Process costing is a method used in mass-production industries to track product costs through various stages of manufacturing. It is especially useful for industries like oil refining, chemical manufacturing, and food processing where output is continuous and units are uniform. This method helps track all direct costs for labor, raw materials, and overhead expenses. By categorizing expenses based on their stage of production, businesses can accurately track production expenses and control inventory, track profit margins, identify inefficiencies, and set competitive prices.

Process costing differs from job costing, which is used for tracking costs for individual and unique products or projects. While process costing is suitable for the continual production of homogeneous products, job costing is more appropriate for businesses like contracting or custom furniture manufacturing where each job is different.

There are three main methods for calculating process costs: weighted average costs, standard costs, and first in, first out (FIFO). The weighted average method is the simplest and most frequently used, where all actual production costs for the period are added and divided by the number of units completed. Standard costs use estimated costs for each process stage, while FIFO creates different costs for units started in the previous period and in the current period.

To calculate process costs, businesses typically follow a step-by-step process that includes analyzing inventory, calculating equivalent units, tallying total applicable costs, calculating per-unit cost, and allocating costs to finished and unfinished goods. By following these steps and using the appropriate method for their industry, businesses can accurately track their production costs and make informed decisions about pricing, inventory management, and overall profitability.

Process Costing: A Comprehensive Guide

1. Understand Equivalent Units

Equivalent units account for the work completed so far on the incomplete items and are crucial for accurately allocating costs in a manufacturing process.

3. Tally Total Applicable Costs

When tallying total applicable costs, it’s important to add up the costs of various production stages that accumulate during the manufacturing process. These costs include direct material costs and conversion costs, which encompass direct labor and manufacturing overhead for each production process. The total cost of goods manufactured (COGM) is then proportionately applied between completed inventory and work in progress.

4. Calculate Per-Unit Cost

The per-unit cost calculation involves considering the costs for both completed units and partly finished equivalents at the end of the period. Costs for unfinished goods are typically expressed as a percentage of the total cost, reflecting the processing expenses incurred up to that point.

5. Allocate Total Costs to Finished and Unfinished Goods

Allocate total costs by dividing them between the number of products completed and the inventory that was in-process at the end of the period. For example, if there are 50,000 finished cracker boxes at $3.64 per box, the total cost would be $182,000. Additionally, if there are 5,000 in-process boxes at $3.64 each, the total cost would be $18,000.

This leaves you with a total production cost of $200,000, providing insight into the amount of money committed to work-in-process inventory.

Process Costing FAQ

What is meant by process costing?

Process costing involves accounting for production costs throughout a series of processes. It is particularly useful for businesses that mass-produce identical goods, such as gallons of gasoline or bags of potato chips, rather than tracking individual costs for each unit.

What are the 5 steps in process costing?

The five steps in process costing are:

• Analyze inventory at the beginning and end of the period.
• Calculate the number of units produced, including completed units and partly completed units.
• Add up all production costs, including direct materials and manufacturing costs.
• Compute the per-unit production cost by dividing total production costs by the number of units.
• Allocate costs proportionately to completed units and equivalent, or unfinished, units.

What is an example of process costing?

For example, a cardboard box maker produces 50,000 boxes in one quarter, with an additional 20,000 boxes half-completed, equivalent to 10,000 finished boxes. If production costs amount to $120,000, the per-unit cost is $2 per box. Costs are then allocated as follows: $100,000 for completed boxes (50,000 x $2) and $20,000 for partly completed or equivalent boxes (10,000 x $2).