ACC107

MANAGEMENT ACCOUNTING

Lecture 8
Process Costing

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 CHAPTER 11: PROCESS COSTING

• The basics of process costing

• Losses in process costing
• Losses with scrap value
• Losses with a disposal cost
• Valuing closing work in progress
• Valuing opening work in progress : FIFO
• Valuing opening work in progress : AVCO

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 LEARNING OBJECTIVES
- describe the characteristics of process costing.
- describe the situations where the use of process costing would be appropriate.
- explain the concepts of normal and abnormal losses and abnormal gains.
- calculate the cost per unit of process outputs.
- prepare process accounts involving normal and abnormal losses and abnormal
gains.
- calculate and explain the concept of equivalent units.
- apportion process costs between work remaining in process and transfers out of
a process using the weighted average and FIFO methods.
- prepare process accounts in situations where work remains incomplete.
- prepare process accounts where losses and gains are identified at different
stages of the process.
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THE BASICS OF PROCESS COSTING
Process costing is a costing method used where it is not possible to identify
separate units of production, or jobs, usually because of the continuous
nature of the production processes involved.
It is common to identify process costing with continuous production
Examples:
- Oil refining
- Paper
- Foods and drinks
- Chemicals

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FEATURES OF PROCESS COSTING
• The output of one process becomes the input to the next until
the finished product is made.
• The continuous nature of production in many processes means
that there will usually be closing work in progress which must be
valued.
• Often losses result in process due to spoilage, wastage,
evaporation and so on.
• Output may be a single product, but there may also be a by-
product or joint product.

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FRAMEWORK FOR DEALING WITH
PROCESS COSTING
Process costing is centered around four key steps.
The exact work done at each step will depend on whether there are
normal losses, scrap, opening and closing work in progress.
 Step 1 - Determine output and losses
 Step 2 - Calculate cost per unit of output, losses and WIP
 Step 3 - Calculate total cost of output, losses and WIP
 Step 4 - Complete accounts

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LOSSES IN PROCESS COSTING
Normal loss is the loss expected during a process. It is not
given a cost.
Abnormal loss is the extra loss resulting when actual loss is
greater than normal or expected loss, and it is given a cost.
Abnormal gain is the gain resulting when actual loss is less than
the normal or expected loss, and it is given a 'negative cost'.

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EXAMPLE

Suppose that input to a process is 1,000 units at a cost of $4,500.

Normal loss is 10% and there are no opening or closing stocks.
Determine the accounting entries for the cost of output and the cost
of the loss if actual output were as follows.
860 units (actual loss is 140 units)
920 units (actual loss is 80 units)

CPU = (total cost – scarp of normal loss) / expected

output
= 4,500/900 = $5 per unit

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• 860 units (actual loss is 140 units)
Process Cost Account
Units $ Units $
Costs 1,000 4,500 Normal loss 100 -
Abnormal loss 40 200
Good output 860 4,300
1,000 4,500 1,000 4,500

• 920 units (actual loss is 80 units)

Process Cost Account
Units $ Units $
Costs 1,000 4,500 Normal loss 100 -
Abnormal 20 100 Good output 920 4,600
gain

1,020 4,600 1,020 4,600 9

LOSSES WITH SCRAP VALUE
Scrap is 'Discarded material having some value.‘
Loss or spoilage may have scrap value.

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EXAMPLE (LOSS WITH SCRAP VALUE)
3,000 units of material are input to a process.
Process costs are as follows.
Material $11,700
Conversion costs $6,300
Output is 2,000 units.
Normal loss is 20% of input.
The units of loss could be sold for $1 each.
Prepare appropriate accounts.
CPU = (total cost – normal loss scrap value) / expected output
= (18,000 - 600)/2,400 = 7.25
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 Process Account
Units $ Units $
Materials 3,000 11,700 Normal loss 600 600
Conversion 6,300 Abnormal loss 400 2,900
Output 2,000 14,500
3,000 18,000 3,000 18,000

Abnormal Loss Account

$ $
Process a/c 2,900 Scrap a/c 400
Abnormal loss 2,500
2,900 2,900

Scrap Account
$ $
Normal loss 600 Cash 1,000
Abnormal loss 400
1,000 1,000 12
LOSSES WITH A DISPOSAL COST
The basic calculations required in such circumstances are as
follows.
 Increase the process costs by the cost of disposing of the
units of normal loss and use the resulting cost per unit to
value good output and abnormal loss/gain.
 The normal loss is given no value in the process account.
 Include the disposal costs of normal loss on the debit side of
the process account.
 Include the disposal costs of abnormal loss in the abnormal
loss account and hence in the transfer of the cost of abnormal
loss to the statement of profit or loss.

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 EXAMPLE WITH DISPOSAL COST
Suppose that the input to a process was 1,000 units at a cost of
$4,500. Normal loss is 10% and there are no opening and
closing inventories. Actual output was 860 units and loss units
has to be disposed at a cost of $0.90 per unit.

