Process Costing System: Examples, Methods, and Steps

Process costing helps make effective pricing decisions by providing accurate cost information that can help determine the product’s selling price. If a manufacturing unit is manufacturing two or more products, which are quite dissimilar to each other, weighted average method is used. Under this method, weighted average is computed and used in valuation of the incomplete units.

Since its introduction in the 1920s, process costing has been utilized in industries such as food processing, chemical manufacturing, and oil refining. When using process costing, the procedure that is used to manufacture a product is divided into well-defined processes. For each process, a separate account is opened to which all incurred costs are charged. The finished material of one process makes up the raw material of the next process. Hence, the cost of each process is transferred alongside the finished material to the next process until it ends in the finished stock account.

Use Accurate Data

The entire production activity is characterised by a number of stages of production, i.e., processes.
This type of process costing is used when companies find it too difficult or time-consuming to collect current information about the actual costs.
This is the term used to describe units that are not yet complete at the end of the period.
The mining industry uses process costing to calculate the cost of extraction and refining minerals.
Process costing is an essential tool for businesses that operate in the manufacturing industry.
In a process costing system, an item cost is determined by tracking the cost of each stage in the production process, rather than tracking the costs for each individual item.

Understanding these steps can help businesses accurately determine the cost of their products and make informed decisions regarding their production processes. Why have three different cost calculation methods for process costing, and why use one version instead of another? Alternatively, process costing that is based on standard costs is required for costing systems that use standard costs. In general, the simplest costing approach is the weighted average method, with FIFO costing being the most difficult. The process costing method involves dividing the production process into distinct stages or processes.

Process costing is widely used in the steel industry, where raw materials like iron ore and coal are processed into steel products. It assists in determining the cost of each process, including blast furnace operations, smelting, casting, rolling, and finishing. If mass produced televisions have the same parts, manufacturers can assign consistent prices to the products based on how much the products cost to manufacture overall.

Allocating Costs

Companies usually make use of this method in a process costing system when it is time-consuming or not convenient to collect the current information about the real costs. This can be done either using the weighted average method, standard costing method, or the first-in-first-out (FIFO) method. It is usually good accounting practice to carefully select the process costing method that best meets a business’s needs. Hence, a process costing system is used to allocate costs to an individual unit after a process of mass production. Sensors can also track process efficiency and identify bottlenecks in production lines. Using IoT-connected systems, utility use in manufacturing processes can be separated and tallied by time or location.

In these industries, the production process is continuous and standardized, making it difficult to determine the exact cost of producing each product unit. Process costing enables manufacturers to allocate costs across production to determine the cost per output unit. We calculate this by dividing the total cost by equivalent completed units in the production phase. The basis of equivalent units can be the weighted average, standard cost, or first-in-first-out inventory method. For instance, a typical example of when to use process costing is when determining the precise cost required to create one gallon of aviation fuel.

Capabilities to monitor and report operational costs, labor, and other expenditures related to production processes, an accurate analysis of manufacturing costs can be generated for process costing. MRP (Materials Requirement Planning) software encompasses all manufacturing resources. It includes equipment tracking, workforce direct labor and allocation, overhead costs, financial accounting, and component costs.

Equivalent Units

This information is useful in setting minimum inventory levels and ensuring that products are not overstocked. The process costing is suitable for the manufacturing companies where identical/homogenous products are produced and there is no gap in the process of production. Process costing provides a more accurate estimate of each unit’s production cost since the costs are allocated based on a predetermined rate. Job costing is less accurate since the actual prices may vary based on the specific requirements of each job. Process costing is simpler than job costing since the production process is standardized, and costs are allocated based on a predetermined rate.

This method assigns average costs to each unit, making it easier for businesses to track and manage their expenses. Understanding process costing is not just about keeping the books in order; it’s about gaining insights into operational efficiency and cost control mechanisms. The production volume can also influence the selection of a process costing method.

Operation cost in batch manufacturing

The main object of average method is to even out the fluctuations in prices and hence is used when the prices fluctuate widely during a particular period. Industries such as cement, soaps, steel, paper, chemicals, medicines, vegetable oils, rubber, etc., use this method to assign the costs. While recording and analyzing the myriad data points in an operation used to be a human chore, process monitoring solutions now assist humans with speed, accuracy, and analytics that couldn’t be achieved in the past. Other advantages directly related to market standing include lower prices, higher profit margins, and often a combination of the two.

By effectively implementing process costing, businesses can make informed decisions, set competitive prices, and maximize profitability.
The per-unit costs are then split according to the number of units completed & units that are under process.
In process costing unit costs are more like averages, the process-costing system requires less bookkeeping than does a job-order costing system.

For instance, by using this system, the firm can set prices according to the costs of production, and also management can assess profit margin by product and isolate problem products before they become serious issues. The total costs a company is responsible for during production can be affected by factors such as the number of products completed and the number of products left in process at the end of an accounting process costing suitable for period. This is one of the major reasons why a lot of large companies make use of the process costing method so that they can track the total costs and total inventory being produced. In this article, we will discuss when to use process costing and what this accounting method is about. Process costing methods are variations of the process costing system that businesses can employ based on their specific needs and production processes. Here are three commonly used process costing methods to arrive at production costs over an accounting period that reflects in financial statements.

Definition of process costing in accounting

This method provides a more accurate picture of the cost of production than the standard cost in industries where the cost of inputs fluctuates frequently. Process costing allocates costs to each production unit based on a predetermined overhead rate. This rate is determined by dividing the total overhead costs by the total number of units produced. In job costing, costs are allocated to each job or project based on the costs incurred. The weighted average method calculates the average cost of all units produced during a period by dividing the total cost of production by the total number of units produced.

This calculation helps determine the overall progress of production and ensures that both partially and fully completed units are considered when calculating costs. As one of the process costing system examples, let’s look at a supposed company, ABC Inc, that produces wire rods, that pass through multiple production departments. This process costing method is the most complicated process costing method compared to the weighted average and standard cost methods. In a situation whereby costs change significantly from one period to the next, the FIFO method can be used to get a more precise product costing. This process costing method is similar to the weighted average costing method, only that it uses an estimated standard cost for each process stage rather than actual costs.

Calculating the Cost per Equivalent Unit

This meticulous tracking ensures that all costs are properly accounted for and attributed to the appropriate stages of production. In conclusion, process costing is a valuable tool used in the manufacturing industry to calculate the cost of producing goods. It is a systematic approach that helps businesses to accurately determine the cost of producing a unit of a product by analyzing every step in the production process. The process costing method determines the cost of each production stage, from raw materials to finished goods. It helps management to understand the costs of producing goods and to identify areas where they can reduce costs. Once the accumulated costs are determined and equivalent units are calculated, the next step is to assign costs to fully completed units.

Job costing is more complex since each job or project may have different requirements and costs. Process costing helps businesses make informed pricing decisions by providing an accurate estimate of the cost of production. This information helps determine the selling price of the product, which is essential for profitability. Materials play a crucial role in process costing, as they are one of the main cost components of producing a product or service. In process costing, the cost of materials is tracked and allocated to each production stage in which they are used. Process costing provides accurate cost tracking of each stage of the production process, allowing companies to identify areas where costs can be reduced or optimized.