Process costing is a costing method of the goods which are produced through the repetitive procedure, method or processes. The method of process costing is used by the companies which produce products in bulk using the same procedure.
Process costing is a method to count the cost of products which are produced in mass numbers. The processing cost includes both direct and indirect cost involved in the production process of these products.
Process cost of the products is counted by calculating the average of the cost of products produced per hour and the cost assigned to products’ production is presented in large batches.
For example, in monthly batches. When goods are produced through mass production, they pass through various processes, and each process has different costs.
The costs associated with each process is calculated, and the expenses incurred in that particular period is charged against each account. In addition to this process, costing also helps in deciding the price of each unit produced in the department.
Process costing is also an integral part of industries which produces a variety of products which goes throw similar processes. For example, industries like automobile, plastic products, or toy factories. In such industries, the end product might be the same, but it goes through similar processes.
Hence, it makes process costing an important part of the industry procedure as it helps in deciding the final cost of end products.
Let us understand process costing with the help of an example of a toy factory. Let us assume that 10,000 stuffed toys were produced in the factory in January.
Let us assume that the cost of raw material required to produce toys in January was $100,000, and the total cost of converting raw material into the final product is $200,000. Let us assume the total number of toys produced in the factory in January is 50,000.
Then the cost of each toy produced in the factory is $6. In this way, the processing cost of each department is added to get the total processing cost of each unit.
In this example, we have assumed the processing cost of all departments together. Usually, companies calculate the processing cost of each department to calculate the final processing cost.
Why use Process costing?
- Process costing helps calculate product cost per unit. The cost of finished goods is considered as the cost of goods while calculating the sales revenue made by the company.
- Process costing is useful in those companies which produce products in bulk but sell products singly. For example, toys are produced in bulk together but are sold individually.
- A small difference in the production cost of a product might make a huge difference in the total profitability. Therefore, it is important to keep a constant eye on the daily production cost.
- Process costing helps managers to keep a check on the manufacturing budget and in this way, they can make sure that they don’t cross the budget limit and the manufacturing costs of different months can be compared to make more establish a budget in the coming months.
- There is certain material which gets parted in a process. By using process costing, you can give value to those materials used.
What are the features of a process costing?
- The processes involved in the production process should be clearly defined, and all types of costs related to each process in a manufacturing process should be collected.
- The stock and cost used in the production process should be recorded regularly and accurately.
- The total cost of each process is calculated using the average of the total production of that particular process.
- The cost of output obtained from one process is considered as the cost of the input of the next process.
- Process costing can be applied when the final products are homogeneous.
- Loses incurred during the production process should also be calculated in the unit cost of the product.
- All types of costs, such as the indirect and direct cost involved in each process, are calculated to calculate the total cost incurred in that process.
- The production process, where process costing can be used, should be continuous and standardized.
Types of Process Costing
There are a total of three types of process costing. All of these process costing methods are useful in different situations and are used to fulfill different accounting needs. Let us learn about each method one by one.
#1. Weighted Average Cost:
The weighted average cost is one of the simplest process costing method. Where all the costs involved in all the processes are calculated together to calculate the total process costing.
#2. Standard Costs:
There is the slightest difference between the weighted average cost method and the standard cost method. In the standard cost method, only the standard cost of a production process is assigned to each department at the place of the actual cost.
When the total cost is obtained by calculating the standard cost, then the difference between actual cost and standard cost is charged to the variance account.
#3. First In First Out (FIFO) Costing:
First In First Out is the most complex process of process costing. This process costing method involves various layers of calculation. For example, the uncompleted product cost and the production of the product in the current process are calculated together.
There is no Last In First Out Method (LIFO) as process costing is applicable only on the sequential processes and the output of the previous process is the input of the following process and not vice versa.