𝑁𝑜𝑟𝑚𝑎𝑙 𝑙𝑜𝑠𝑠 = 10% × 1,000 = 100 𝑢𝑛𝑖𝑡𝑠

𝐴𝑏𝑛𝑜𝑟𝑚𝑎𝑙 𝑙𝑜𝑠𝑠 = 900 − 860 = 40 𝑢𝑛𝑖𝑡𝑠

4500+(100×0.90)
𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 = = $5.10
900
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 ACCOUNTS
Units $ Units $
Cost of input 1,000 4,500 Output 860 4,386
Disposal cost of NL 90 Normal loss 100
Abnormal loss 40 204
1,000 4,590 1,000 4,590

$ $
Process account 204 Statement of Profit and 240
loss
Disposal cost (40 x $0.90) 36
240 240
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VALUING CLOSING WORK IN
PROGRESS
When units are partly completed at the end of a period (and hence there is
closing work in progress), it is necessary to calculate the equivalent units of
production in order to determine the cost of a completed unit.
Equivalent units are notional whole units which represent incomplete work, and
which are used to apportion costs between work in process and completed
output.

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 EXAMPLE
Calculation of equivalent units (EU)

Materials Labour and overhead

Total units Degree of Equivalent Degree of Equivalent
completion units completion units
Finished 800 100% 800 100% 800
output
Closing WIP 200 100% 200 25% 50
1000 1000 850

Statement of costs per equivalent unit (EU)

Materials Labour and

Overhead
Cost incurred in the period $6200 $2850
Equivalent units of work done 1000 850
Cost per equivalent unit (approx.) $6.20 $3.3529 17
 EXAMPLE CONTINUED
Statement of evaluation

MATERIAL LABOUR & OVERHEAD

Item Equiv Cost per Cost Equiv Cost per EU Cost Total
units EU units cost
$ $ $ $ $
Finished out put 800 6.20 4,960 800 3.3529 2,682 7,642
Closing W.I.P 200 6.20 1,240 50 3.3529 168 1,408
1,000 6,200 850 2,850 9,050

Process Account
Units $ Units $
Materials 1,000 6,200 Finished goods 800 7,642
Labour overhead 2,850 W.I.P 200 1,408
1,000 9,050 1,000 9,050
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VALUING OPENING WORK IN PROGRESS: FIFO

Opening work in progress is partly complete at the beginning of a

period and is valued at the cost incurred to date.
The FIFO method of valuation deals with production on a first in,
first out basis.
The assumption is that the first units completed in any period are
the units of opening inventory that were held at the beginning of
the period.

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VALUING OPENING WORK IN
PROGRESS: AVCO

Weighted average cost method of inventory valuation

calculates a weighted average cost of units produced from
both opening inventory and units introduced in the current
period.
By this method no distinction is made between units of
opening inventory and new units introduced to the process
during the accounting period.
The cost of opening inventory is added to costs incurred
during the period, and completed units of opening inventory
are each given a value of one full equivalent unit of
production.
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 CHAPTER 11: PROCESS COSTING

• The basics of process costing

• Losses in process costing
• Losses with scrap value
• Losses with a disposal cost
• Valuing closing work in progress
• Valuing opening work in progress : FIFO
• Valuing opening work in progress : AVCO

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JOINT PRODUCTS AND BY
PRODUCTS
Joint products are two or more products which are output from the
same processing operation, but which are indistinguishable from
each other up to their point of separation
 Example: in the oil refining industry where diesel fuel, petrol,
paraffin and kerosene are all produced from the same process.
A by-product is a supplementary or secondary product (arising as
the result of a process) whose value is small relative to that of the
principal product
 Example: in the timber industry by-products include sawdust,
small offcuts and bark.

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JOINT PRODUCTS VERSUS BY-
PRODUCTS
A joint product is regarded as an important saleable item, and so it
should be separately costed
 The profitability of each joint product should be assessed in the
cost accounts

A by-product is not important as a saleable item, and whatever

revenue it earns is a 'bonus' for the organisation
 Because of their relative insignificance, by-products are not
separately costed

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PROBLEMS IN ACCOUNTING FOR JOINT
PRODUCTS
Two main problems:
 How common costs should be apportioned between products, in
order to put a value to closing inventories and to the cost of sale
(and profit) for each product.
 Whether it is more profitable to sell a joint product at one stage of
processing, or to process the product further and sell it at a later
stage.

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DEALING WITH COMMON COSTS
The point at which joint products and by-products become
separately identifiable is known as the split-off point or separation
point.
Costs incurred up to this point are called common costs or joint
costs.
The main methods of apportioning joint costs are as follows:
 Physical measurement
 Relative sales value apportionment method; sales value at split-
off point

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PHYSICAL MEASUREMENT
With physical measurement, the common cost is apportioned to the joint products
on the basis of the proportion that the output of each product bears by weight or
volume to the total output.
This method has the following limitations.
 It is unsuitable where the products separate during the processes into different
states
 It does not take into account the relative income-earning potentials of the
individual products.

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 SALES VALUE AT SPLIT-OFF POINT
With relative sales value apportionment of common costs, the cost is allocated
according to the product's ability to produce income.
This method is most widely used because the assumption that some profit margin
should be attained for all products under normal marketing conditions is satisfied.
The common cost is apportioned to each product in the proportion that the sales
(market) value of that product bears to the sales value of the total output from the
particular processes concerned.

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ACCOUNTING FOR BY-PRODUCTS
A by-product has some commercial value it may be treated as
follows.
 Income from the sale of the byproduct may be added to sales
of the main product.
 The sales of the by-product may be treated as a separate
source of income, i.e. 'other income'.
 The sales income of the by-product may be deducted from the
cost of production or cost of sales of the main product.
 The net realisable value of the by-product may be deducted
from the cost of production of the main product.

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REFERENCES AND READINGS

 Colin Drury (2020) Chapter 5

 BPP (2022) Chapter 9

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QUESTIONS?

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