PROCESS COSTING | ACCOUNTANCY &AUDITING|L-10|

What is process costing?

Process costing refers to a cost accounting method that is used for assigning production costs to mass-produced goods.

For instance, large manufacturing companies that mass-produce inventory might use process costing to calculate the total amount of direct and indirect costs associated with products that are completed and left in-process at the end of a given time period.

Some industries where process costing methods might be applied are the food industry, fuel and oil industries and chemical processing industries.

Example of process costing

Different departments, such as a design team, a floor team, an assembly department and even a shipping and receiving department can have separate processing costs associated with unit production. As the inventory moves through each stage of development, each department may add its calculated costs to the overall process costing of producing goods.

A company that produces ink cartridges applies process costing through several departments. The first department—the design department—is where the overall shape, dimensions and other design elements of the cartridges are processed.

During a 30-day period, the design department accumulates a total amount of $80,000 of direct costs for materials and resources and $100,000 of converted costs for labor and overhead costs. The design department processes 10,000 cartridges during the 30-day period, which means that the per-unit cost of the cartridges amounts to $8 for direct costs (materials and resources) and $10 for conversion, or indirect, costs.

As the ink cartridges move through other departments during the production period, different costs will be added to the total amount of costs incurred during production.

The importance of using process costing

Process costing is a vital tool companies and production supervisors use to track product costs in industries that deal with mass amounts of produced goods and are subject to regular price fluctuations due to process and multiple production lines. Process costing results in a cost of goods manufactured (COGM) figure that is often listed on your company’s income statement.

More specifically, process costing is important because it helps companies:

Control inventory numbers and be able to distribute accurately

Monitor profits to know precisely how much they are spending and earning

Report numbers from each department uniformly and accurately

Types of process costing

A company can use several different methods of process costing to determine the total costs incurred before, during and after production, as well as the total amount of units produced. Standard process costing may be used for simply calculating production costs, while averaging assigns costs to specific units of production, and first-in, first-out calculates unit costs as they are started and completed.

A company may use one or all methods of calculating process costing, depending on what they produce, how they produce it and how they track their production processes. The most common methods of process costing include:

Standard cost

Standard cost refers to calculating costs for production units instead of actual costs. Actual costs are compared with the total costs accumulated based on standard costs, and the difference between the total costs accumulated and the actual costs accumulated is recorded and charged to another account, in this instance, a variance account.

Weighted average

This type of process costing groups together all the costs associated with production and assigns them to the units the company produced. This type of method may not take into account the time period of production and can be the simplest type of process costing to calculate.