Process costing

Process costing
 Process costing is a method of costing used mainly in manufacturing
where units are continuously mass-produced through one or more
processes.

 In process costing, it is the process that is costed (unlike job costing

where each job is costed separately). The method used is to take the total
cost of the process and average it over the units of production.

 Process costing is adopted when there is mass production through a

sequence of several processes. Example include chemical, flour and glass
manufacturing
Direct material
Direct labour
overheads Process 1

Direct material
Direct labour Process 2
overheads

Direct material Process 3

Direct labour
overheads
Finished goods Cost of goods sold

3
 Process Cost Systems
 In a process cost system, costs are tracked through a series
of connected manufacturing processes or departments;
used for large volume production of uniform products
 An accounting system used to apply costs:
• To similar products
• That are mass-produced
• In a continuous fashion
• Manufacturing process can be clearly segregated in to
clearly identifiable processes or departments.

 Process costing is appropriate for industries: chemicals,

food processing, breweries, petroleum refining, metal
manufacturing, steel making, paper industry etc.
 Process costing assumes a sequential flow of costs from
Process Cost Accounting System
 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

9
 Process A Process B

Material 500 Process B 800 Process A800 Process C 1100

Labour 100 Material 50
Overhead200 Labour 150
Overhead100
800 800
1100 1100

Process C Finished Goods

Process B 1100 Finished Gds 1500 Process C 1500 Cost of GDs Sold 1300
Material 80
Labour 110 Bal c/d 200
Overhead 210
1500 1500 1500
1500

10
Joint-Cost Basics
Split-off point
Joint costs are costs
Incurred in
Raw milk producing the raw milk

Separable costs are costs

Cream Liquid Skim incurred in producing these
separately identifiable products
 Lilac Flour Meal
 Processed Wheat to produce White flour (60%), Suji (10%), Wholemeal Flour (10%) and
Bran (20%)
 The purchase price of wheat and operating cost up to the point of separation of end
products were treated as Joint Costs.
 Packing, Selling and distribution cost incurred after the sieving stage was identified with
individual products and treated as Separable costs.

Joint Costs 1665000

 At Present: The average unit cost for each product
Seperable Costs 55620
was arrived at by dividing the total joint costs by the
combined output of the four products. Total 17,20,620
Profit 21,780
Profit margin 1.266%
Monthly Wheat Input = 900 tons
Joint Cost
allocated Profit
on the Joint Cost Separable Sales Profit (Loss) for
Production Production Total Cost Per
Product basis of Per Ton Costs per Price per (Loss) per Total
in % in tons Ton (Rs.)
production (Rs.) Ton (Rs.) Ton (Rs.) ton (Rs.) Output
quantities (Rs.)
(Rs.)
White flour 60 540 999000 1850 78 1928 2100 172 92880
Suji 10 90 166500 1850 84 1934 2480 546 49140
Wholemeal flour 10 90 166500 1850 34 1884 2000 116 10440
Bran 20 180 333000 1850 16 1866 1140 -726 -130680
900 16,65,000 1850 21780
Product Production Production Sales Value Total Sales % of Total Joint Cost Allocated Separable Total Cost Profit Profit (Loss)
in % in tons Per ton Value (Rs.) Sales allocated on the Cost Per Costs per Per Ton (Loss) per for Total
(Rs.) Value basis of Sales ton Ton (Rs.) ton (Rs.) Output (Rs.)
White flour 60 540 2100 1134000 65.08 Value 1083780 2007 78 2005 15 8100
Suji 10 90 2480 223200 12.81 213300 2370 84 2454 26 2340
Wholemeal flour 10 90 2000 180000 10.33 172260 1914 34 1948 52 4680
Bran 20 180 1140 205200 11.78 195660 1087 16 1103 37 6660
900 1742400 100.00 1665000 21780
Methods of allocating the Joint Cost
1. Net Realisable Value Method
2. Relative Sales Value Method
3. Physical Unit Method
4. Weighted Average Method
5. Profit Method
 Net Realisable Value (NRV) Method
• It is based on the assumption that the processing costs
incurred subsequent to the split-off point contribute
nothing to profit i.e., the increase in the products
Joint Costs
sales value 1665000
is equal to the separable
White flour Suji
costs.Bran
WholeMeal Total
Selling Price per ton (Rs.) 2100 2480 2000 1140
Prodn in tons 540 90 90 180
Sales Value (Rs.) 1134000 223200 180000 205200 1742400

