1. Process Costing Ppt 6l3e5b

PROCESS COSTING CH:4 H&P

■ 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.

Process costing is used where there is a continuous flow of identical units and it is common to identify it with continuous production such as the following. • Oil refining • The manufacture of soap • Paint manufacture • Food and drink manufacture

■ CIMA Official Terminology – Process costing is a 'form of costing applicable to continuous processes where process costs are attributed to the number of units produced. – This may involve estimating the NUMBER OF EQUIVALENT UNITS in stock at the start and end of the period under consideration.'

1. Features of process costing ■ The features of process costing which make it different from other methods of costing such as job or batch costing are as follows. – (a) The continuous nature of production in many processes means that there will usually be closing work in progress which must be valued. In process costing it is not possible to build up cost records of the cost of each individual unit of output because production in progress is an indistinguishable homogeneous mass. – (b) There is often a loss in process due to spoilage, wastage, evaporation and so on. – (c) The output of one process becomes the input to the next until the finished product is made in the final process. – (d) Output from production may be a single product, but there may also be a by-product (or by-products) and/or t products.

2. The basics of process costing ■ 1. Process s: Costs incurred in processes are recorded in what are known as process s. A process has two sides, and on each side there are two columns – one for QUANTITIES (of raw materials, work in progress and finished goods) and one for COSTS. (a) On the left hand side of the process (b) On the right hand side of the process we record the inputs to the process and the cost of these inputs.

we record what happens to the inputs by the end of the period. (i) Some of the input might be converted So we might show the quantity of material input into finished goods, so we show the to a process during the period and its cost, the units of finished goods and the cost of cost of labour and the cost of overheads. these units. (ii) Some of the material input might evaporate or get spilled or damaged, so there would be losses. So we record the loss units and the cost of the loss. (iii) At the end of a period, some units of input might be in the process of being turned into finished units so would be work in progress (WIP). We record the units of WIP and the cost of these units.

■ The quantity columns on each side of the should total to the same amount. Why? Well think about it. If we put 100 kgs of material in to a process (which we record on the left hand side of the ) we should know what has happened to those 100 kgs. Some would be losses maybe, some would be WIP, some would be finished units, but the total should be 100 kgs. ■ Likewise the cost of the inputs to the process during a period (ie the total of the costs recorded on the left hand side of the ) is the cost of the outputs of the process. If we have recorded material, labour and overhead costs totalling $1,000 and at the end of the process we have 100 finished units (and no losses or WIP), then that output cost $1,000. PROCESS Units Material

Units 1,000

$ 11,000

Labour

4,000

Overhead

3,000 1,000

18,000

Units

$

Closing WIP

200

2,000

Finished units

800

16,000

1,000

18,000

Example: basics of process costing ■ Suppose that Purr and Miaow Co make squeaky toys for cats. Production of the toys involves two processes, shaping and colouring. ■ During the year to 31 March 20X3, 1,000,000 units of material worth $500,000 were input to the first process, shaping. Direct labour costs of $200,000 and production overhead costs of $200,000 were also incurred in connection with the shaping process. ■ There were no opening or closing inventories in the shaping department. The process for shaping for the year ended 31 March 20X3 is as PROCESS 1 (SHAPING) follows. Units

Direct materials

$

Units

$

1,000,00 500,000 Output to Process 1,000,00 900,00 0 2 0 0 200,000

Direct labour Production overheads

200,000

1,000,00 900,000 0

1,000,00 900,00 0 0

■ When using process costing, if a series of separate processes is needed to manufacture the finished product, the output of one process becomes the input to the next until the final output is made in the final process. In our example, all output from shaping was transferred to the second process, colouring, during the year to 31 March 20X3. An additional 500,000 units of material, costing $300,000, were input to the colouring process. Direct labour costs of $150,000 and production overhead costs of $150,000 were also incurred. There were no opening or closing inventories in the colouring department. The process for colouring for the year ended 31 March PROCESS 2 (COLOURING) 20X3 is as follows. Units

Materials from process 1 Added materials

1,000,00 0 500,000

$

Output to finished 900,000 goods

Units

$

1,500,00 1,500,00 0 0

300,000

Direct labour

150,000

Production overhead

150,000

Direct labour and production overhead may be treated together in an assessment question as conversion cost. 1,500,00 1,500,00 0 0

1,500,00 1,500,00 0 0

Added materials, labour and overhead in Process 2 are usually added gradually throughout the process. Materials from Process 1, in contrast, will often be introduced in full at the start of the second process.

3. Framework for dealing with process costing ■ Use our suggested four-step approach when dealing with process costing questions.

Process costing is centred around four key steps. The exact work done at each step will depend on the circumstances of the question, but the approach can always be used.

