Chapter 2

Introduction to Process Costing

Learning Outcomes
 Discuss the basic mechanics of process costing system,
 Prepare process accounts from raw materials to finished
goods.
References:-
• Essential Reading :

• Periasamy, P., Textbook of Financial Cost and Management Accounting, Global Media.

• http://ebookcentral.proquest.com/lib/momp/detail.action?docID=3011183

• Arora, M N., Advanced Cost Accounting : Theory, Problems and Solutions, Himalaya
Publishing House
• http://ebookcentral.proquest.com/lib/momp/detail.action?docID=588039

• Suggested Reading :

• Arora, M N., Cost and Management Accounting : Theory, Problems and Solutions, Himalaya
Publishing House
Introduction
In many industries, for manufacturing a product, the raw
material has to pass through several distinct stages of
manufacture in a pre-determined sequence. Each such stage of
manufacture is called a 'process'.
The goods produced are identical and all factory processes
are standardised.
Method of cost ascertainment in such industries is known
as process costing in which costs are compiled for each process
by preparing a separate account of each process.
Definition
Charles T. Horngren defines process costing as "a method of
costing deals with the mass production of the like units that
usually pass the continuous fashion through a number of
operations called process costing."
Characteristics of Process
Costing
1. Continuous or mass production where products which passes through distinct
process or operations.
2. Each process is deemed as a separate operations or production centers.
3. Products produced are completely homogenous and standardized.
4. Output and cost of one process are transferred to the next process till the finished
product completed.
5. Cost of raw materials, labour and overheads are collected for each process.
6. The cost of a finished unit is determined by accumulated of all costs incurred in
all the process divided by the number of units produced.
7. The cost of normal and abnormal losses usually incurred at different stages of
production is added to finished goods.
8. The interconnected processes make the final output of by-product or joint
products possible.
Job Costing Vs Process Costing
Job Costing Vs Process Costing
cont..
Advantages of Process Costing
1. Determination of the cost of process and unit cost is possible
at short intervals.
2. Effective cost control is possible.
3. Computation of average cost is easier because the products
produced are homogenous.
4. It ensures correct valuation of opening and closing stock of
work in progress in each process.
5. It is simple to operate and involve less expenditure.
Disadvantages of Process
Costing
1. Computation of average cost does not give the true picture
because costs are obtained on historical basis.
2. Operational weakness and inefficiencies on processes can be
concealed.
3. Valuation of work in progress is done on estimated basis, it
leads to inaccuracies in total costs.
4. It is difficult to measure the performance of individual
workers and supervisors.
Stages in Process Costing
1. The factory is divided into a number of processes and an
account is maintained for each process.
2. Each process account is debited with material cost, labour
cost, direct expenses and overheads allocated or
apportioned to the process.
3. The output of process is transferred to the next process in
the sequence. In other words, finished output of one process
becomes input of next process.
4. Finished output of last process is transferred to the finished
goods account.
Stages in Process Costing
Losses in Process Costing
Normal Loss
The amount of loss which cannot be avoided because of the nature of
material or process is called as normal process loss. Such a loss is quite expected
under normal conditions. It is caused by factors like chemical change,
evaporation, withdrawals for tests or sampling, unavoidable spoiled quantities,
etc.
Abnormal Loss
This type of loss consists of loss due to carelessness, machine break-down,
accident, use of defective materials, etc. It arises due to abnormal factors and
represents a loss which is over and above the normal loss. If the actual loss is
greater than normal loss, it is known as abnormal loss.
Losses in Process Costing
Abnormal Gain
The normal process loss represents the loss that would be
expected under normal conditions. It is an estimated figure.
The actual loss may be greater or less than the normal loss.
If the actual loss is greater than normal loss, it is known as
abnormal loss. But if actual loss is less than normal loss, a gain
is obtained which is termed as abnormal gain.
 Accounting Treatment of Losses
in Process Costing
Normal Loss
It is a fundamental costing principle that the cost of normal losses
should be borne by the good production. Normal loss is generally
determined as a percentage of input.
Sometimes such a loss is due to loss of weight, say, due to
evaporation or chemical action. Since such a wastage is not physically
present, obviously it cannot have any value.
However, when normal loss is physically present in the form of scrap,
it may have some value, i.e. it may be sold at some price. Whenever
scrapped material has any value, it is credited to the Process Account.
Accounting Treatment of Losses
in Process Costing
Abnormal Loss
Unlike normal loss, abnormal loss is not absorbed by good-
production, rather it is transferred to Costing Profit and Loss
Account.
The value of abnormal loss is calculated by using the following
formula: Normal Cost of Normal Ouput
 No. of units of Abnormal Loss
Normal Output (in units)
It is credited to the process accounts.
Accounting Treatment of Losses
in Process Costing
Abnormal Gain
The value of abnormal gain is calculated in a manner similar to
abnormal loss. It is shown on the debit side of the Process
Account and credit side of the Abnormal Gain Account. Like
abnormal loss, it is ultimately transferred to Costing Profit and
Loss Account.
The value of abnormal gain is calculated by using the following
formula: Normal Cost of Normal Ouput
 No. of units of Abnormal Gain
Normal Output (in units)
Preparation of Process Accounts
(Without process losses and no WIP)
Solved Problem 1
Product Y passes through three distinct processes to completion. These
processes are numbered 1, 2, and 3 respectively. During the week ended 15th
January, 2020, 500 units are produced. The following information is
obtained:
Particulars Process 1 Process 2 Process 3
Direct Materials RO 350 RO 160 RO 150
Direct Labor RO 250 RO 200 RO 250
The overhead expenses for the period were RO 140 apportioned to each
process on the basis of wages. Prepare all process accounts.
Solution
Preparation of Process Accounts
(Without process losses and no WIP)
Practice Problem 1
Following figures show the cost of a product which passes through
three processes. In January 2020, 1000 units were produced. Prepare
the process accounts and find out cost per unit of each process.
Particulars Process I (in RO) Process II (in RO) Process III (in RO)
Raw Materials 50,000 30,000 20,000
Wages 30,000 25,000 25,000
Direct Expenses 7,000 3,000 5,000
Overhead expenses were RO 12,000 and it should be apportioned on
the basis of wages.
Preparation of Process Accounts
(With process losses and no WIP)
• Solved Problem 2
In Process A, 1,000 units were introduced at a cost of RO
20,000, the other expenditure incurred in the process were
material RO 10,000 and wages RO 4,950. The Normal loss is 10%
during production and possess a scrap value of RO 3 each. The
output of process A was 800 units. Find out the value of
Abnormal Loss.
Solution
Preparation of Process Accounts
(With process losses and no WIP)
Practice Problem 2
In process Y, 75 units of a commodity were transferred from
process X at a cost of RO 1,310. The labour and overhead
expenses amounting to RO 190 were incurred. 20 percent of the
units entered are normally lost and sold @ RO 4 per unit. The
output of the process was 70 units. Prepare process Y Account
Practice Problem 3
Practice Problem 4
Practice Problem 5
Practice Problem 6

