PROCESS

COSTING
CH:4 H&P
■ Process costing is a costing method used where it is not possible to
identify separate units of production, or jobs, usually because of the
continuous nature of the production processes involved.

Process costing is used where there is a

continuous flow of identical units and it is common
to identify it with
continuous production such as the following.
• Oil refining
• The manufacture of soap
• Paint manufacture
• Food and drink manufacture
■ CIMA Official Terminology
– Process costing is a 'form of costing applicable to continuous
processes where process costs are attributed to the number of
units produced.
– This may involve estimating the NUMBER OF EQUIVALENT UNITS in
stock at the start and end of the period under consideration.'
1. Features of process costing
■ The features of process costing which make it different from other
methods of costing such as job or batch costing are as follows.
– (a) The continuous nature of production in many processes means that
there will usually be closing work in progress which must be
valued. In process costing it is not possible to build up cost records of
the cost of each individual unit of output because production in progress
is an indistinguishable homogeneous mass.
– (b) There is often a loss in process due to spoilage, wastage,
evaporation and so on.
– (c) The output of one process becomes the input to the next until the
finished product is made in the final process.
– (d) Output from production may be a single product, but there may also
be a by-product (or by-products) and/or joint products.
2. The basics of process costing
■ 1. Process accounts: Costs incurred in processes are recorded in what are
known as process accounts.
A process account has two sides, and on each
side there are two columns – one for
QUANTITIES (of raw materials, work
in progress and finished goods) and one for
COSTS.
(a) On the left hand side of the process (b) On the right hand side of the process
account we record the inputs to the process account we record what happens to the
and the cost of these inputs. inputs by the end of the period.
(i) Some of the input might be converted
So we might show the quantity of material input into finished goods, so we show the
to a process during the period and its cost, the units of finished goods and the cost of
cost of labour and the cost of overheads. these units.
(ii) Some of the material input might
evaporate or get spilled or damaged, so
there would be losses.
So we record the loss units and the
cost of the loss.
(iii) At the end of a period, some units of
input might be in the process of being
turned into finished units so would be
work in progress (WIP). We record the
units of WIP and the cost of these units.
■ The quantity columns on each side of the account should total to the
same amount. Why? Well think about it. If we put 100 kgs of material in to
a process (which we record on the left hand side of the account) we should
know what has happened to those 100 kgs. Some would be losses maybe,
some would be WIP, some would be finished units, but the total should
be 100 kgs.
■ Likewise the cost of the inputs to the process during a period (ie the
total of the costs recorded on the left hand side of the account) is the cost
of the outputs of the process. If we have recorded material, labour and
overhead costs totalling $1,000 and at the end of the process we have 100
finished units (and no losses or WIP), then that output cost $1,000.
PROCESS ACCOUNT
Units Units $ Units $
Material 1,000 11,000 Closing WIP 200 2,000
Labour 4,000 Finished units 800 16,000
Overhead 3,000
1,000 18,000 1,000 18,000
Example: basics of process costing
■ Suppose that Purr and Miaow Co make squeaky toys for cats. Production of
the toys involves two processes, shaping and colouring.
■ During the year to 31 March 20X3, 1,000,000 units of material worth
$500,000 were input to the first process, shaping. Direct labour costs of
$200,000 and production overhead costs of $200,000 were also incurred in
connection with the shaping process.
■ There were no opening or closing inventories in the shaping department.
The process account for shaping for the year ended 31 March 20X3 is as
follows. PROCESS 1 (SHAPING) ACCOUNT
Units $ Units $

1,000,00 500,000 Output to Process 1,000,00 900,00

Direct materials 0 2 0 0

200,000
Direct labour

Production 200,000
overheads

1,000,00 900,000 1,000,00 900,00

0 0 0
■ When using process costing, if a series of separate processes is needed
to manufacture the finished product, the output of one process becomes
the input to the next until the final output is made in the final process. In
our example, all output from shaping was transferred to the second process,
colouring, during the year to 31 March 20X3. An additional 500,000 units of
material, costing $300,000, were input to the colouring process. Direct
labour costs of $150,000 and production overhead costs of $150,000 were
also incurred. There were no opening or closing inventories in the colouring
department. The process account for colouring for the year ended 31 March
20X3 is as follows. PROCESS 2 (COLOURING) ACCOUNT
Units $ Units $

