
By costing
P/L A/C

xxx

Rs
xxx
xx
xxx

3. 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:
Formula to find Abnormal Gain
Total Cost incurred Scrap Value of Normal Loss /Input units Normal Loss
Units*Abnormal gain unit
16

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
Abnormal Gain A/c.
Dr.
particular Unit
To Normal Xx
loss a/c
By costing
P/L A/C
total

Cr.
Rs
xxx

particular Unit
By process xx
a/c
By costing
P/L A/C

xxx

Rs
Xxx
Xx
Xxx

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
17

element of cost (viz. material, labour and overheads) because the percentage of
completion of the different cost component may be different
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, labourer
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-in progress will be equal to the equivalent units of work-in
progress 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.
II.
III.
IV.

when there is only closing work-in-progress but without process losses

when there is only closing work-in-progress but with process losses
when there is only opening as well as closing work-in progress without
process losses
when there is opening as well as closing work-in progress with process
losses Situation I : Only closing work-in-progress without process losses :
In this case, the existence of process loss is ignored. Closing work-inprogress is converted into equivalent units on the basis of estimates on
18

degree of completion of materials, labour and production overhead.

Afterwards, the cost per equivalent unit
calculated and the same is used to value the finished output transferred and
the closing work-in progress Situation II: 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 perio .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. Situation III: Where there is opening and
closing work-in progress without process losses. Since the production is
continuous activity there is possibility of opening as well as closing work
inprogress. 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-inprogress 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.
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

19

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

The five steps in process costing are as follows:

Step 1. Summarize the flow of physical units of output.
Step 2. Compute output in terms of equivalent units.
Step 3. Compute equivalent-unit costs.
Step 4. Summarize total costs to account for
Step 5. Assign total costs to units completed and to ending work in process.
The weighted-average method and the first-in, first-out (FIFO) method are two
common process-costing methods. The primary difference between the two
methods is that the FIFO method segregates current period production costs and
units from the production costs and units that are part of beginning work in
process. The chapter also discusses use of standard costs and process costing with
transferred-in costs.
If the steps listed above are combined into a single report:
Step 1A: Analyze the flow of physical units through the work-in-process inventory
account. Units to be accounted for (inflows) must equal Units Accounted For
(outflows).
Step 2 1B: Calculate equivalent units only for Units Completed and Transferred
Out and Ending Balance in Work-In-Process. Multiply physical units by percent
20

complete for each cost column (materials, labor and overhead) for each line and
total equivalent units for each cost column.

THE TWO COMMON PROCESS METHODS

If the steps listed above are combined into a single report: Step 1A: Analyze the
flow of physical units through the work-in-process inventory account. Units to be
accounted for (inflows) must equal Units Accounted For (outflows). Step 2 1B
Calculate equivalent units only for Units Completed and Transferred Out and
Ending Balance in Work-In-Process. Multiply physical units by percent complete
for each cost column (materials, labor and overhead) for each line and total
equivalent units for each cost column.
. Step 2A: Total costs in beginning inventory and costs added during the period for
each cost column (materials, labor and overhead) and in total.
Step 2B: For each cost column (materials, labor and overhead), divide total costs
from Step 2A by total equivalent units from Step 2 to compute cost per equivalent
unit. Step 3: For Completed and Transferred Out, multiply equivalent units from
Step 2 by cost per equivalent unit from Step 2B for each cost column (materials,
labor and overhead). For Ending Balance, multiply equivalent units from Step 2 by
cost per equivalent unit from Step 2B for each cost column (materials, labor and
overhead). Total costs assigned in each cost column and the total column. Total
costs to be assigned in Step 2A must equal total costs assigned in Step 3. Note that
labor and overhead may be combined as conversion cost only if the percent
complete is the same.
21

