# Features Of Process Costing Accounting Essay

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The method of costing basically aims at finding out the cost of a product or service, which is offered by the organisation. Process costing is also a method of costing which is used in those industries where the production is in in continuous process, i.e. the output of one process becomes the input of the subsequent process and so on. Examples of such industries are paint works, chemical plants, food manufacturing, oil refining, paper mill, textile mills, banking industries, sugar factories, fruit canning, dairy and so on. In such industries, the output is put in the first process and the output of each process becomes the input of the subsequent process till the final product emerges from the last process. This method is employed where it is not possible to trace the items of the prime cost (which consists of all direct costs) to a particular order because its identity is lost in the continuous production.

## Features of Process Costing

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The objective of process costing is to find out the cost of each process by identifying the direct costs with the particular process and apportioning the indirect costs i.e. overheads to each process on some suitable basis.

The features of process costing are as follows:

The production is in continuous flow and is uniform. All units coming out as finished products are uniform with each other in all respects.

The product is manufactured in a continuous flow and hence individual units lose their identity.

Cost per process is ascertained and cost of each process is transferred to the subsequent process until the finished product emerges.

The unit cost is obtained by dividing the total cost for a particular period by the total output. This is the average cost of the product unit.

In a particular process normal and abnormal losses emerges. Normal loss is loss, which is inevitable in any process and thus cannot be avoided or controlled. Any loss, which, is over and above, the normal loss is called as abnormal loss and is to be accounted for separately. For example, if 1000 units are put in process 1 and it is anticipated that there will be a normal loss of 1% in the process, the output expected is 1000 - 1% of 1000 that is 990. If actual production is 980, there is an abnormal loss of 10 units. On the other hand if the production is 995, there is an abnormal gain of 5 units. Abnormal gain and abnormal loss are to be accounted for in the process cost accounts.

Sometimes each process may be treated as profit centre and so while transferring the cost from one process to another, a percentage of profit is added in the cost of that process. This is known as inter process profit and needs to be accounted for in the process cost accounts.

Though the cost per unit is computed by dividing the total cost by the number of units, there can be a problem on incomplete units at the end of a particular accounting period. In such cases equivalent units have to be worked out for computing the cost per unit.

GENERAL PRINCIPLES

Following general principles are followed for cost determination under Processes Costing:

The production activities of the factory are classified by processes or departments. Each process or department includes a number of operations, none of which is separately measurable and each of which completes a distinct stage in the manufacture of the product. The boundaries of the are determined by

Jurisdiction or supervision,

Similarity of work performed, and

Physical location of men and machines in the plant.

All direct and indirect cost of particular period is classified by processes. Each process account is debited with the amount of direct material, and labour and with a proportionate part of overhead expenses.

Production in terms of physical quantities is recorded in respective process accounts.

The total cost of each process is divided by the total production of the process and average cost per unit for the period is obtained.

In case certain products remain in process at the end of a period, their stage of completion is estimated and inventory is computed in terms of completed products. For example, if 20 units are in process and it is estimated that they are complete only to the extent of 25%, completed products will be taken as 5 units only.

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When products are processed in more than one department, costs of one department are transferred to the next department as initial costs. The total cost and cost per unit is thus determined by cumulating costs of different departments.

In case of loss or spoilage of units in a department, the loss is borne by the units produced in that department. Thus the average cost per unit is increased.

## Preparing Process Cost Accounts

The objective of the process costing is to work out the cost of each process, transfer the same to the subsequent process and finally ascertain the total cost of production. Therefore it is necessary to charge various costs to each process. For this, the factory is divided into distinct processes or operations and an account is kept of each process to which all the costs are debited. The following are the various elements of cost, which are shown in the process accounts.

Materials: Raw materials required for each process is drawn from stores against material requisitions. Proper procedure like preparing and authorizing the requisition, pricing of the issues, return of material to the stores, transfer of material from one process to another should be followed with issuing the materials. Cost of materials consumed should be computed as per the method employed for pricing of the issues and the cost should be debited to the process account.

Labour: Wages paid to workers and supervisory staff should be charged to the particular process if they can be identified with it. If workers work on two or more processes, proper allocation should be made according to some basis like time spent on each process.

Direct Expenses: If expenses are identifiable with a particular process, they should charge to that process. For example, cost of electricity, depreciation may be charged directly to a process if they are identifiable with it.

Overheads: By nature, overheads are indirect expenses and hence cannot be identified with a particular process. These expenses can be apportioned on some suitable basis and charged to the process.

DIFFERENCE BETWEEN JOB COSTING AND PROCESS COSTING

The basic points of difference between job costing and process costing can be put as under:

## Process Costing

Cost computation

Cost Unit

Nature

Supervision and control

Completion of job

Specific orders

Costs are computed for each job separately.

The cost unit in case of job costing is a 'job."

Each job may be different. Production is not continuous.

Greater supervision and control by the management is required.

Completion of job is necessary for computation of the job. Once the job is completed all costs are added to ascertain the total cost of the job.

Job is executed against orders.

Costs are computed for each process over a period of time i.e. production for a process during a given period.

The cost unit in case of process costing is a "process."

Each process for the total output is the same and generally production is continuous.

Comparatively less control is required since the work in processes gets standardised.