And what is the profit of each processor

Practice Problem 7
Practice Problem 8
Al Marai Company uses 2 processes to manufacture fruit juices namely Mixing and packing.
The output from process mixing becomes input for packing. Al Maria requests you to prepare
process accounts and calculate the cost per unit at the end of each process.

Particulars Mixing process Packing process

Raw material 4000 KG @ RO 2 per kg

Other Direct material 1200 RO 800 RO

Direct labor 800 RO 600 RO

Production overheads 780 RO 806 RO

Normal Loss 2% 10%

Output 3600 KG 3480 KG

Scrap is realized at 400 Bz per unit and 600 Bz per unit for mixing and packing respectively
Practice Problem 9
Al Masaya LLC uses two process to complete its product- Process A and Process B. Following are the details of
the processes.

Units introduced = 2000 units at the rate of RO. 2 per unit

Particulars Process A Process B

Direct material 2000 1600
Direct labor 1000 1800
Direct expenses 400 200
Selling Price per unit 10 8
Normal loss (As a % of input) 10% 8%
Normal loss realization rate RO. 1 per unit RO. 0.500Bz per
unit

Assume that ½ of the output of process A is transferred to process B and remaining sold in the market. The
entire output of process B was sold in the market. You are required to prepare process A’s and B’s account
Thank you.