Download - EBF211 Process Costing(1)
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EBF211/31A
MANAGEMENT ACCOUNTING 1
PROCESS COSTING
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Introduction
Process costing is a costing methodused where it is not possible to
identify separate units ofproduction, or jobs, usually becauseof the continuous nature of theproduction processes involved.
Process costs are attributed to thenumber of units produced.
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Introduction cont.
Process costing is used in those industrieswhere masses of similar products orservices are produced. Continuous flow ofidentical units.Eg.
Products are produced in similar manner
and consume same amount of cost andoverheads.
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Features of process costing
Continuous nature of production meansthere will be opening and closing WIP tobe valued.
Often a loss in process spoilage,wastage, evaporation.
Output of one process becomes the inputof the next.
Output may be a single product, but theremay be a by-product/joint products.
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Basics of process costing
Process accounts
2 sides, 2 columns each side
LHS record inputs and cost of inputs
RHS record what happens to inputs
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Process accounts
Process 1
Units Units Materials 1,000 11,000 Closing WIP 200 2,000Labour 4,000 Finished units 800 16,000Overheads 3,000
1,000 18,000 1,000 18,000
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Process Accounts - Scenarios
1. No losses within the process
2. Normal losses with no scrap value
3. Normal losses with a scrap value
4. Abnormal losses and gains
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1. No losses
A simple example:
During the month of August ABC, a processing company, incurredthe following costs in respect of each of its processes:
Process 1 Process 2
Direct materials 6,000 4,000Direct labour 1,000 2,000Direct expenses 2,000 3,000Production overhead 1,000 2,000
The quantities of input and output were as follows:Process 1 Process 2
kg kgInput 500 200Output 500 700
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Process accounts
Process 1kg kg
Materials 500 6,000 Output 500 10,000Labour 1,000Expenses 2,000Overheads 1,000
500 10,000 500 10,000
Process 2kg kg
Process 1 500 10,000 Output 700 21,000
Materials 200 4,000Labour 2,000Expenses 3,000Overheads 2,000
700 21,000 700 21,000
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Approach to process costing
Step 1 determine output and losses Determine expected output
Calculate normal loss and abnormal loss and gain
Calculate equivalent units if there is any closing WIP
Step 2 calculate cost per unit of output, losses and WIP Calculate cost per unit or cost per equivalent production
Step 3 calculate the total cost of output, losses and WIP May need a statement of evaluation
Step 4 complete accounts Complete the process accounts
Write up the other accounts
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Normal and abnormal losses
Normal (or uncontrollable) losses Occur under efficient operating conditions and
are unavoidable
Expected loss allowed for in the budget Inherent part of production and thus absorbed
by good production.
Either valued at zero or at disposal value.
Abnormal (or controllable) losses Not expected to occur under efficient operating
conditions
Any loss in excess of the normal loss allowance
Arise from inefficiencies and thus are not
included in the process costs.
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Treating the losses
In an abnormal loss account, the debitentry shows the units (and their value)from the process account. The credit entry
shows the impact on the income statement.
In an abnormal gain account, the debitentry shows the effect on the income
statement, while the credit entry shows theunits (and their value) from the processaccount.
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Calculating the cost per unit of output
Normal losses (no scrap value)
= Input cost
Expected output
Normal losses (scrap value)
= Input cost less scrap value of normal loss
Expected output
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2 & 3. Normal losses and scrap value
Example:
The costs of the process are as follows:Process 1
Direct materials 6,000Direct labour 1,000Direct expenses 2,000Production overhead 1,000
The input quantity was 500 kg and the expected losswas 10 per cent of input. Actual output was 450 kg.
1. Prepare the process account.2. If normal loss could be sold for scrap at 5 per kg,
what is the effect of this on entries in the process account
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4a. Abnormal losses
The excess above a normal loss
Example:Input 500 kg of materials costing 6,000
Labour cost 1,000Expenses cost 2,000Overhead cost 1,000
Normal loss is estimated to be 10 per cent of input.Losses may be sold as scrap for 5 per kg.
Actual output was 430 kg.
1. Prepare the process account.2. Prepare the scrap account and abnormal loss account.
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4b. Abnormal gains
Where actual loss is smaller thanexpected
Using the same example as previously
however assume that the actual output
achieved was 470kg.
1. Prepare the process account.2. Prepare the scrap account and abnormal
gain account.
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Accounting for scrap
Revenue from scrap is treated as areduction in costs.
Normal loss either nil or at scrap value
DR Scrap a/c
CR Process a/c
Abnormal losses and gains never affect the
cost of good production analysed inabnormal loss / gain account
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Equivalent production (units)
Assumed so far that all output is fully complete.
Will now consider where output started during the
period is partially complete at the end i.e.WIP.
Need to convert WIP into finished equivalents sothat the unit cost can be obtained.
Done by estimating the percentage degree ofcompletion of the WIP.
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Equivalent units
EUs are notional whole unitsrepresenting incomplete work.
Used to apportion costs betweenwork in progress and completedoutput.
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Equivalent production cont.
500 units in progress which are 25% complete= complete units
Further complications arise if WIP has reached different
degrees of completion in respect of each cost element.
It is common in many processes for the materials to beadded in full at the start of processing and for them tobe converted into the final product by the actions oflabour and related overhead costs.
Labour and overheads = conversion costs
Separate equivalent production calculation isperformed for each cost element.
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Equivalent production example
Example
Input materials 1,000 kg @ 9 per kg
Labour cost 4,800
Overhead cost 5,580Outputs Finished goods: 900 kg
Closing work in progress: 100 kg
The work in progress is completed:
100% as to material60% as to labour
30% as to overhead
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Opening and closing WIP of
uncompleted units
Two methods of calculating Weighted average method
Opening work in progress is treated asfollows: The opening work in progress is listed as an
additional part of the input to the process for theperiod.
The cost of the opening WIP is added to the costsincurred in the period.
The cost per equivalent unit of each cost elementis calculated as before, and this is used to value
each part of the output. The output value is basedon the average cost per equivalent unit, hence thename of this method.
First in first out (FIFO)
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Weighted average example 1
Magpie Co. produces an item which is manufactured in two consecutive processes.
Information relating to Process 2 during September is as follows:
Opening Inventory 800 units
Degree of completion of opening inventory :
Process 1 materials 100% 4,700
Added materials 40% 600
Conversion costs 30% 1,000
6,300
During September, 3,000 units were transferred from process 1 at a valuation of
18,100. Added materials costs 9,600 and conversion costs were 11,800.Closing inventory at 30 September was 1,000 units which were 100% complete
with respect to process 1 materials and 60% complete with respect to added
materials. Conversion cost work was 40% complete.
Prepare the Process 2 account for September.
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Weighted average example 2
The following information is available for Process 3 in June:Units Cost Degree of completion and cost
Process 2 Materials Conversioninput added in costs
Process 3 % % %
Opening stock 100 692 100 176 60 300 30 216Closing stock 80 100 70 55Input costs:Input fromprocess 2 900 1,600Materials addedin process 3 3,294
Conversion costs 4,190
Normal loss is 10 per cent of input from Process 2; 70 units were scrapped in themonth, and all scrap units can be sold for 0.20 each.Output to the next process was 850 units.
You arerequired to complete the account for Process 3 in June.