Materials from 1,000,00 Output to finished 1,500,00 1,500,00

process 1 0 900,000 goods 0 0
Added materials 500,000 300,000
Direct labour 150,000
Production overhead 150,000
Direct labour and production overhead may be treated together in an assessment question as conversion cost.
1,500,00 1,500,00 1,500,00 1,500,00
0 0 0 0
Added materials, labour and overhead in Process 2 are usually added gradually
throughout the process. Materials from Process 1, in contrast, will often be introduced
in full at the start of the second process.
3. Framework for dealing with process
costing
■ Use our suggested four-step approach when dealing with process costing
questions.

Process costing is centred around four key steps.

The exact work done at each step will depend on
the circumstances of
the question, but the approach can always be
used.
Step 1 Determine output and losses
• Determine expected output.
• Calculate normal loss and abnormal loss and gain.
• Calculate equivalent units if there is closing work in progress.
Step 2 Calculate cost per unit of output, losses and WIP
Calculate cost per unit or cost per equivalent unit.
Step 3 Calculate total cost of output, losses and WIP
In some examples this will be straightforward. In cases where there is
work in progress, a statement of evaluation will have to be prepared.
Step 4 Complete accounts
• Complete the process account.
• Write up the other accounts required by the question.
It always saves time in an assessment if you don't have
to think too long about how to approach a question before
you begin. This four-step approach can be applied to any
process costing question so it would be a good idea to
memorise it now. It will be useful as a framework for any
workings that you may need to do.
DEALING WITH LOSSES IN PROCESS
■ Losses may occur in process. If a certain level of loss is expected, this is
known as normal loss.
■ If losses are greater than expected, the extra loss is abnormal loss.
■ If losses are less than expected, the difference is known as abnormal gain.
Losses/Gains
■ During a production process, a loss may occur.
– Normal loss is 'expected loss, allowed for in the budget, and normally
calculated as a percentage of the good output,
– from a process during a period of time. Normal losses are generally
either valued at zero or at their disposal values.'
– Abnormal loss is 'any loss in excess of the normal loss allowance'.
– Abnormal gain is 'improvement on the accepted or normal loss
associated with a production activity'.
■ CIMA Official Terminology

Losses may occur due to wastage, spoilage, evaporation, and so on.

Since normal loss is not given a cost, the cost of producing these units is borne by the 'good' units of
output.
Abnormal loss and gain units are valued at the same unit rate as 'good' units. Abnormal events do not
therefore affect
the cost of good production. Their costs are analysed separately in an abnormal loss or abnormal
gain account.
■ The bookkeeping
– (a) In an abnormal loss account, the debit entry shows the units
(and their value) from the process account. The credit entry
shows the impact on the income statement.
– (b) In an abnormal gain account, the debit entry shows the effect
on the income statement, while the credit entry shows the units
(and their value) from the process account.
Example: abnormal losses
and gains
Suppose that input to a process is 1,000 units at a
cost of $4,500. Normal loss is 10% and there are
no opening or
closing inventories. Determine the accounting
entries for the cost of output and the cost of the
loss if actual output were
as follows.
(a) 860 units (so that actual loss is 140 units)
(b) 920 units (so that actual loss is 80 units)
■ Solution:
– Before we demonstrate the use of the 'four-step framework' we will
summarise the way that the losses are dealt with.
– (a) Normal loss is given no share of cost.
– (b) The cost of output is therefore based on the expected units of
output, which in our example amount to 90% of 1,000 = 900 units.
– (c) Abnormal loss is given a cost, which is written off to the income
statement via an abnormal loss/gain account.
– (d) Abnormal gain is treated in the same way, except that being a gain
rather than a loss, it appears as a debit entry in the process account
(as it is a sort of input, being additional unexpected units), whereas a
loss appears as a credit entry in this account (as it is a sort of
output).
 ■ (a) Output is 860 units
Step 1 Determine output and losses Step 4 Complete accounts
If actual output is 860 units and the actual loss is 140
units:
PROCESS ACCOUNT
Units Units $ Units $
Actual loss Cost
140 incurred 1,000 4,500 Normal loss 100 0
Normal loss (10% of 1,000)
Output (finishedgoods
100
a/c) 860 x (× $5) 860 4,300
Abnormal loss
40 Abnormal loss 40 x
($5) 40 200
Step 2 Calculate cost per unit of output and
losses 1,000 4,500
The cost per unit of output and the cost per unit of 1,000 4,500
abnormal loss are based on expected output. ABNORMAL LOSS ACCOUNT
=Costs incurred / Expected output
= $4,500/900 units Units $ Units $
= $5 per unit Process
Step 3 Calculate total cost of output and losses a/c 40 200 Income statement 40 200
Normal loss is not assigned any cost.
$
Cost of output (860 × $5)
4,300
Normal loss
0
Abnormal loss (40 × $5)
200
4,500
 ■ (b) Output is 920 units Step 4 Complete accounts