Example #1: Micro Labs Company produces house paint in two processing
departments: the Mixing Department which mixes the paint colors and the
Finishing Department which puts the paint in containers and labels them. The
following information related to the companys operation for October follows: a)
Raw materials were issued for use in production: Mixing department, $551,000,
and the Finishing department, $629,000. b) Direct labor costs incurred: Mixing
department $230,000, and Finishing department $270,000. c) Manufacturing
overhead cost applied: Mixing department $665,000, and Finishing department,
$405,000. d) The cost of the mixed paint transferred from the Mixing department
to the Finishing department was $1,850,000. e) Paint that had been prepared for
shipping was transferred from the Finishing . department to Finished Goods.
Cost of the transferred paint was $3,200,000. Required: Prepare journal entries to
record items a) through e) above. 1.9 Solution #1: a) Debit: Work in Process
Mixing 551,000 Debit Work in Process Finishing 629,000 Credit: Raw Materials
1,180,000 b) Debit: Work in Process Mixing 230,000 Debit: Work in Process
Finishing 270,000 Credit: Wages and Salaries Payable 500,000 c) Debit: Work in
Process Mixing 665,000 Debit: Work in Process Finishing 405,000 Credit:
Manufacturing Overhead 1,070,000 d) Debit: Work in Process Finishing
1,850,000 Credit: Work in Process Mixing 1,850,000 e) Debit: Finished Goods
3,200,000 Credit: Work in Process Finishing
Required: Determine the equivalent units of production for the month. 2.1 Solution
#2: 2.2 Example #3
2.3 Solution #3: 2.4 Example #4: Micro Labs must assign the manufacturing costs
in work-in-process inventory at the end of October to the gallons finished and
ready for sale and the gallons still in process at October 31. Required: Using the
data and solutions from Examples #1, #2 and #3, compute the ending balance in
work-in-process inventory for the Mixing department and the cost of gallons

22

CHAPTER OVERVIEW
A. Job-Order Costing vs. Process Costing. Process costing is used in industries
that produce homogenous products such as bricks, flour, and cement on a
continuous basis.
1. Similarities between job-order and process costing. Job-order and process
costing systems share some characteristics:
a. Both systems have the same basic purposeto assign material, labor, and
overhead cost to products.
b. Both systems use the same basic manufacturing accounts: Manufacturing
Overhead, Raw Materials, Work In Process, and Finished Goods.
c. The flow of costs through the manufacturing accounts is basically the same.
2. Differences between job-order and process costing. The differences between
job-order and process costing occur because the flow of units in a process costing
system is more or less continuous and the units are essentially indistinguishable
from one another. Under process costing:
a. A single homogenous product is produced on a continuous basis over a long
period of time. This differs from job-order costing in which many different
products may be produced in a single period.
23

b. Costs in process costing are accumulated by department, rather than by

individual job.
c. The department production report is the key document in process costing,
showing the accumulation and disposition of cost. In job-order costing, the job-cost
sheet is the key document.
B. Overview of Process Costing. Manufacturing costs are accumulated in
processing departments in a process costing system. A processing department is
any location in the organization where work is performed on a product and where
materials, labor, and overhead costs are added to the product. Processing
departments should also have two other features. First, the activity performed in
the processing department should be essentially the same for all units that pass
through the department. Second, the output of the department should be
homogeneous. In process costing, the average cost of processing units for a period
is assigned to each unit passing through the department.
Two process costing methods are illustrated in the textthe weighted-average
method and the FIFO method. While the FIFO method provides more current cost
data for decision-making and performance evaluation purposes, it is more difficult
for students to grasp. For that reason, the FIFO method is covered in an appendix.
C. Equivalent Units of Product. In order to calculate the average cost per unit,
the total number of units must be determined. Partially completed units pose a
difficulty that is overcome using the concept of equivalent units. Equivalent units
are the equivalent, in terms of completed units, of partially completed units. The
formula for computing equivalent units is:

Equivalent units are the number of complete, whole units one could obtain from
the materials and effort contained in partially completed units.
24

Under the weighted-average method, the equivalent units for a particular cost
category (e.g., materials or conversion cost) is computed by adding together the
number of units completed and transferred out to the next department during the
period and the equivalent units in the ending work in process inventory in the
department.

