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Process Costing Explained

Process costing explained with examples free of cost .It is for students of managerial accounting ,read this to quickly go through process costing.<br>http://www.brightscholarships.com<br>Twitter @scholarshipskys

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Process Costing Explained

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  1. Process Costing Explained with examples More Info :www.brightscholarships.com

  2. Process costing • Process costing is adopted when there is mass production through a sequence of several processes • Example include chemical, flour and glass manufacturing • It computes the average cost per unit by dividing the costs or production for a particular period by the number of units produced during the period

  3. Direct material Direct labour overheads Process 1 Direct material Direct labour overheads Process 2 Direct material Direct labour overheads Process 3 Finished goods Cost of goods sold

  4. Accounting for Process Costing • Costs are accumulated by each process • Each process maintains its process account • The process account is debited with the costs incurred and credited with goods completed and transferred to other process account • When the goods are completed, they will be transferred to finished goods account • When the goods are sold, the amount will be transferred to the cost of goods sold account

  5. Process A Process B Process B 800 Process C 1100 Material 500 Labour 100 Overhead200 Process A800 Material 50 Labour 150 Overhead100 800 800 1100 1100 Process C Finished Goods Finished Gds 1500 Cost of GDs Sold 1300 Bal c/d 200 Process B 1100 Material 80 Labour 110 Overhead 210 Process C 1500 1500 1500 1500 1500

  6. Accounting for losses and scrap in process account

  7. Accounting for losses in process costing • In a production process, losses are inherent and unavoidable • Nature of losses • Normal loss • Abnormal loss

  8. Accounting for scrap • Damaged goods may be sold as scrap • Revenue arising from the scrap should be treated as a reduction in cost rather than an increase in sales revenue

  9. Example

  10. Joyce Ltd. operates a factory involving two production • Processes. The output of process 1 is transferred to process • 2. The information of production for January 2005 is as • follows: • Cost for Process 1 • Materials: 3000 units at $5 per unit • Labour $2400 • Cost for Process 2 • Materials: 2000 unit at $8 per unit • Labour $1680 • No opening and closing work in progress • Output for January 2005 • Process 1: 2300 units • Process 2 4000 units

  11. General overhead, for January 2005 amounted to $7140, • are absorbed into the process cost at a rate of 375% of • direct labour costs in process 1 and 496.4% of direct labour • cost in process 2. • The normal output of process 1 and process 2 is 80% and • 90% of input respectively • Waste matters from process 1 and sold for $4 per unit • and those from process 2 for $6 per unit • Required: • Process 1 • (b) Process 2 • (c) Scrap • (d) Abnormal loss • (e) Abnormal gain

  12. Process 1 account Units $ Units $ Scrap: normal loss (4*600) 600 2400 Materials 3000 15000 ($5 *3000) Process 2 ($10*2300) 2300 23000 Labour 2400 Overhead 9000 (2400*375%) Abnormal loss ($10 *100) 100 1000 3000 264000 3000 26400 Cost per unit = Total expected cost Total expected output = $26400-$2400 3000-600 = $10 per unit

  13. Process 2 account Units $ Units $ Scrap: normal loss ($6*430) 430 2580 Process 1 2300 23000 Materials 2000 16000 Finished goods ($12*4000) 4000 48000 Labour 1680 Overhead 8340 (1680*469.4%) 4300 49020 Abnormal gain ($12 *130) 130 1560 4430 50580 4430 50580 Cost per unit = = $49020-$2580 4300-430 = $12 per unit

  14. Abnormal loss account Units $ Units $ Process 1 100 1000 Scrap 100 400 Profit and loss 600 100 1000 100 1000 Abnormal Gain account Units $ Units $ Scrap: value of abnormal gain 130 780 Process 2 130 1560 Profit and loss 780 100 1000 100 1000 Loss on scrap value due to abnormal gain

  15. Scrap account Units $ Units $ Abnormal gain (Process 2) 130 780 (130*$6) Normal loss 600 2400 (Process 1) Normal loss 430 2580 (Process 2) Cash –process 1 (600+100)*$4 700 2800 Abnormal loss 100 400 (Process 1) (100*$4) Cash – process 2 (430-130)*$6 300 1800 1130 5380 1130 5380

  16. Wk 1: Determining the output and loss: Process 1 Input 3000 units Less: normal loss (20%) Expected output Actual output 2300 units 600 units 2400 units Abnormal loss 100 units Wk 2: Determining the output and loss: Process 2 Input (2300+2000) 4300 units Less: normal loss (10%) Expected output Actual output 4000 units 430 units 3870 units Abnormal gain 130 units Back 1 Back 2

  17. Equivalent units of production

  18. Equivalent units of production • If there is no opening or closing work in progress (WIP) the unit cost of products can be obtained as follows Unit Cost = Sum of production costs Production quantity

  19. However, If there is opening or closing work in progress, the partly completed production will have a lower cost than the fully completed production • We have to converted the work in progress into finished equivalent units of production (EUP)