Completion of the job is not awaited. For accounting cost per unit is computed by dividing the total cost by process output.

It is not necessary under process costing. Goods are for mass consumption and hence they may be produced on a continuing basis.

JOB COSTING

In case of special order concerns products produced or jobs undertaken are of diverse nature. They involve materials and labour in different quantities and entail different amount of overhead costs. In such concerns, it is necessary to keep a separate record of each lot of products or jobs from the time the work on the job or product begins till it is completed. A separate job card or cost sheet is maintained for each job or product in which all expenses of materials, labour, overheads are entered and cost of completing a job or manufacturing product is found out. Such a cost system is known as job or terminal or specific costing.

## Features of job costing:

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The main features of job costing are as follows:

It is a specific order costing.

A job is carried out or a product is produced to meet the specific requirements of the order.

Job costing enables a business to ascertain the cost of a job on the basis of which quotation for the job may be given.

While computing the cost, direct costs are charged to the job directly as they are traceable to the job. Indirect expenses i.e. overheads are charged to the job on some suitable basis.

Each job completed may be different from other jobs and hence it is difficult to have standardization of controls and therefore more detailed supervision and control is necessary.

At the end of the accounting period, work-in-progress may or may not exist.

GENERAL PRINCIPLES

Following general principles are followed for cost determination under Job Costing:

Ascertaining profit or loss: It helps in finding out the cost of production of every order and thus helps in ascertaining profit or loss made out on its execution. The management can judge the profitability of each job and decide its future course of action.

Accurate estimates: It helps the management in making more accurate estimates about the costs of similar jobs to be executed in future on the basis of past records. The management can conveniently and accurately determine and quote prices for orders of a similar nature which are in prospect.

Exercising control: It enables the management to control operational inefficiency by comparing actual costs with the estimated ones.

## Factors affecting job costing:

A system of job costing should be adopted after considering the following factors:

Each order or job costing should be continuously identifiable from the stage of putting in raw material to the stage of completion.

The system is very expensive because it requires a lot of clerical work in estimating costs, designing and scheduling of production. It should therefore, be adopted when absolutely warranted.

## Key points of Job costing process:

Establish a method of recording costs.

Obtain a set of management accounts

Produce an operating account

Allocate costs

Obtain satisfactory job information

Calculate the job cost.

The method of job costing offers the following advantages:

It helps in identifying profitable and non-profitable jobs.

It facilities preparation of tenders, estimates, etc.

It enables the management to identify the person or department who has been responsible for excessive spoilage or defective work.

It facilitates the application of "cost plus" formula while accepting government orders.

Cost information relating to completed jobs helps the management in knowing the trend of different cost components for future cost control purposes.

## Limitations of job costing:

Job costing suffers from certain limitations:

It is said that it is too time consuming and requires detailed record keeping. This makes the method more expensive.

Record keeping for different jobs may prove complicated.

Inefficiencies of the organizations may be charged to a job though it may not be responsible for the same.

In spite of the above mentioned limitations, job costing is still an extremely useful method for computation of the cost of a job. The limitation of time consuming can be removed by computerization and this can also reduce the complexity of the record keeping.

Examples of industries where JOB COSTING is applied:

Printing shops

Ship - builders

Custom furniture manufacturer

Contractors

Accounting and law firms

Medical clinics

Examples of industries where PROCESS COSTING is applied:

Chemical plants

Food processors

Textile companies

Petroleum products manufacturer

Glass factories

## Banking industries

Household appliance manufacturers

Lumber and pulp mills

Sugar factories

Job order costing is used in service organizations such as law firms, advertising agencies, hospitals as well as manufacturing companies. In an advertising agency each advertising campaign is a 'job' and costs for direct materials (customs, props, film, etc.) and labour (actors, directors and extras) are accounted for and charged to each advertising campaign's job cost sheet.

A share of the studio's overhead costs such as utilities, wages of maintenance workers, depreciation of tools and so forth, is also charged to each advertising campaign. In an advertising agency, the advertising campaign is not on continuous basis rather it is only when order from customers is received and that too as per the specifications of the customers. Also each advertising campaign (job) can be different from the other one. Thus, the method used in such type of business organization is the job costing or job order costing. A job may be a product, unit, batch, sales order, project, contract, service, specific program or any other cost objective that is apparent and unique in terms of materials and other services used.

Also, the job order costing is a versatile and widely used costing method and may be encountered in virtually any organization that provides diverse products or services.

## Banking Process:

The system of process costing is suitable for industries involving continuous production of the same product or products through the same processes. In a business like banking where product passes through different stages, each distinct and well defined, process costing is employed. A separate account for each process is opened and all expenditure is charged there on. The objective of process costing is to find out the cost of each process by identifying the direct costs with the particular process and apportioning the indirect costs i.e. overheads to each process on some suitable basis. The units coming out the process as the finished output are uniform in all respects and hence the cost per unit is computed.

The method of process costing is applicable where the output results from a sequence of continuous or repetitive operations or processes and products are identical and cannot be segregated. Therefore, bank uses process costing to determine the cost of checking account withdrawal.

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QUESTION 3

Why might an advertising agency use job costing for an advertising campaign by Pepsi, whereas a bank uses process costing to determine the cost of checking account withdrawal.

## Date of submission: 10th OCTOBER 2012

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