What Is Costing? Definition, Objectives and Advantages

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• If 1,000 cars are 60% complete on the painting, but 40% complete on the testing, then equivalent units will need to be established for each type of cost.
• On this basis management is able to take decision in respect of make or buy the required commodities.
• In a manufacturing process the number of units of output may not necessarily be the same as the number of units of inputs.
• Direct material costs Rs. 25,000 for the filling department, and conversion costs amount to Rs. 50,000 (including direct labor and overhead).
• (4) The production records of each process are kept in such a way as to show the quantity of production and the wastage and scrap and the cost of production of each process for each period.

Also, when one order does not affect the production process and a standardization of the process and product exists. However, if there are significant differences among the costs of various products, a process costing system would not provide adequate product-cost information. Costing is generally used in such industries such as petroleum, coal mining, chemicals, textiles, paper, plastic, glass, food, banks, courier, cement, and soap. (16) The cost per unit produced is the average cost which is calculated by dividing the total process cost by the number of units produced. Process costing is so called because, under process costing cost of the product is ascertained process wise. Process costing is also known as ‘Continuous Costing’, because industries which adopt process costing undertake production of goods on a continuous basis.

There are many expenses which are incurred for more than two processes the total of such expenses may be apportioned either on suitable basis or at predetermined rate based on direct labour charges or prime cost etc. The objective of the first in first out method is to value the inventory at the current costs and as such the main problem is to calculate the equivalent production under this method. The entire production activity is characterised by a number of stages of production, i.e., processes. The boundaries of the process are determined by similarity of work performed, supervision and physical location of men and machines in the plant. As a result, unit cost of each process is obtained by averaging the total cost of each process. (7) This method provides the average cost per unit and the average cost per unit is not always accurate.

Important Terms of Process Costing

Manufacturing departments are often organized by the various stages of the production process. Each department, or process, will have its own work in process inventory account, but there will only be one finished goods inventory account. Since there are eight slices per pizza, the leftover pizza would be considered two full equivalent units of pizzas. The equivalent unit is determined separately for direct materials and for conversion costs as part of the computation of the per-unit cost for both material and conversion costs.

• Finally, Alpine assigns overhead to each product, and the process of allocating overhead is the same process used in job costing.
• (1) The factory is divided into a number of processes and an account is maintained for each process.
• The job estimate given to the customer won’t list the profit as a line item.
• Using either a periodic or perpetual inventory system, we determine the amount of direct materials used during the period.
• Assembly lines can be combined or separated based on actual production and resource management.

It is necessary to know the cost at every stage of production and this is fulfilled by process costing method. On this basis management is able to take decision in respect of make or buy the required commodities. For example – in Process 1st yarn is produced or manufactured at a cost of Rs. 125 per kg.

FAQs on Process Costing

During month, this department has finished 10,000 pairs of shoes and passes them to next stage. When we assign a cost to a product, we can use job costing if it is a unique product or a service and we can assign the costs directly. When a manufacturing process involves the continuous production of identical units rather than distinguishable job lots, there can be no job orientation. As raw materials progress through the production cycle, identical packages of paper are produced. In addition, the importance of process costing in cost accounting cannot be understated as it can help managers identify bottlenecks and other areas of waste in the production process. By reducing these costs, organizations can increase their profits and competitiveness.

Can process costing be applied to service industries?

Job costing, on the other hand, requires the owner to manage dozens, or even hundreds of individual projects. The batches are slightly different, and the manufacturer makes free accounting software and online invoicing adjustments to switch from one product to another. Tesla Corporation, which adds materials at the beginning of production, uses a weighted-average process-costing system.

Definition of Costing

Costing can also be defined as a systematic process for determining the unit cost of output produced or service rendered. For manufacturing with great work in progress, there will be a problem as management needs to estimate the equivalent of finished goods. Any error in estimation will impact the entire cost of inventory in that assembly line. So, we will take raw materials (sugar, milk, butter, cocoa, flavorings, etc.) and bring them into the cooking department. Once we are done with the candy mixture preparation, we will move on to the forming, then cooking, and finally the packaging. Food processing operations, for example, begin with the direct material, such as a potato, and gradually transform the direct material into finished products (such as wafers) by various rendering operations.

All of these units will have to be traced through the entire production line to ensure that the correct value is placed on them. This would affect the profitability of the business as they unknowingly sell their products at a lower rate. Making the combs is a process that requires material and labor costs, and costs are incurred as the product moves from one department to another. Instead of using the actual costs for each stage, this method uses an estimated standard cost. It is common for companies to turn to this method when collecting current information about real costs is time-consuming or cumbersome. (2) Group 2 includes 37,400 units that are both started and completed this month.

While the costing systems are different from each other, management uses the information provided to make similar managerial decisions, such as setting the sales price. For example, in a job order cost system, each job is unique, which allows management to establish individual prices for individual projects. By using this system, each department tracks its own costs and all those costs will be rolled up to arrive at a total cost to produce a specific number of products. 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.

Companies that mass produce a product allocate the costs to each department and use process costing. For example, General Mills uses process costing for its cereal, pasta, baking products, and pet foods. Job order systems are custom orders because the cost of the direct material and direct labor are traced directly to the job being produced. You’ll also learn the concepts of conversion costs and equivalent units of production and how to use these for calculating the unit and total cost of items produced using a process costing system.

Process Costing also allows companies to set prices according to production costs. (8) Because cost of production is ascertained periodically, management is in a position to receive various reports periodically and review the progress and efficiency of the production process. (8) The cost of production of one process is transferred to subsequent process or processes just as output on one process is transferred as input of other process. Most of the businesses in today’s world do not produce only one type of product but usually have a lot of variety to stay competitive.

This involves summing up the total costs for all production stages, such as the direct materials and conversion costs. In a process cost system, the direct expenses and production overhead are calculated for every one of the stages of production. Thus, a job order cost system is used for custom jobs when it is easy to determine the cost of materials and labor used for each job.