Where is process costing used

Therefore, the costs are maintained by each department, rather than by job, as they are in job order costing. How does an organization determine the cost of each unit in a process costing environment? The costs in each department are allocated to the number of units produced in a given period. This requires determination of the number of units produced, but this is not always an easy process. At the end of the accounting period, there typically are always units still in production, and these units are only partially complete.

Think of it this way: At midnight on the last day of the month, all accounting numbers need to be determined in order to process the financial statements for that month, but the production process does not stop at the end of each accounting period. However, the number of units produced must be calculated at the end of the accounting period to determine the number of equivalent units , or the number of units that would have been produced if the units were produced sequentially and in their entirety in a particular time period.

The number of equivalent units is different from the number of actual units and represents the number of full or whole units that could have been produced given the amount of effort applied. To illustrate, consider this analogy. You have five large pizzas that each contained eight slices.

Your friends served themselves, and when they were finished eating, there were several partial pizzas left. In equivalent units, determine how many whole pizzas are left if the remaining slices are divided as shown in Figure. Together, there are sixteen slices left. 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. Major Characteristics of Process Costing Process costing is the optimal system for a company to use when the production process results in many similar units. It is used when production is continuous or occurs in large batches and it is difficult to trace a particular input cost to a specific individual product.

For example, before David and William found ways to make five large cookies per batch, their family always made one large cookie per batch. In order to make five cookies at a time, they had to gather the ingredients and baking materials, including five bowls and five cookie sheets.

The exact amount of ingredients for one large cookie was mixed in each separate bowl and then placed on the cookie sheet. When this method was used, it was easy to establish that exactly one egg, two cups of flour, three-quarter cup of chocolate chips, three-quarter cup of sugar, one-quarter teaspoon salt, and so forth, were in each cookie.

This made it easy to determine the exact cost of each cookie. But if David and William used one bowl instead of five bowls, measured the ingredients into it and then divided the dough into five large cookies, they could not know for certain that each cookie has exactly two cups of flour.

It is also impossible to trace the chocolate chips from each bag to each cookie because the chips were mixed together. These variations do not affect the taste and are not important in this type of accounting. Process costing is optimal when the products are relatively homogenous or indistinguishable from one another, such as bottles of vegetable oil or boxes of cereal.

Often, process costing makes sense if the individual costs or values of each unit are not significant. For example, it would not be cost effective for a restaurant to make each cup of iced tea separately or to track the direct material and direct labor used to make each eight-ounce glass of iced tea served to a customer. In this scenario, job order costing is a less efficient accounting method because it costs more to track the costs per eight ounces of iced tea than the cost of a batch of tea.

Overall, when it is difficult or not economically feasible to track the costs of a product individually, process costing is typically the best cost system to use.

Process costing can also accommodate increasingly complex business scenarios. While making drumsticks may sound simple, an immense amount of technology is involved.

Rock City Percussion makes 8, hickory sticks per day, four days each week. The sticks made of maple and birch are manufactured on the fifth day of the week. It is difficult to tell the first drumstick made on Monday from the 32,th one made on Thursday, so a computer matches the sticks in pairs based on the tone produced.

Process costing measures and assigns the costs to the associated department. The basic 5A hickory stick consists only of hickory as direct material. The rest of the manufacturing process involves direct labor and manufacturing overhead, so the focus is on properly assigning those costs. Thus, process costing works well for simple production processes such as cereal, rubber, and steel, and for more complicated production processes such as the manufacturing of electronics and watches, if there is a degree of similarity in the production process.

In a process cost system, each department accumulates its costs to compute the value of work in process inventory, so there will be a work in process inventory for each manufacturing or production department as well as an inventory cost for finished goods inventory. Manufacturing departments are often organized by the various stages of the production process. For example, blending, baking, and packaging could each be categorized as manufacturing or production departments for the cookie producer, while cutting, assembly, and finishing could be manufacturing or production departments with accompanying costs for a furniture manufacturer.

Each department, or process, will have its own work in process inventory account, but there will only be one finished goods inventory account. There are two methods used to compute the values in the work in process and finished goods inventories.

The first method is the weighted-average method, which includes all costs costs incurred during the current period and costs incurred during the prior period and carried over to the current period. This method is often favored, because in the process cost production method there often is little product left at the end of the period and most has been transferred out. After these units are sold, the newer completed units can then be sold.

Since the FIFO process costing method is more complicated than the weighted-average method, the FIFO method is typically covered in more advanced accounting courses. With processing, it is difficult to establish how much of each material, and exactly how much time is in each unit of finished product.