Step 1 Determine output and losses

If actual output is 920 units and the actual loss is 80 units: PROCESS ACCOUNT
Units Units $ Units $
Actual loss
Cost incurred 1,000 4,500 Normal loss 100 0
80
Normal loss (10% of 1,000) Abnormal gain Output (finished goods
100 a/c 20 x (× $5) 20 100 a/c) 920x (× $5) 920 4,600
Abnormal gain
20 1,020 4,600 1,020 4,600
Step 2 Calculate cost per unit of output and losses
The cost per unit of output and the cost per unit of abnormal ABNORMAL GAIN
gain are based on expected output. Units $ Units $
=Costs incurred /Expected output
= $4,500 / 900 Income
= $5 per unit statement 20 100 Process a/c 20 100
(Whether there is abnormal loss or gain does not affect the
valuation of units of output. The figure of $5 per unit is
exactly the same as in the previous paragraph, when there
were 40 units of abnormal loss.)
Step 3 Calculate total cost of output and losses
$
Cost of output (920 × $5)
4,600
Normal loss
0
Abnormal gain (20 × $5)
(100)
4,500
Example: Abnormal losses and gains
■ During a four-week period, period 3, costs of input to a process
were $29,070. Input was 1,000 units, output was 850 units and
normal loss is 10%.
■ During the next period, period 4, costs of input were again
$29,070. Input was again 1,000 units, but output was 950 units.
There were no units of opening or closing inventory.
■ Required Prepare the process account and abnormal loss or
gain account for each period.
Step 1 Determine output and losses
Period 3

