EBF211 Process Costing(1)

8/3/2019 EBF211 Process Costing(1)

1/24

EBF211/31A

MANAGEMENT ACCOUNTING 1

PROCESS COSTING


2/24

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.


3/24

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.


4/24

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.


5/24

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


6/24

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


7/24

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


8/24

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


9/24

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


10/24

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


11/24

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.


12/24

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.


13/24

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


14/24

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


15/24

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.


16/24

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.


17/24

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


18/24

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.


19/24

Equivalent units

EUs are notional whole unitsrepresenting incomplete work.

Used to apportion costs betweenwork in progress and completedoutput.


20/24

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.


21/24

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


22/24

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)


23/24

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.


24/24

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.

EBF211 Process Costing(1)

Documents