UNDERSTANDING THE PROCESS COSTING SYSTEM

PROCESS COSTING

Companies use process costing to calculate item costs by tracking the cost of each stage in the manufacturing process rather than tracking expenses for each individual item. They divide the overall cost by the number of products after adding up the costs of all the phases in the process. This is known as the cost per unit. When there is mass manufacturing of identical items and the costs associated with individual units of output cannot be distinguished from one another then here process costing is employed. A hybrid costing approach is utilized when a production process includes both mass manufacturing and customized parts.

TYPES OF PROCESS COSTING SYSTEM

The process costing system is of three types. The three types are weighted average costs, standard costs, and first-in-first-out (FIFO). The details of these types are:

WEIGHTED AVERAGE COST:

This version implies that all expenses, whether from the previous or current period, are aggregated and assigned to generated units. It is the most straightforward variant to compute.

STANDARD COSTS:

The prices in this version are standard. Its computation is identical to weighted average costing, except that standard costs are allocated to production units rather than real costs; total costs are accumulated based on standard costs, and the difference is charged to a variance account.

FIRST IN- FIRST OUT (FIFO):

FIFO is a more complicated computation that produces two levels of costs: one for any units of production that were begun but not finished in the previous production period, and another for any units of production that are started in the current period.

Why are there three distinct cost calculation techniques for process costing, and why do you pick one over the other?

For various cost accounting purposes, different computations are necessary. The weighted average technique is utilized when there is no standard costing system in place or when the cost changes from period to period are so little that the management team does not require the small increase in costing accuracy that the FIFO method provides. For costing systems that employ standard costs, process costing based on standard costs is required instead. If the comparison is to be done, it is proven that weighted average cost is the simplest type of the process costing system and the most complex and difficult type is first in first out (FIFO).

It’s particularly beneficial in instances when firms make such a diverse range of goods that assigning real prices to each one is problematic; under the other process costing techniques, which both utilize actual costs, there’s a good risk that costs for various products may become jumbled up. Finally, FIFO costing is used when product costs change significantly from period to period, to the point where the management team needs to know the new costing levels in order to re-price products appropriately, determine if there are internal costing issues that need to be resolved, or possibly change manager performance-based compensation. The weighted average technique is the easiest costing method, whereas FIFO costing is the most complicated.

STEPS OF PROCESS COSTING

Process costing considers work in progress, things that have entered but not finished the manufacturing process, at the beginning and end of each period to properly estimate the cost of producing each unit. In process costing, there are five main steps.

ANALYZE THE INVENTORY:

The first stage in determining process costing is to evaluate the inventory by analyzing the inventory’s cost-flow. A company can determine the amount of inventory that was accounted for at the start of the period, the amount that was completed during the accounting period, and how much of the inventory was left as in-process at the end of the accounting period by determining the costs of each process of production.

CALCULATE EQUIVALENT UNITS:

To account for things that remain incomplete at the end of each period, process costing employs the idea of comparable units. Multiply the number of unfinished units at the end of the period by a percentage reflecting their progress through the manufacturing process for this stage.

CALCULATE APPLICABLE COSTS: 

Add up the expenses of all phases of production, including direct materials and conversion charges.

COST PER UNIT CALCULATION:

Calculate the expenses per unit once you’ve estimated all of the costs involved with the manufacturing process for both finished and in-process inventories. At the conclusion of the accounting period, this comprises the costs of completed units and equivalents of finished units.

ALLOCATE COSTS FOR COMPLETE AND INCOMPLETE PRODUCTS:

Costs for completed and finished work-in-progress inventory should be allocated to the appropriate accounts. This can assist you to figure out how much money you have locked up in your current work-in-progress inventory.

Consider reading: What is a Job Order Costing System?

BENEFITS OF PROCESS COSTING

A company can get many benefits from process costing. Some of which are as follows:

EASE OF USE:

Process costing can help companies improve their operations to reduce costs, so they can offer products at more competitive prices. It highlights the cost of each step in the manufacturing process, helping companies target redundant, outdated, or inefficient processes.

FLEXIBILITY:

Companies may use process costing to enhance their operations and lower expenses, allowing them to provide products at more competitive rates. It shows the cost of each stage in the production process, allowing firms to identify procedures that are redundant, obsolete, or inefficient.

TRACK:

Through the process costing system, the company can see if the money is being spent correctly and at the right place and if the company is under budget. The cost can be determined at each step.

AFFORDABILITY:

It is simple and affordable than the other process used in accounting.

ACCURACY:

The cost of each product can be easily and very accurately accumulated.

QBM GUIDELINES

Various corporations and multinational organizations use process costing systems to calculate their product line cost as it helps a business forecast the future investments and profits of a company. They can predict the sales and budget for manufacturing their products. There are many enterprise resource planning systems that incorporate process costing systems while QBM is equipped with a wide variety of features including process costing features. QBM is an enterprise resource planning system that uses the latest technology to make sure that businesses stay ahead and can compete globally.

So, what are you waiting for? Contact us today to try a QBM edition.