In manufacturing, process costing is an approach used to determine the cost of continuous mass production through one or more processes. Process costing typically involves adding direct material costs at the beginning of the process and adding indirect costs (both direct labor and overhead) gradually during the production process. Below are some fictional process costing system examples showing how it works. Process costing and job order costing are both acceptable methods for tracking costs and production levels. Some companies use a single method, while some companies use both, which creates a hybrid costing system. The system a company uses depends on the nature of the product the company manufactures.

  • Where degree of completion of opening work in progress is not given, average method is used.
  • Process costing refers to a method of accumulating cost of production by process.
  • The assumption is that the cost of each unit is the same as that of any other unit, so there is no need to track information at an individual unit level.
  • Under this method, cost is accumulated from various processes for various products.

This costing system is used when the costs of producing each individual unit are very similar, and it is difficult to track the costs for each individual unit throughout the production process. In this article, we will discuss the process costing system examples, methods, and steps. Each department, production process, and batch process keeps track of their direct material and direct labour costs, as well as the number of units produced. 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.

If a manufacturing unit is manufacturing two or more products, which are quite dissimilar to each other, weighted average method is used. Under this method, weighted average is computed and used in valuation of the incomplete units. The first in first out (FIFO) method of costing is used to introduce the subject of materials costing. The FIFO method of costing issued materials follows the principle that materials used should carry the actual experienced cost of the specific units used. Process costing is used by the industries where the goods are produced through the sequence of several processes. Process costing is suitable for industries like paint, oil refining, rubber, chemicals, sugar, paper, soap-making, textiles, etc.

Process costing is generally used in industries that deal with chemicals, distilled products, canned products, food products, oil refineries, edible oils, soap, paper, textiles, and others. (7) This method provides the average cost per unit and the average cost per unit is not always accurate. As such, the average cost is not of much use for the purpose of detailed analysis and operating efficiency.

(15) Some loss of materials in process (due to chemical action or evaporation, etc.) is unavoidable. Throughout the process it is stirred, cracked, and blended so that it is not possible to trace a tank of gasoline back to a specific barrel of oil. Our mission is to empower readers with the most factual and reliable financial information possible to help them make informed decisions for their individual needs. (1) When costs are recorded at the end of the period, it is not possible to exercise control over costs.

Process Costing: Features, Objects and Procedure Cost Accounting

Process Costing refers to a method of accumulating cost of production by process. It represents a method of cost procedure applicable to continuous or mass production industries producing standard products. Costs are compiled for each process or department by preparing a separate account for each process. The cost for the direct material, direct labor, and overheads is assigned to the process which is then allocated for the batch of production.

  • This is the term used to describe units that are not yet complete at the end of the period.
  • In a manufacturing process the number of units of output may not necessarily be the same as the number of units of inputs.
  • Let’s consider industries where the output units are uniform and individually not worth a lot.
  • In other words, finished output of one process becomes input (materials) of the next process.
  • Process costing system is an accounting method usually used by manufacturing companies that mass produces very identical products or units of output.

With processing, it is difficult to establish how much of each material, and exactly how much time is in each unit of finished product. This will require the use of the equivalent unit computation, and management selects the method (weighted average or FIFO) that best fits their information system. Process costing refers to a type of costing procedure commonly adopted by factories.

Management Accounting and Developed Costing Systems

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. When using this method, the total number of units completed and transferred out is added to the equivalent units of work-in-progress to get the total number of units at the end of the period.

Calculate the equivalent units to account for the number of unfinished items at the end of the period

Under this method, cost is accumulated from various processes for various products. They are used where the products pass through only some of the processes but not all the processes of the industry. In this method, the assumption is that the incomplete units from the opening stock are completed first and then the units introduced in the process are completed. The costs added in each process during the current period is prorated to the production necessary to complete the opening work in progress, to complete the units added in the process and units in the work in progress. We know that, there will be Work in progress during the opening and closing of a period and thus an organization needs to decide on the cost flow assumptions. For computing costs under process costing the organization can use either the FIFO or weighted average cost flow assumption.

Consider a manufacturing facility of the business for garments manufacturing company. Due to the large amount of data they have to track, maintaining spreadsheets and manual calculations consumes a lot of time. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.

What is process costing in cost accounting?

(2) It is difficult to apportion total cost among joint products and bye-products. (4) The computation of costs per unit at any one process is very easy, as the units are homogeneous, and as such, the cost per unit can be found out easily by averaging. (3) The output of a process is transferred to the next process in the sequence. In other words, finished output of one process becomes input (materials) of the next process. The output or the part of output at the stage of every process can be sold out either at profit or loss. Thus the management can know about the profit or loss at every process by preparing Processes Account.

Production Possibility Frontier (PPF)

Then, all the costs for the current period are summed up and divided by the total number of units. This method is used for cases where there are slight fluctuations in costs from period to period or where there is no standard costing system. After going through a series of processes, raw materials are transformed into final commodities in manufacturing companies that employ process pricing. The three components of process cost are direct materials, direct labor, and manufacturing overhead. Accurately assessing these components helps to track and allocate production costs across different stages or processes. In a process cost system, costs are maintained by each department, and the method for determining the cost per individual unit is different than in a job order costing system.

As one of the process costing system examples, let’s look at a supposed company, ABC Inc, that produces wire rods, that pass through multiple production departments. In many companies, each stage of the production process is usually handled by a different department. Hence, each department prepares a report that includes the three elements of process costing which are the department’s direct materials, direct labor, and manufacturing overhead. The company then combines these reports to analyze the applicable total cost of the product. Hence, a process costing system is used to allocate costs to an individual unit after a process of mass production.