PROCESS COST SYSTEM: CHARACTERISTICS AND EXAMPLES - DUDAS - 2025

The process costing system is a term used in cost accounting to describe a method of collecting and allocating manufacturing costs to units produced in the manufacturing industry, to determine the total cost of production of a unit of product.

A process costing system accumulates costs when a large number of identical units are produced. In this situation, it is more efficient to accumulate costs at the aggregate level for a large batch of products and then allocate them to the individual units produced.

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It is based on the assumption that the cost of each unit is the same as that of any other unit produced, so it is not necessary to track the information at the level of an individual unit.

The use of the process cost system is optimal under certain conditions. If the products that come out are homogeneous or if the goods produced have a low value, then it may be beneficial to use process costing.

Similarly, if it is difficult or impractical to trace production costs directly to individual units of production, it is beneficial to use process costing.

System utility

It is used particularly in environments where production passes through multiple cost centers.

Some industrial products can be counted. These come off the production line in separate units and the accountant can add up how many have been produced.

Other types of products cannot be counted. These substances do not come in discrete packages of one, two or three units, but are in the form of liquids, grains or particles.

The process cost calculation is useful when an industrial process goes through several stages and the output of one stage of the process becomes the input for the next. In each process, inputs, processing and waste are observed, those quantities are measured and a value is assigned to each unit that leaves.

The process costing system can give a value to products that cannot be counted, taking into account the cost of inputs and losses due to waste.

characteristics

The process cost system is used when there is a mass production of similar products, where the costs associated with the individual units of production do not differ from each other.

Under this concept, costs are accumulated in a given period of time, and then consistently assigned to all units produced during that period of time. It has the following characteristics:

- Only homogeneous products are produced. Production is uniform. Therefore, the unit cost of production can only be determined by averaging the expenses incurred during a particular period.

- The production is carried out continuously and goes through two or more processes. The finished product of one process becomes the raw material for the next process or operation, and so on until the final product is obtained.

- Management has clearly defined cost centers and cost accumulation per process, such as material cost, labor cost, and overhead for each cost center.

Products and by-products

- In certain cases, more than one product is produced. One product can have more value and becomes more important than others. If so, a higher-value product is the main product and the lower-value product is a by-product.

- The main product does not require any additional processing. However, by-products may require some additional processing before they can be sold. Both the main product and the by-products are valued according to this costing method.

Accounting management

- Accurate accounting records are kept for each process, such as the number of units fully produced, the number of units partially produced, and the total costs incurred.

- In all processes some losses may arise. Such losses can be normal and / or abnormal. The accounting treatment of normal losses and abnormal losses are studied in this costing system.

- The cost assigned to units produced or in process is recorded in the inventory asset account, where it appears on the balance sheet.

- When products are sold, the cost is transferred to the cost of merchandise sold account, where it appears in the income statement.

Other features

- Not all input units can be converted into finished products in all processes during a specific period. Some may be in process. With this cost system, the effective unit rate is calculated. Therefore, an exact average cost is obtained.

- Sometimes goods are transferred from one process to the next at a transfer price, instead of the cost price. The transfer price is compared with the market price to know the level of efficiency or the losses that occur in a particular process.

What type of companies use this system?

The classic example of a process costing system is an oil refinery, where it is impossible to track the cost of a specific unit of oil as it moves through the refinery.

For example, how would you determine the precise cost required to create a gallon of jet fuel, when thousands of gallons of the same fuel leave a refinery every hour? The cost accounting methodology used for this scenario is the process cost system.

This cost system is the only reasonable approach to determining product costs in many industries. You use most journal entries found in a cost-per-job environment. Therefore, it is not necessary to restructure the chart of accounts to a significant degree.

This makes it easy to switch to a cost-per-job system from a cost-per-process system if the need arises, or to adopt a hybrid approach using components from both systems.

Examples

Examples of industries where this type of production takes place include in addition to oil refining, food production and chemical processing.

Examples of operations that are likely to use the process costing system instead of another costing method include the following:

- Cola bottling plant.

- Company that produces bricks.

- Manufacturer of breakfast cereals.

- Company that manufactures computer chips.

- Wood producing company.

For example, for the company that bottles cola, it would not be feasible or useful to separate and record the cost of each bottle of cola in the bottling process. Therefore, the company would allocate costs to the bottling process as a whole over a period of time.

