Process Costing

Process costing is designed for settings where products are indistinguishable from each other and pass through several processes or departments. This system accumulates costs for each process over a period, then averages these costs across all completed and partially completed units. Why is this important?
It allows management to measure efficiency, value closing stock accurately, and control costs at every stage.

Process costing is a method for collecting and assigning production costs to units of output in industries where products are manufactured in a continuous flow. Each process or department accumulates costs, and the total cost is divided by the number of units produced to arrive at an average cost per unit.

When is Process Costing Used?
This method suits industries such as chemicals, cement, oil refining, paper, and paint where production is standardized, and output is homogeneous. The focus is on tracking costs through processes that are usually sequential, with output from one process becoming input for the next.

Preparation of Process Accounts

a. Structure of a Process Account

Each process maintains its own account. Here's the typical format:

Every process account tracks all costs i.e., material, labor, overhead incurred in that process. At the end, outputs are transferred either to the next process or to finished goods, with losses recognized as normal or abnormal.

Normal and Abnormal Losses

a. Normal Loss

Normal loss is the expected wastage or loss inherent in the process under normal operating conditions. For example, in a chemical process, a certain percentage may always evaporate. This is anticipated and considered unavoidable.

• Normal loss units are credited in the process account, often at their scrap or realizable value.
• The cost of normal loss is absorbed by the good units produced. This slightly increases the cost per unit of output.

Normal loss is never transferred to the costing profit and loss account; it's built into the cost of production.

b. Abnormal Loss and Abnormal Gain

Abnormal loss is any loss over and above the normal loss. This could arise from avoidable inefficiencies, accidents, or unexpected breakdowns. Conversely, if actual loss is less than the normal loss, the difference is called an Abnormal Gain.

• Abnormal loss units are valued at the same cost per unit as good output and transferred to a separate abnormal loss account.
• Any scrap value from abnormal loss is credited to the abnormal loss account, with the net loss ultimately transferred to the costing profit and loss account.
• Abnormal gain (where actual loss is less than normal) is treated similarly, but it results in a credit to the costing profit and loss account.

Equivalent Production

a. Meaning and Purpose

What if all units aren't 100% complete at period end? Equivalent production expresses incomplete units as their equivalent in fully completed units, allowing for proper cost allocation between finished output and closing work-in-progress (WIP).

b. Calculation Methods

• FIFO Method: Assumes that opening WIP is completed first. Costs are segregated between those spent in the earlier period (on opening WIP) and costs incurred this period.
• Weighted Average Method: Averages out costs of opening WIP and current period costs over all production (including closing WIP).

Each method yields slightly different per-unit costs, and exam questions may specify which to use. Always pay close attention to the degree of completion for materials, labor, and overhead when calculating equivalent units.

Example: Calculation Involving Normal and Abnormal Loss

Let's see how the theory translates into a practical scenario:

Scenario: 10,000 units are introduced into a process. Normal loss is estimated at 10%. Actual output is 8,800 units. Scrap value of normal loss is ₹2 per unit. Total process costs (excluding scrap value) are ₹88,000.

1. Calculate normal loss and abnormal loss units.
2. Compute the cost per unit for good output.
3. Show the process account.

Step 1: Calculate normal loss and abnormal loss.
Normal loss = 10% of 10,000 = 1,000 units.
Expected output = 10,000 - 1,000 = 9,000 units.
Actual output = 8,800 units.
Abnormal loss = Expected output - Actual output = 9,000 - 8,800 = 200 units.

Step 2: Compute net process cost and cost per unit.
Scrap value from normal loss = 1,000 units × ₹2 = ₹2,000.
Net process cost = ₹88,000 - ₹2,000 = ₹86,000.
Cost per unit = ₹86,000 / (9,000 - 200) = ₹86,000 / 8,800 = ₹9.77 per unit (rounded to two decimals).

Step 3: Prepare the process account.

Particulars	Units	Amount (₹)	Particulars	Units	Amount (₹)
To Input	10,000	88,000	By Normal Loss	1,000	2,000
			By Abnormal Loss	200	1,954
			By Output (to next process)	8,800	85,846

Where:
Abnormal Loss value = 200 units × ₹9.77 = ₹1,954
Output value = 8,800 units × ₹9.77 = ₹85,846

Keep practicing such questions. Focus on the logic—what flows in, what is lost (normally or abnormally), and what comes out. This clarity will serves you well in understanding the flow of costs and using this knowledge to improve efficiency and profitability.