Units
Step 4 Complete accounts
Actual output
850
PROCESS ACCOUNT
Normal loss (10% × 1,000) Units $ Units $
100
Period 3
Abnormal loss
50 29,070
Input Cost of input 1,000 Normal loss 100 0
1,000 Finished goods
Period 4 a/c 850 27,455
(850× $32.30)
Units Abnormal loss
Step 2 Calculate cost per unit of output and losses
Actual output a/c 50 1,615
For each 950
period the cost per unit is based on expected output.
=Cost of input / Expected units of output (50× $32.30)
Normal loss (10% × 1,000)
= $29,070/ 900 29,070 1,000
100
= $32.30 per unit 1,000 29,070
Abnormal gain
(50) Period 4
Step 3 Calculate total cost of output and losses
Input 29,070
Period 1,000
3
$ Cost of input 1,000 Normal loss 100 0
Cost of output (850 × $32.30) Abnormal gain Finished goods
27,455 a/c 50 1,615 a/c 950 30,685
Normal loss ABNORMAL
(50 × $32.30) LOSS OR(950
GAIN ACCOUNT
× $32.30)
0 30,685 1,050
Abnormal loss (50 × $32.30) 1,050 $ $30,685
1,615 Period 3 Period 4
29,070 Abnormal loss in 1,615 Abnormal gain in
Period 4 process a/c process a/c 1,615
$
Abnormal loss in 1,615 Abnormal gain in
Cost of output (950 × $32.30) process a/c process a/c 1,615
30,685
Example :Cost of output
■ CFC Co manufactures a product in a single process operation. Normal loss is
10% of input. Loss occurs at the end of the process. Data for June are as follows.
■ Opening and closing inventories of work in progress
Nil
■ Cost of input materials (3,300 units)
$59,100
■ Direct labour and production overhead
$30,000
■ Output to finished goods
2,750 units
– The full cost of finished
The output
correct in June was
answer is C.
– A $74,250
– B $81,000
– C $82,500
– D $89,100
Step 1 Determine output and losses
Units
Actual output
2,750
Normal loss (10% × 3,300)
330
Abnormal loss
220
3,300
Step 2 Calculate cost per unit of output and
losses
=Cost of input / Expected units of output
= $89,100 / 3,300 -330
= $30 per unit
Step 3 Calculate total cost of output and losses
$
Cost of output (2,750 × $30)
82,500
Normal loss
0
Abnormal loss (220 × $30)
6,600
89,100
Example: Abnormal gain
■ Y Co makes a product Emm which goes through several processes. The following
information is available for the month of June.
Kg
■ Opening WIP 5,200
■ Closing WIP 3,500
■ Input 58,300
■ Normal loss 400
■ Transferred to finished goods 59,900
– What was the abnormal gain in June?
■ A 260 kg
■ B 300 kg
■ C 400 kg
The correct answer is B.
■ D 560 kg
The abnormal gain is the balancing figure. 63,800 – 5,200 – 58,300
= 300
ACCOUNTING FOR SCRAP
■ Scrap is 'discarded material having some value'. CIMA
Official Terminology

(a) Revenue from scrap is treated, not as an addition to sales revenue, but as a
REDUCTION IN COSTS.
The valuation of normal loss is either at scrap value or nil. It is
conventional for the scrap value of normal loss to be deducted from the
cost of materials before a cost per equivalent unit is calculated.

(b) The scrap value of normal loss is therefore used to reduce the material costs of
the process.
DEBIT Scrap account
CREDIT Process account
with the scrap value of the normal loss.
Abnormal losses and gains never affect the cost of
good units of production. The scrap value of
abnormal losses is not
credited to the process account, and the abnormal
loss and gain units carry the same full cost as a
good unit of
(c) The scrap value of abnormal loss is used to reduce the cost of abnormal
loss.
DEBIT Scrap account
CREDIT Abnormal loss account
with the scrap value of abnormal loss, which therefore reduces the write-off
of cost to the income statement.
(d) The scrap value of abnormal gain arises because the actual units sold as
scrap will be less than the scrap value of normal loss. Because there are fewer
units of scrap than expected, there will be less revenue from scrap as a direct
consequence of the abnormal gain. The abnormal gain account should
therefore be debited with the scrap value.
DEBIT Abnormal gain account
CREDIT Scrap account
with the scrap value of abnormal gain.
(e) The scrap account is completed by recording the actual cash received from
the sale of scrap.
DEBIT Cash received
CREDIT Scrap account
with the cash received from the sale of the actual scrap.
Example: scrap and abnormal loss
or
A gain
factory has two production processes. Normal loss in each process is 10%
and scrapped units sell for $0.50 each from process 1 and $3 each from
process 2. Relevant information for costing purposes relating to period 5 is
as follows.
Direct materials added: Process 1
Process 2
units 2,000
1,250
cost $8,100
$1,900
Direct labour $4,000
$10,000
Production overhead 150% of direct labour cost
120% of direct labour cost