Seperable Cost per ton (Rs.) 78 84 34 16

Total Separable Cost 42120 7560 3060 2880

NRV (Sales- Separable costs) 1091880 215640 176940 202320 1686780

NRV weight 0.65 0.13 0.10 0.12
Jt Cost Allocation (NRV Approach) 1077781 212856 174655 199708
Per Ton Joint Cost 1996 2365 1941 1109
 Relative Sales Value Method
• As per this method the joint cost is allocated on the
basis of the market value of the products
manufactured.
• Joint
Assumption
Costs is: if a product
1665000 White flour isSuji
having higher sales
WholeMeal Bran Total
Selling Price per ton (Rs.) 2100 2480 2000 1140
price
Prodn in tons
it costs more to produce
540
and
90
hence
90
market
180
value
is the
Sales Value (Rs.) basis to allocate joint 1134000 cost.
223200 180000 205200 1742400
Sales weight 0.65 0.13 0.10 0.12
Jt Cost on Sales Value (SalesValueWt X Jt Cost) 1083626 213285 172004 196085
Per Ton Cost 2007 2370 1911 1089
 Physical Unit Method
• On the basis of units manufactured
Joint Costs 1665000
White flour Suji WholeMeal Bran Total
Prodn in tons 540 90 90 180 900
Physical Unit Method
Output Proportion 0.6 0.1 0.1 0.2
Joint Cost on PU 999000 166500 166500 333000
Per Ton Jt Cost 1850 1850 1850 1850
 Weighted Average Method
• When Products are heterogeneous, the weighted average approach can be used.
• This method by logic superior to the physical unit method as it assigns weight to
each individual product and thus recognises the unique importance of each product.
• The weight factor may be the time required to process the units, the production
procedure, Sale price, Amount of prime cost ( direct labour and direct material )
used for each product etc.
Joint Costs 1665000 Assuming Each Product is unique
White flour Suji WholeMeal Bran Total
Prodn in tons 540 90 90 180 900
Weighted Average Method
Wheat Consumption weight 4 3 2 1
Weighted Output 2160 270 180 180 2790
Ratio 0.77 0.10 0.06 0.06
Joint Cost (Weighted Average) 1289032 161129 107419 107419 1665000
 Profit Margin Method
• This method is based on the assumption that profits
are earned on the totalWhite
costflour
incurred and not on the
Suji WholeMeal Bran Total
joint cost only.
Selling Price per ton (Rs.)
Prodn in tons
2100
540
2480
90
2000
90
1140
180
Sales Value (Rs.) 1134000 223200 180000 205200 1742400
Sales weight 0.65 0.13 0.10 0.12
Jt Cost on Sales Value (SalesValueWt X Jt Cost) 1083626 213285 172004 196085
Per Ton Cost 2007 2370 1911 1089
Seperable Cost per ton (Rs.) 78 84 34 16
Total Separable Cost 42120 7560 3060 2880 55620
Joint Cost 1665000
Total Cost 1720620
Profit 21780
Profit Margin 1.25
Profit Margin (Selling price x profit margin) 26.25 31 25 14.25
Production Cost (Selling Price- Profit) 2074 2449 1975 1126
Joint Cost allocated/ton (Prod Cost - Seperable
Cost) 1996 2365 1941 1110
MMC manufactures memory modules in two step process. Chip fabrication
and module assembly. In chip fabrication, each batch of raw silicon wafers
yields 500 standard chips and 500 deluxe chips. Chips are classified as
standard and deluxe on the basis of their density ( number of memory bits
on each chip). Standard chips have 500 memory bits per chip and deluxe
chips have 1000 memory bits per chip. Joint costs to process each batch are
$24000.
In module assembly each batch of standard chips is converted in to standard
memory modules at a separately identified cost of $1000 and then sold for
$8500. Each batch of deluxe chips is converted into deluxe memory
modules at a separately identified cost of $1500 and then sold for $25000.
Q1. Allocate joint costs of each batch.
Q2. Which method should MMC use?
Q3. MMC can further process each batch to 500 standard memory modules to yield
400 DRAM. The selling price per DRAM product will be $26. products at an
additional costs of $1600
Net Realizable Value Standard Delux Total
Step I Units Price Value Units Price Value
Sale Value Given 500 $8,500 $42,50,000 500 $25,000 $125,00,000 $167,50,000
Memory Bits per chip Given 500 1000
Step 2
Sperable Cost Given $1,000 $5,00,000 $1,500 $7,50,000
NRV at Split Off Pt $7,500 $37,50,000 $23,500 $117,50,000 $155,00,000
Total NRV of Both
products at Spilt off Pt $31,000
Joint Cost Given $24,000

Weightege 24% 76%

Joint Cost allocated $5,806 $18,194
Unit Jt Cost $11.6 $18.2
Total Cost per Chip $6,806 $19,694
Net Realizable Value Standard Delux Total
Step I
Physical Unit Method Units Price Value Units Price Value
Sale Value Given 500 $8,500 $42,50,000 500 $25,000 $125,00,000 $167,50,000
Memory Bits per chip Given 500 1000
Physical Meausres of Total Production 500 1000
Step 2
Weightage
Sperable Cost Given 33%
$1,000 $5,00,000 $1,500 67%
$7,50,000
Joint
NRV CostOff
at Split Alloted
Pt $8,000
$7,500 $37,50,000 $16,000 $155,00,000
$23,500 $117,50,000
Total
Total NRVCost
of Both $9,000 $17,500
Unit Jtatcost
products Spilt off Pt divide/no of units $16.0 $16.0 $31,000
Joint Cost Given $24,000
Sales Value Method
Standard Delux
Sales Value $42,50,000 $125,00,000
Sales Value Proportion 25.4% 74.6%
Joint Cost Allocaiton $6,089.55 $17,910.45
Seperable Cost $1,000 $1,500
Total Cost $7,089.55 $19,410.45
Jt Cost per unit $12.18 $17.91