definition and explanation of process costing systemk

7/29/2019 Definition and Explanation of Process Costing Systemk

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COSTINGPROCESS COSTING

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Definition and Explanation of Process Costing System:

Cost accumulation procedures used by manufacturing concerns are classified as either job order costing

or process costing. The Job Order Costing System chapter deals with the procedures applicable to job

order costing. It is important to understand that, except for some modifications, the accumulation of

materials costs, labor costs, and factory overhead also applies to process costing system.

Process costing method is used for industries producing chemicals, petroleum, textiles, steel, rubber,

cement, flour, pharmaceuticals, shoes, plastics, sugar, and coal. Process costing system is also used by

firms manufacturing items such as rivets, screws, bolts, and small electrical parts. A third type of

industry using process costing system is the assembly type industry which manufactures such things as

typewriters, automobiles, airplanes, and household electric appliances (washing machines, refrigerators,

toasters, irons, radios, television sets, etc.). Finally certain service industries, such as gas, water, and

heat, cost their products by using process costing system. Thus, process costing is used when products

are manufactured under conditions of continuous processing or under mass production methods. In

fact, process costing procedures are often termed "continuous or mass production cost accounting

procedures".

The type of manufacturing operations performed determines the cost procedures that must be used.

For example, a company manufactures custom machinery will use job order costing, whereas a chemical

company will use process costing. In the case of machinery manufacturer, a job order cost sheet is

prepared for each order, accumulating the costs of materials, labor, and factory overhead. In contrast

the chemical company cannot identify materials, labor, and factory overhead with each order, sinceeach order is part of a batch or a continuous process. The individual order identity is lost, and the cost of

a completed unit must be computed by dividing total cost incurred during a period by total units

completed. The summarization of the costs takes place via the cost of production report, which is an

extremely efficient, economical, and timesaving device for the collection of large amounts of data. The

entire process costing discussion is presented in this chapter and other two chapters (Process Costing

System - Addition of Materials, Average and FIFO Costing and By-Products and Joint Products Costing).

This chapter considers the (1) cost of production report, (2) calculation of departmental unit costs, (3)

costing of work in process, (4) computations of costs transferred to other departments or to the finished

goods storeroom, and (5) effect of lost units on unit costs. Chapter Process Costing System - Addition of

Materials, Average and FIFO Costing deals with (1) special problems involved in adding materials indepartments other than the first, (2) problems connected with the beginning work in process, and (3)

the possibility of using costing methods. Chapter By-Products and Joint Products Costing discusses the

costing of by-products and joint products.

Characteristics and Procedure of Process Costing System:

The characteristics of process costing system:


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A cost of production report is used to collect , summarize and compute total and unit costs. Production

is accumulated and reported by departments. Costs are posted to departmental work in process

accounts. Production in process at the end of a period is restated in terms of completed units.Total cost

charged to a department is divided by total computed production of the department in order to

determine a unit cost for a specific period.Costs of completed units of a department are transferred to

the next processing department in order to arrive at the total costs of the finished products during a

period. At the same time, costs are assigned to units still in process.The procedures of process costing

are designed to:Accumulate materials, labor, and factory overhead costs by departments.Determine a

unit cost for each department.Transfer costs from one department to the next and to finished

goods.Assign costs to the inventory of work in process (WIP)

If accurate units and inventory costs are to be established by process costing procedures, costs of a

period must be identified with units produced in the same period.

Costing By Departments:

The nature of manufacturing operations in firms using process or job order cost procedures is usually

such that work on product takes place in several departments.With either procedure,

departmentalization of materials, labor, and factory overhead costs facilitates application of

responsibility accounting. Each department performs a specific operation or process towards the

completion of the product. For example, after the blending department has completed the starting

phase of the work on product, units are transferred to the testing department, after which they may go

to the terminal department for completion and transferred to the finished goods storeroom. Both units

and costs are transferred from one manufacturing department to another manufacturing department.

