Process costing

PROCESS COSTING

It is a continuous operation costing method that is applied where homogeneous or standard products are produced in a series of repetitive operations. Examples of industries that use process costing are pharmaceuticals,

Some Process Costing Terms

1.      Normal loss: It is the loss that is expected to occur in a production process. It is an expected loss because it cannot be prevented from occurring. Normal loss units are not given cost. Instead, cost of normal loss is borne by the good output produced. It is normally given as a percentage of input. Normal loss is also known as expected loss.

2.      Abnormal loss: It is any excess loss incurred in a production process over that which is expected. It is calculated as the difference between actual loss and expected loss. It can also be calculated as the difference between expected output and actual output.

3.      Abnormal gain: This refers to any savings in losses in a production process. It is a gain that occurs when actual loss is less than expected loss or when actual output is more than expected output.

4.      Joint products: These are two or more products produced simultaneously in a single process each having significantly high saleable value to merit recognition as a main product. That is, they are two or more products that are produced together in a single production process and each product has a high saleable value that is equal or almost equal to one another, each can be considered a main product. Examples include petrol and diesel fuel, etc.

5.      By product: It is any product produced incidentally to the production of a main product and has minor saleable value relative to the main product. Examples include off-cuts of wood in wood processing; bitumen, petroleum jelly, etc. in oil refining and so on. Revenue generated from the sale of by-product can be treated either,

·         as sundry income and thus credited directly to the income statement or

·         by using it to reduce the process cost before determining cost per unit.

6.      Joint cost: This is the cost incurred in single process that yields two or more products simultaneously. Example can be cost of crude oil used in producing various types of fuel.

7.       Equivalent units: It is a number of fully completed units that represents a given number of uncompleted units. For example, 1,000 units of a particular product that are 40% complete will be equivalent to 400 (1,000 × 40%) fully completed units.

8.      Process scrap: This refers to discarded materials, products or residue from a production process having relatively minor saleable value. Scrap may be sold or reintroduced into the production process. The proceeds from the sale of scrap are normally used to reduce the total process cost before calculating cost per unit. Example of scrap may be the off-cuts of wood in wood processing, etc.

9.      Process waste: This refers to discarded materials, products or residue from a production process without saleable value. Scrap may be sold or reintroduced into the production process. Example may be saw dust in wood processing, etc.

10.  Reworked units: These are substandard products that require further processing before sale.

11.  Split-off point or point of separation: This is a stage in a production process where all the individual products being produced together are separately indentified. For example, the stage in the oil refining process where petrol is separated from diesel fuel.

12.  Further processing cost: It is any cost incurred after the split-off point to make a product complete for sale. That is, the cost incurred in a production process from the split-off point to the point when the final product is ready for consumption. Some products may either be sold immediately after the split-off point or processed further before sale so that they can attract a high selling price.

Where process costing is applied, a factory may be divided into different cost centres with each cost centre taking charge of a distinct process. A process account is opened to record the cost incurred in the production process and the value of output transferred. A simple process account may be as follows:

                                                                      Process Account

	Input Units	Cost Per Units	Amount		Output Units	Cost Per Unit	Amount
		$	$			$	$
Direct material	x	x	x	Normal loss	x	x	x
Direct labour	-	-	x	Abnormal loss	x	x	x
Production overhead	-	-	x	Transferred output	x	x	x
Abnormal gain	x	x	x		_		_
	x		x		x		x

Note

1.      Abnormal gain and abnormal loss cannot occur together in the same process.

2.      Any scrap value realized from the sale of normal loss is credited to the process account to reduce the total cost of the process. The scrap revenue is matched with any normal loss units in the process account.

3.      Abnormal loss, abnormal gain and transferred output units are valued using the same cost per unit calculated as follows:

      Cost per unit =  

Input units less normal loss units are known as expected output.

EXERCISE 1

The following data relates to the processing activities of Beulah Enterprise.

Direct material (20,000 units)	$40,000
Direct labour	$80,000
Production overhead	$50,000
Normal loss	10% of inputs
Process scrap per unit	$ 0.5
Actual output	17,000 units

Required: Prepare a process account to record the above data.

EXERCISE 2

Record the following data in the process account of ABC limited.

Input	10,000 kilogram
Direct material cost	$85,000
Conversion cost	$120,000
Normal loss	5%
Finished goods	9,800 kilogram
Scrap value per kilogram	$0.20

EXERCISE 3

The following data relates to the processing activities of Beulah Enterprise.

Direct material (20,000 units)	$40,000
Direct labour	$80,000
Production overhead	$50,000
Normal loss	10% of inputs
Actual output	20,000 units

Required: Prepare a process account to record the above data.

EXERCISE 4

Sappho Limited produces drinks and uses process costing to ascertain the cost of its products. The data below was in respect of its operations for the past month.

	Process 1	Process 2
Input	40,000 litres	-
Direct material cost	$5,400,000	$2,400,000
Direct labour cost	$3,500,000	$1,200,000
Production overhead	$2,500,000	$900,000
Expected output	38,000 litres	37,500 litres
Actual loss	1,500 litres	1,000 litres
Scrap value of losses	$5 per litre	-

You are required to prepare the two process accounts for the month.