D. Production Report. The purpose of a production report is to summarize all of

the activity that takes place in a department's work in process account for a period.
A production report consists of three parts:
A quantity schedule and a computation of equivalent units.
A computation of costs per equivalent unit.
A reconciliation of all cost flows into and out of the department during the period.
E. Production Report: Weighted-Average Method. Emphasize that the
weighted-average method does not attempt to separate units in the beginning
inventory from units started during the current period. Costs and units from
beginning inventory are blended together with costs and units from the current
period.
1. Quantity Schedule and Equivalent Units. The first step in preparing a
production report is to prepare a quantity schedule, which shows the physical flow
of units through the department. This schedule allows managers to see at glance
how many units moved through the department during the period. Using the
quantity schedule, the equivalent units can be easily computed.
2. Costs per Equivalent Unit.The second step in preparing a production report is
to calculate the costs per equivalent unit. The cost per equivalent unit is computed
for a particular cost category (i.e., materials, labor, overhead, or conversion) by
dividing its total cost by its total equivalent units. Note that under the weighted25

average method the costs include both the costs already in beginning inventory as
well as the costs added by the department during the current period.
3. Cost Reconciliation. The third step in preparing a production report is to
prepare a cost reconciliation. The purpose of a cost reconciliation is to show how
the costs from beginning work in process inventory and costs that have been added
during the period are accounted for.
a. Costs come into the department from units in beginning inventory, from
material, labor, and overhead costs that are added during the period, and from any
units that might have been transferred in from a prior department.
b. A department's costs are accounted for by showing the costs that are transferred
out to the next department (or to finished goods) and by specifying the costs that
remain in the ending work in process inventory.
F. Operation Costing. The costing systems discussed in Chapters 3 and 4
represent the two ends of a continuum. On one end is job-order costing and on the
other is process costing. Between the two extremes, there are many hybrid
systems. Operation costing is an example of such a hybrid system. It is used in
situations where products have some common as well as individual characteristics.
TVs, for example, have some common characteristics in that all models must be
assembled and tested following the same basic steps. However, each model has
different components with different costs. The costs of the components (materials)
would be charged to a batch of a particular model individually, as in job-order
costing, but the conversion costs may be assigned using process costing.

26

CONCLUSION
Process costing is used in production processes where relatively large numbers of
nearly identical products are manufactured. The purpose of a process-costing
system is the same as that of a job-order costing system-to accumulate costs and
assign these costs to units of product. Product costs are needed for planning, cost
control, decision making, and reporting to various outside organizations. The flow
of costs in process-costing systems and job-order costing systems is the same.
Costs of direct material, direct labor, and manufacturing overhead are added to a
Work-in-Process Inventory account. Direct labor and manufacturing overhead are
often combined into a single cost category termed conversion costs. When products
are completed, the costs assigned to them are transferred either to Finished-Goods
Inventory or to the next production department's Work-in-Process Inventory
account. In sequential production processes, the cost of the goods transferred from
one production department to another is called transferred-in cost. There are some
27

important differences between job-order and process-costing systems. Chief among

these is that job-order costing systems accumulate production costs by job or batch,
whereas process-costing systems accumulate costs by department. Another
important difference is the focus on equivalent units in process costing. An
equivalent unit is a measure of the amount of productive input that has been
applied to a fully or partially completed unit of product. In process costing,
production costs per equivalent unit are calculated for direct-material and
conversion costs. The key document in a process-costing system is the
departmental production report, rather than the job-cost sheet used in job-order
costing. There are four steps in preparing a departmental production report: (1)
analyze the physical flow of units, (2) calculate the equivalent units, (3) compute
the cost per equivalent unit, and (4) analyze the total costs of the department.
In the weighted-average method of process costing, the cost per equivalent unit, for
each cost category, is a weighted average of (1) the costs assigned to the beginning
work-in-process inventory and (2) the costs incurred during the current period.
Job-order and process costing represent the polar extremes of product-costing
systems. Operation costing is a hybrid of these two methods. It is designed for
production processes in which the direct material differs significantly among
product lines but the conversion activities are essentially the same. Direct-material
costs are accumulated by batches of products using job-order costing methods.
Conversion costs are accumulated by production departments and are assigned to
product units by process-costing methods
REFERENCE
1. http://smccd.edu/accounts
2. http://fisher.osu.edu/
3. http://smallbusiness.chron.com/

28