Output to process 2/finished goods 1,750 units

2,800 units
Actual production overhead $17,800
Required:
Prepare the accounts for process 1, process 2, scrap, abnormal loss or gain.
Step 1 Determine output and losses

Process 1 Process 2
Units Units
Output 1,750 2,800
Normal loss (10% of input) 200 300
Abnormal loss 50 -
Abnormal gain - (100)
Input 2,000 3,000*

* 1,750 units from Process 1 + 1,250 units input to

process.
Step 2 Calculate cost per unit of output and losses

Process 1 Process 2
$ $
Cost of input
– material 8,100 1,900
– from Process 1 – (1,750 × $10) 17,500
– labour 4,000 10,000
– overhead (150% × $4,000) 6,000 (120% × $10,000) 12,000
18,100 41,400
Less: scrap value of
normal loss (200 × $0.50) (100) (300 × $3) (900)
18,000 40,500
Expected output
90% of 2,000 1,800
90% of 3,000 2,700
Cost per unit
$18,000 ÷ 1,800 $10
$40,500 ÷ 2,700 $15
Step 3 Calculate total cost of output and losses

Process 1 Process 2
$ $
Output (1,750 × $10) 17,500 (2,800 × $15) 42,000
Normal loss (200 × $0.50)* 100 (300 × $3)* 900
Abnormal loss (50 × $10) 500 –
18,100 42,900
Abnormal gain – (100 × $15) (1,500)
18,100 41,400

* Remember that normal loss is valued at scrap value only.

Step 4 Complete accounts PROCESS 1 ACCOUNT

Units
Units $ $
Scrap a/c (normal
Direct material 2,000 8,100 loss) 200 100

1,750 17,500
Direct labour
PROCESS 2 ACCOUNT4,000 Process 2 a/c
Production overhead
a/c Units $ 6,000 Abnormal loss a/cUnits 50$ 500
Direct materials: From 1,750 17,500 Scrap a/c (normal
process 1 loss) 300 2,000
90018,100
2,000
1,250 1,900 18,100Finished goods
Added materials a/c 2,800 42,000
Direct labour 10,000
Production o'hd 12,000
3,000
41,400
Abnormal gain 100 1,500
3,100
42,900 3,100 42,900
 ABNORMAL LOSS ACCOUNT
$ $
Scrap a/c: sale of scrap of extra loss (50 units
Process 1 (50 units) 500 @$0.50) 25
Income statement 475
500 500
ABNORMAL GAIN ACCOUNT
$ $
Scrap a/c (loss of scrap
revenue Process 2 abnormal gain 1,500
due to abnormal gain, (100 units)
100 units × $3) 300
Income statement 1,200
1500 1500
SCRAP ACCOUNT
$ $
Scrap value of normal loss Cash a/c - cash received
Process 1 (200 units) Loss in process 1 (250 units)
@$0.50 100 @$0.50 125
Process 2 (300 units) Loss in process 2 (200 units)
@$3.00 900 @$3.00 600
Abnormal loss a/c (process
1) 25 Abnormal gain a/c (process 2) 300
VALUING CLOSING WORK IN
PROGRESS
■ When units are partly completed at the end of a period (ie when there is
closing work in progress) it is necessary to calculate THE EQUIVALENT
UNITS OF PRODUCTION in order to determine the cost of a completed
unit.

•In the earlier problem we have looked at so far we have assumed that
opening and closing inventories of work in process have been nil.

•We must now look at more realistic issue and consider how to allocate the
costs incurred in a period between completed output (ie finished units) and
partly completed closing inventory.
Example: valuation of closing inventory
■ Tim Co is a manufacturer of processed goods. In March 20X3, in one
process, there was no opening inventory, but 5,000 units of input were
introduced to the process during the month, at the following cost.