Separate departmental work in process (WIP) accounts are used to charge each department for the

materials, labor, and factory overhead used to complete its share of manufacturing process.

Process costing involves averaging costs for a particular period in order to obtain departmental and

cumulative unit costs. The cost of a completed unit is determined by dividing the total cost of a period

by the total units produced during the period. Determining departmental production for a period

includes evaluating units still in process. The breakdown of costs for the computation of total unit costs

and for costing units transferred and departmental work in process (WIP) inventories is also desirable

for cost control purposes.Departmental total and unit costs are determined by the use of the cost of

production report, which is described and illustrated in detail on the Cost Of Production Report page.

Most of the activity in process costing system involves the accumulation of data needed for the

preparation of these reports.


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Cost of Production Report (CPR):

Definition and Explanation of Cost of Production Report (CPR):

A departmental cost of production report (CPR) shows all costs chargeable to a department. It is not

only the source for summary journal entries at the end of the month but also a most convenient vehicle

for presenting and disposing of costs accumulated during the month. A cost of production report shows:

Total unit costs transferred to it from a preceding department.Materials, labor, and factory overhead

added by the department. Unit cost added by the department. Total and unit costs accumulated to the

end of operations in the department. The cost of the beginning and ending work in process inventories.

Cost transferred to a succeeding department or to a finished goods storeroom. It is customary to divide

the cost section of the report into two parts: one showing costs for which the department is

accountable, including departmental and cumulative total and unit costs, the other showing the

disposition of these costs. A quantity schedule showing the total number of units for which adepartment is accountable and the disposition made of these units is also part of each department's

cost of production report. Information in this schedule, adjusted for equivalent production is used to

determine the unit costs added by a department, the costing of the ending work in process inventory,

and the cost to be transferred out of the department.A cost of production report determines periodic

total and unit costs. However, a report that would merely summarize the total costs of materials, labor,

and factory overhead and shows only the unit cost for the period would not be satisfactory for

controlling costs. Total figures mean very little; cost control requires detailed data. Therefore, in most

instances, the total cost is broken down by cost elements for each department head responsible for the

costs incurred. Furthermore, detailed departmental figures are needed because of the various

completion stages of the work in process inventories.Either in the cost of production report itself or inthe supporting schedules, each item of material used by a department is listed; every labor operation is

shown separately; factory overhead components are noted individually; and a unit cost is derived for

each item. To condense the illustrated cost of production reports, only total materials, labor, and factory

overhead charged to departments are considered; and unit costs are computed only for each cost

element rather than for each item.


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Process Costing System - Case Study:

Case A. Accounting for Spoiled Units:

The House Hold Aids Company assembles clip clothespins in three sections, and uses process costing.

Under normal operating conditions, each section has a spoilage rate of 2%. However, spoilage can go as

high as 5% and is usually discovered when a faulty pin enters process or on final completion by a section.

The spring mechanism is the only material which can be saved from a spoiled unit. The production

supervisor assigns a worker once or twice a week to remove the springs from spoiled units. The salvaged

springs are placed in bins at the assembly tables in section No1 to be used again. No accounting entry is

made of this salvage operation.

In the past, the controller has made no attempt to account for spoilage separately. Lost unit costs have

been absorbed by the units transferred out of the section and those remaining in the process. However,

because spoilage is increasing, a different method is needed.

Solution:

The spoiled work should be broken into normal and abnormal spoilage. The cost of normal spoilage

should be absorbed by good completed units. All materials salvaged should be assigned a value and

placed in materials inventory. Sectional materials costs should be reduced by the value assigned to

salvaged materials.

Abnormal spoilage should be charged to factory overhead account. The cost to be included in this

account should be the amount accumulated against a clothespin up to the point of being scraped, and

the total loss in scraped clothespins should be shown in the cost of production report of the department

responsible for the loss.

definition and explanation of process costing systemk

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