The diagram above shows the cost flows in a process cost system that processes the products in a specified sequential order. That is, the production and processing of products begin in the Mixing Department. Each Department inputs direct materials and further processes the products. Then the Packaging Department transfers the products to Finished Goods Inventory. Materials, labor, and factory overhead costs are added in each department. The sum of the departmental work in process costs is the total cost of the batch that is transferred to Finished Goods.
XYZ Inc makes paper products from wood pulp wherein raw materials go through a production cycle that ends with the production of identical reams of paper. Assume in the month of August, the company completes 150,000 reams of paper, spending raw materials total of $50,000, $70,000 in direct labor, and $30,000 for overhead. This means that in this process costing system example, the company incurred a total cost of $150,000 for the 150,000 reams of paper that it produces. Hence, the cost per unit will be calculated as $1 (total cost of $150,000/150,000 reams of paper). As one of the process costing system examples, let’s look at a supposed company, ABC Inc, that produces wire rods, that pass through multiple production departments.
Analyze inventory to determine the amount of inventory at the beginning of the period
This can be done either using the weighted average method, standard costing method, or the first-in-first-out (FIFO) method. It is usually good accounting practice to carefully select the process costing method that best meets a business’s needs. A company has to analyze the flow of items during the production period to determine the amount of inventory at the beginning of the period.
Hence, a process costing system is used to estimate product costs in manufacturing industries. There is no last in, first out (LIFO) costing method used in process costing, since the underlying assumption of process costing is that the first unit produced is, in fact, the first unit used, which is the FIFO concept. Process costing is the only reasonable approach to determining product costs in many industries. It uses most of the same journal entries found in a job costing environment, so there is no need to restructure the chart of accounts to any significant degree. This makes it easy to switch over to a job costing system from a process costing one if the need arises, or to adopt a hybrid approach that uses portions of both systems.
First in, first out (FIFO) method
Each of these processing departments will be a work-in-process center. So a job costing system may have only one work-in-process, while a process costing system will have several. Manufacturing overhead will be estimated, just as in the job costing method, but will need to be recorded as incurred. The clearing account will be used to accumulate the actual costs, and a reconciliation will be done at the end of each period. Next is to allocate costs for the completed and incomplete products to the corresponding accounts in order to determine how much money is tied up in the current work-in-progress products.
- The cost allocated per unit is recorded on the balance sheet in the inventory asset account.
- When using this costing system, it is assumed that the production process is homogeneous and that all products go through the same sequence of production stages.
- So a job costing system may have only one work-in-process, while a process costing system will have several.
- According to this costing system, the total costs gathered over a certain period of time are added up, and distributed uniformly across the products produced during that time.
- Since all the expenses have to be summed up in a process costing system, they have to be reported in the same manner which brings about uniformity to reports and makes tracking costs over time easier.
- Scrap value exampleMr Bean can no longer afford to give his staff 5% of the bars.
For instance, if there are 2,000 units of inventory still in progress that are 75% complete, it is assumed that for process costing purposes, these unfinished 2,000 units are equivalent to 1,500 units (i.e. 2,000 x 75%). The homogeneous products produced in the chemical, oil, timber, textile, https://www.bookstime.com/ or food processing sectors cannot be identified from one another because such identical items usually pass through several stages during the course of production. Hence, a process costing system is used to allocate costs to an individual unit after a process of mass production.
Example of Process Cost Accounting
In an exam, use the first in first out (FIFO) method if the percentage completion of each element of opening WIP is given. Use the weighted average (WA) method if the value of each element of opening WIP is given. [Note that the two methods give different valuations for the closing WIP.]In the weighted average method, no distinction is made between units of opening inventory and new units introduced to the process during the accounting period.
- Process costing is the only reasonable approach to determining product costs in many industries.
- It means the cost per unit will be calculated as $2 ($100,000/50,000).
- The cost accounting methodology used for this scenario is process costing.
- Alternatively, process costing that is based on standard costs is required for costing systems that use standard costs.
- Examples of companies that use process costing methods would include processed food companies that make millions of identical packages of edibles and oil companies that produce millions of gallons of fuel.
- Costing is simpler in this system because rather than having to prepare a costing sheet for many products, we only need to do costing for three departments or processes.
The first department in the process is the casting department, where the widgets are initially created. During the month of March, the casting department incurs $50,000 of direct material costs and $120,000 of conversion costs (comprised of direct labor and factory overhead). The department processes 10,000 widgets during March, so this means that process costing examples the per unit cost of the widgets passing through the casting department during that time period is $5.00 for direct materials and $12.00 for conversion costs. The widgets then move to the trimming department for further work, and these per-unit costs will be carried along with the widgets into that department, where additional costs will be added.