This will require the use of the equivalent unit computation, and management selects the method weighted average or FIFO that best fits their information system. Process costing can also be used by service organizations that provide homogeneous services and often do not have inventory to value, such as a hotel reservation system. Although they have no inventory, the hotel might want to know its costs per reservation for a period.

They could allocate the total costs incurred by the reservation system based on the number of inquiries they served. In the case of a not-for-profit company, the same process could be used to determine the average costs incurred by a department that performs interviews. Both process costing and job order costing maintain the costs of direct material, direct labor, and manufacturing overhead. The process of production does not change because of the costing method.

The costing method is chosen based on the production process. Raw materials move through the production cycle in a continuous flow, ending with the production of identical packages of paper. This month, it completes , packages. For certain types of manufacturers, process costing is the most practical and efficient accounting method for determining product costs.

Still, this method has both advantages and disadvantages. It can be difficult to accurately assign costs to work in progress, for example. Consider the following pros and cons. Process costing can be easier to use than other costing methods, and it can help companies zero in on areas for potential cost cutting.

With process costing, companies track the flow of costs from department to department, rather than tracking costs for each individual item.

Each department adds direct labor and manufacturing overhead costs, plus the cost of any raw materials it uses. Companies may use separate work-in-process inventory accounts for each department or stage in the process. Process costing assigns expenses to different departments in your business, and it accounts for various cost areas including materials and payroll.

Those costs are then rolled up to determine an overall dollar figure and used to find the price-per-unit. All departments must use uniform reporting and not double count efforts. Enterprise resource planning ERP software can help with this process. It brings data from various business software modules from around your company — such as supply chain management, financial management and payroll management — into one digital space.

By storing data from disparate areas of your company in one digital ecosystem, you can more easily track data and costs from throughout the manufacturing process and keep tabs on expenses and profitability. ERP platforms with integrated financial management software also help you more expertly, easily and accurately perform process costing. By working together with the same information across the business, costs can easily be tracked by department and roll up into macro-level process costing reports.

And it can help you more expertly, easily and accurately perform process costing. Process costing is an important accounting method for manufacturers that make large volumes of identical items, such as companies in the food processing, oil and chemicals industries.

For these companies, it can be difficult or impossible to directly allocate costs to each item as it moves through the manufacturing process. Process costing enables companies to estimate item costs by adding up the expenses of each step in the manufacturing process, then dividing by the number of items.

To ensure accuracy, companies need to include only product-related costs from each department involved in the process and correctly allocate cost to work-in-progress at each stage. Financial management software, particularly platforms integrated into a larger ERP tool, can help track costs by department, as well as generate overview reports and store historical data to monitor trends over time. Using process costing, a seltzer bottling company would assign costs to each stage in the bottling process.

It then totals the costs from each stage over an accounting period, dividing the overall process cost by the number of finished bottles to obtain a cost per bottle. What are the advantages and disadvantages of process costing? For companies that make large volumes of homogeneous products, process costing is much simpler than job costing.

It also enables companies to hone in on the cost of each stage in the manufacturing process and look for ways to reduce cost if necessary. But there are drawbacks, too. Process costing can be time consuming, and it can be difficult to accurately assign product costs to each manufacturing stage and to work-in-progress items. A process costing system is a method typically used within certain sectors of the manufacturing industry to determine the total production cost for each unit of product.

It accumulates cost from each process or department and allocates them to the individual products produced. Process costing is generally used by manufacturers that produce a large volume of identical items, such as companies involved in oil refining, food production, chemical processing, textiles, glass, cement and paint.

Analyze inventory flow 2. Convert in-process inventory to equivalent units 3. Compute all applicable costs 4. Calculate the cost per unit of finished and in-process inventory 5. Allocate costs to units of finished and in-process inventory. Leave Us A Review! CFO Training. Examples of Operations To Use Process Costing Examples of operations likely to use the process costing method over another costing method include the following: Cola bottling plant Company that produces bricks Breakfast cereal maker Company that makes computer chips Company that produces lumber For example, for the company that bottles cola, it would not be feasible or worthwhile to separate and record the cost of each bottle of cola in the bottling process.

In the third stage, filled bottles are inspected, labeled, and packaged. Work in process begins with the first stage of production mixing and blending , continues with the second stage bottling , and ends with the third stage inspecting, labeling, and packaging.

When products have gone through all three stages of production, they are shipped to a warehouse, and the costs are entered into finished goods inventory. Once products are delivered to retail stores, product costs are transferred from finished goods inventory to cost of goods sold. Skip to main content. Module 4: Process Costing and Production Costs. Search for:. Product costs are assigned to jobs. Unit Cost Information Similarities Unit cost information is needed by management for decision-making purposes.

Differences Process Costing Job Costing Unit cost information comes from the departmental production cost report. Unit cost information comes from the job cost sheet.