$
– Direct materials
16,560
– Direct labour
7,360
– Production overhead
5,520

29,440
■ Of the 5,000 units introduced, 4,000 were completely finished during the
month and transferred to the next process. Closing inventory of 1,000 units
was only 60% complete with respect to materials and conversion costs.
■ Solution:
■ (a) The problem in this example is to divide the costs of production
($29,440) between the finished output of 4,000 units and the closing
inventory of 1,000 units. It is argued, with good reason, that a division of
costs in proportion to the number of units of each (4,000:1,000) would not
be 'fair' because closing inventory has not been completed, and has not yet
'received' its full amount of materials and conversion costs, but only 60% of
the full amount. The 1,000 units of closing inventory, being only 60%
complete, are the equivalent of 600 fully worked units.
■ (b) To apportion costs fairly and proportionately, units of production must be
converted into the equivalent of completed units, ie into equivalent units
of production.
Equivalent units are 'notional whole units
representing incomplete work. Used to apportion
costs between work in
progress and completed output …' CIMA Official
Terminology
Step 1 Determine output
Step 2 Calculate cost per unit of output, and WIP
For this step in our framework we need to prepare a statement
of equivalent units.
For this step in our framework we need to prepare a statement of costs per
STATEMENT OF EQUIVALENT UNITS equivalent unit because equivalent units are the basis for apportioning costs.
Total Equivalent
STATEMENT OF COSTS PER EQUIVALENT UNIT
Completio
units n units =Total costs / Equivalent units
Fully worked units 4,000 100% 4,000 = $29,440 /4,600 .
Closing inventory 1,000 60% 600 = Cost per equivalent unit $6.40

5,000 4,600
Step 3 Calculate total cost of output and WIP Step 4 Complete accounts
For this step in our framework a statement of evaluation may The process account would be shown as follows.
now be prepared, to show how the costs should be apportioned PROCESS ACCOUNT
between finished output and closing inventory.
Units
STATEMENT OF EVALUATION Units $ $
Equivalent Cost per equivalent
Item units unit Valuation $ Direct 16,560 4,00 25,600
Fully worked materials 5,000 Output to next process 0
units 4,000 $6.40 25,600
Closing 1,00
inventory 600 $6.40 3,840 Direct labour 7,360 Closing inventory c/f 0 3,840
4,600 29,440 Production
o'hd 5,520
A few hints on preparing accounts:
When preparing a process account, it might help to make the entries as follows.
29,440 5,00 29,440
(a) Enter the units first. The units columns are simply memorandum
5,000 columns, but they help you
0 to
make sure
that there are no units unaccounted for (for example as loss).
(b) Enter the costs of materials, labour and overheads next. These should be given to you.
(c) Enter your valuation of finished output and closing inventory next. The value of the credit
entries should,
 Example: changes in inventory
level and losses
The following data have been collected for a process.
Opening Output to finished
inventory none goods 2,000 units
Input units 2,800 units Closing inventory 450 units, 70% complete
Cost of input $16,695 Total loss 350 units
Normal loss 10%; nil scrap value
Required:
Prepare the process account for the period.
Step 1 Determine output and losses
STATEMENT OF EQUIVALENT UNITS
Equivalent
units
of work Step 2 Calculate cost per unit of output, losses and WIP
done this STATEMENT OF COST PER EQUIVALENT UNIT
= Costs incurred/ Equivalent units of work done
Total units period
= $16,695 / 2,385
(× Cost per equivalent unit = $7
Completely worked units 2,000 100%) 2,000
(× 70%)
Closing inventory 450 315
Normal loss 280 0
(×
Abnormal loss 70 100%) 70
Step 3 Calculate total cost of output, losses and WIP Step 4 Complete
STATEMENT OF 2,800
EVALUATION 2,385 accounts
Equivalent PROCESS ACCOUNT
units $ Units $ Units $
Completely worked units 2,000 14,000 Opening inventory – – Normal loss 280 0
Closing inventory 315 2,205
Abnormal loss 70 490 16,69 14,000
Input costs 2,800 5 Finished goods a/c 2,000
2,385 16,695
Abnormal loss a/c 70 490
Closing inventory c/d 450 2,205

16,69 16,695
2,800 5 2,800