Then they would divide that overall process cost by the number of bottles produced during that time period to allocate production costs to each bottle of cola.

goals

The main objective of the process costing system is to collect the costs of services or products. This information about the cost of a service or product is used by management to control operations, determine product prices, and display financial statements.

In addition, the cost system improves control by providing information on the costs that each manufacturing process or department has incurred in particular. Other objectives are:

- Determine the unit cost.

- Allocate the accumulated costs of materials, labor and factory costs to process the cost centers.

- Express incomplete units in terms of finished units.

- Give an accounting treatment for the processing of losses, such as waste, scrap, defective products and goods in poor condition.

- Differentiate the main product from the secondary product and a joint product.

- Give an accounting treatment to the joint product and the by-product.

Calculate cost accurately

Accurate costing is an essential prerequisite for making sound management decisions. The process costing system is related to this complexity and allows the manufacturer to cost the results in a way that is useful for the business.

If management understands the costs involved, this can help them set prices and budgets in a realistic way. The result is greater efficiency.

Advantages and disadvantages

Advantage

- It is simple and less expensive to find out the cost of each process.

- It is easy to allocate the cost of processing to be able to have accurate costs.

- Production activity in process costing is standardized. Therefore, both management control and supervision are made easier.

- In process costing, products are homogeneous. As a result, unit costs can be easily calculated by averaging the total cost. Price quotes become easier.

- It is possible to periodically determine the costs of the process in short periods.

Cost containment

A company can better contain manufacturing expenses. Under this system, each department is assigned a cost center.

As expenses are allocated throughout the production process, a report is created indicating the expenses incurred under each respective cost center. These reports help identify inefficiencies within the supply chain.

For example, a report might indicate that 50% of production costs come from the purchasing department. Management can then dictate the steps the purchasing team must take to minimize costs.

Inventory control

Tracking inventory can be a cumbersome task for large corporations. However, this process can be simplified by implementing a process cost system.

Throughout the manufacturing process, each department documents any purchased materials. Additionally, each product is valuated and added to the cost center report. Management includes this information on the company's tax return.

Uniformity

Many organizations allow each of their departments to operate autonomously.

In this scenario, each department may have its own jargon, making interdepartmental communication difficult. Additionally, keeping systems and policies separate means that additional money and time must be spent to train employees.

By implementing a process costing system, a company will ensure that each department, regardless of function, operates in a uniform manner. This will allow members of the manufacturing supply chain to be in sync with one another.

Disadvantages

- The cost obtained at the end of the accounting period is of a historical nature and is of little use for effective administrative control.

- Since the cost of the process is the average cost, it may not be accurate for the analysis, evaluation and control of the performance of various departments.

- Once a mistake is made in a process, it carries over to subsequent processes.

- Cost per process does not assess the efficiency of individual workers or the supervisor.

- The calculation of the average cost is difficult in those cases where more than one type of product is manufactured.

Examples

Production within a large corporation may require the product to move through more than one department, such as purchasing, manufacturing, quality control, and distribution.

Each of these departments has its own budget. As a result, there must be a process costing system to compile the respective costs assumed by each group.

ABC Company

To illustrate a process-costing system, ABC International produces purple-colored devices, which require processing through multiple production departments.

The first department in the process is the foundry department, where items are initially created.

During the month of March, the foundry department incurred $ 50,000 in direct materials costs and $ 120,000 in conversion costs, comprised of direct labor and factory overhead.

The department processed 10,000 items during March. This means that the unit cost of the items that passed through the foundry department during that time period was $ 5.00 ($ 50,000 / 10,000 items) for direct materials and $ 12.00 ($ 120,000 / 10,000) for conversion costs.

These items will then be moved to the cutting department for further processing. These unit costs will be carried to that department along with the items, where additional costs will be added.

Sugar refining

In the sugar refining process, the sugar cane is crushed into a liquid that is mixed with lime. Then, once the solids settle, the juice is concentrated into syrup.

After the sugar crystallizes into the syrup, the molasses are separated by centrifugation and then sold as separate products. The bleached color of refined sugar is then achieved through a process that involves incorporating sulfur dioxide.

There is a solid by-product of the process, known as 'bagasse', which can be used as fuel, sold as animal feed or used in the production of paper.

Through the process cost system, the accountant arrives at a value for the cost of each of the by-products and for the remaining work in progress.

References

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6. Peter Hann (2018). The Objectives of Process Costing. Toughnickel. Taken from: toughnickel.com.
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