  20. Example

  21. The total production cost for January 2005 was $40000. 8000 units had been completed and 4000 units wee 50% complete. Equivalent units of production 8000 units completed 8000 4000 units were 50% completed 2000 10000 Finished goods = $40000/10000 * 8000 = $32000 Closing work in progress = $40000/10000*2000 = $8000

  22. Three categories in determining the equivalent units of production • Opening work in progress • Started and completed units • Closing work in progress

  23. Opening work in progress (OWIP) • These units were started in the previous period and are to be completed in the current period 1/3 EUP completed In previous period 2/3 EUP completed in current period

  24. Started and completed units (SACU) • These units are started andcompleted in the current period 1 EUP completed in current period

  25. Closing Work in progress (CWIP) • These units are started in the current period and are to be completed in the coming period 1/3 EUP completed in current period Incomplete part

  26. Two methods of cost flows in process costing • First in First out • Weighted average cost

  27. FIFO Method WAVCO Method 10 units of OWIP (60% completed in previous Period) 10 units of OWIP (60% completed in previous Period) 10 EUP 4 EUP + + 70 EUP 70 EUP 70 SACU 70 SACU + + 40 units of CWIP (20% completed) 40 units of CWIP (20% completed) 8 EUP 8 EUP 88 EUP 82 EUP

  28. Example

  29. Lucky Ltd. makes toys in a one-department production process. The following information is available related to the production in February 2005. Opening work in progress: 1000 units Degree of completionCost % $ Direct materials 100 6000 Conversion (labour + overhead) 60 1200 February production: 20000 units $ Direct materials 30000 Conversion 52200 82200 7200 Closing work in progress: 3000 units (20% as complete as to conversion

  30. You are required to : • Prepare Process 1 account using • The FIFO method of valuation; and • The weighted average method of valuation

  31. First in First out

  32. Wk 1: Number of Equivalent units (EU) Total Materials Conversion Units EU EU Opening work in progress Other completed units Total completed units Closing work in progress 1000 0 400 (40%) 17000 17000 17000 18000 17000 17400 3000 3000 600 (20%) 21000 20000 18000 20000-3000 Wk 2: Costs Total Materials Conversion $ $ $ Costs incurred in the period Costs per equivalent units No opening WIP 82200 30000 52200 4.4 1.5 2.9

  33. Wk 3: Cost of units transferred to finished goods and closing WIP Total Materials Conversion $ $ $ Opening WIP Cost to complete 1000 units completed 17000 units completed Transfer to finished goods Closing WIP 7200 6000 1200 1160 1160 (Wk 4) 8360 6000 2360 74800 25500 49300 (Wk 5) 83160 31500 51660 (Wk 6) 6240 4500 1740 89400 36000 53400 Wk:4 Conversion: $2.9*400= 1160 Wk 5: Materials: 17000*$1.5 = $25500 Conversion: 17000*$2.9 = $49300 Wk 6: Materials: 3000*$1.5 = $4500 Conversion: 600*$2.9 = $1740

  34. Process account Units $ Units $ Opening WIP 1000 7200 Finished goods 18000 83160 Materials 20000 30000 Closing WIP 3000 6240 Conversion 52200 21000 89400 21000 89400

  35. Weighted average cost method

  36. Wk 1: Number of Equivalent units (EU) Total Materials Conversion Units EU EU Opening work in progress Other completed units Total completed units Closing work in progress 1000 1000 1000 17000 17000 17000 18000 18000 18000 3000 3000 600 (20%) 21000 21000 18600 20000-3000 Wk 2: Costs Total Materials Conversion $ $ $ Opening WIP Costs incurred in the period Costs per equivalent units 7200 6000 1200 82200 30000 52200 89400 36000 53400 4.5853 1.7143 2.8710

  37. Wk 3: Cost of units transferred to finished goods and closing WIP Total Materials Conversion $ $ $ (Wk 4) 82535 30587 51678 Transfer to finished goods Closing WIP (Wk 5) 6865 5143 1722 89400 35730 53400 Wk 4: Materials: 18000*$1.7143 = $30587 Conversion: 17000*$2.8710 = $51678 Wk 5: Materials: 3000*$1.7143 = $51678 Conversion: 600*$2.8710 = $1722

  38. Process account Units $ Units $ Opening WIP 1000 7200 Finished goods 18000 82535 Materials 20000 30000 Closing WIP 3000 6865 Conversion 52200 21000 89400 21000 89400

  39. Lost units in process costing

  40. Nature of losses • Normal loss • Abnormal loss

  41. Normal loss • Normal loss are the losses within the expectation during the production • Reasons: • Low quality materials and workers are engaged • There may be an inherent problem in production process

  42. Abnormal loss • The lost units that is out of expectation

  43. Continuous loss • Continuous losses occur evenly throughout the production process • For example, the weight loss in making mild powder

  44. Discrete loss • Discrete losses occur at the specific point • A firm will not be aware of discrete losses unless the products are inspected at the inspection point • For example, wrong buttons on a garment and wrong colour of toy cars m

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