Step 1 Determine output and losses • Determine expected output. • Calculate normal loss and abnormal loss and gain. • Calculate equivalent units if there is closing work in progress. Step 2 Calculate cost per unit of output, losses and WIP Calculate cost per unit or cost per equivalent unit. Step 3 Calculate total cost of output, losses and WIP In some examples this will be straightforward. In cases where there is work in progress, a statement of evaluation will have to be prepared. Step 4 Complete s • Complete the process . • Write up the other s required by the question. It always saves time in an assessment if you don't have to think too long about how to approach a question before you begin. This four-step approach can be applied to any process costing question so it would be a good idea to memorise it now. It will be useful as a framework for any workings that you may need to do.

DEALING WITH LOSSES IN PROCESS ■ Losses may occur in process. If a certain level of loss is expected, this is known as normal loss. ■ If losses are greater than expected, the extra loss is abnormal loss. ■ If losses are less than expected, the difference is known as abnormal gain.

Losses/Gains ■ During a production process, a loss may occur. – Normal loss is 'expected loss, allowed for in the budget, and normally calculated as a percentage of the good output, – from a process during a period of time. Normal losses are generally either valued at zero or at their disposal values.' – Abnormal loss is 'any loss in excess of the normal loss allowance'. – Abnormal gain is 'improvement on the accepted or normal loss associated with a production activity'. ■ CIMA Official Terminology Losses may occur due to wastage, spoilage, evaporation, and so on. Since normal loss is not given a cost, the cost of producing these units is borne by the 'good' units of output. Abnormal loss and gain units are valued at the same unit rate as 'good' units. Abnormal events do not therefore affect the cost of good production. Their costs are analysed separately in an abnormal loss or abnormal gain .

■ The bookkeeping – (a) In an abnormal loss , the debit entry shows the units (and their value) from the process . The credit entry shows the impact on the income statement. – (b) In an abnormal gain , the debit entry shows the effect on the income statement, while the credit entry shows the units (and their value) from the process .

Example: abnormal losses and gains

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 inventories. Determine the ing entries for the cost of output and the cost of the loss if actual output were as follows. (a) 860 units (so that actual loss is 140 units) (b) 920 units (so that actual loss is 80 units)

■ Solution: – Before we demonstrate the use of the 'four-step framework' we will summarise the way that the losses are dealt with. – (a) Normal loss is given no share of cost. – (b) The cost of output is therefore based on the expected units of output, which in our example amount to 90% of 1,000 = 900 units. – (c) Abnormal loss is given a cost, which is written off to the income statement via an abnormal loss/gain . – (d) Abnormal gain is treated in the same way, except that being a gain rather than a loss, it appears as a debit entry in the process (as it is a sort of input, being additional unexpected units), whereas a loss appears as a credit entry in this (as it is a sort of output).

■ (a) Output is 860 units Step 1 Determine output and losses If actual output is 860 units and the actual loss is 140 units:

Step 4 Complete s

PROCESS

Units Actual loss 140 Normal loss (10% of 1,000) 100 Abnormal loss 40 Step 2 Calculate cost per unit of output and losses The cost per unit of output and the cost per unit of abnormal loss are based on expected output. =Costs incurred / Expected output = $4,500/900 units = $5 per unit Step 3 Calculate total cost of output and losses Normal loss is not assigned any cost. $ Cost of output (860 × $5) 4,300 Normal loss 0 Abnormal loss (40 × $5) 200 4,500

Cost incurred

Units

$

1,000

4,500

Normal loss

Units

$

100

0

Output (finishedgoods a/c) 860 x (× $5)

860 4,300

Abnormal loss 40 x ($5)

40

200

1,000 4,500 1,000

4,500

ABNORMAL LOSS Process a/c

Units

$

40

200

Income statement

Units

$

40

200

■ (b) Output is 920 units

Step 4 Complete s

Step 1 Determine output and losses If actual output is 920 units and the actual loss is 80 units: Units Actual loss Cost incurred 80 Abnormal gain Normal loss (10% of 1,000) a/c 20 x (× $5) 100 Abnormal gain 20 Step 2 Calculate cost per unit of output and losses The cost per unit of output and the cost per unit of abnormal gain are based on expected output. =Costs incurred /Expected output Income = $4,500 / 900 statement = $5 per unit (Whether there is abnormal loss or gain does not affect the valuation of units of output. The figure of $5 per unit is exactly the same as in the previous paragraph, when there were 40 units of abnormal loss.) Step 3 Calculate total cost of output and losses $ Cost of output (920 × $5) 4,600 Normal loss 0 Abnormal gain (20 × $5) (100) 4,500

PROCESS Units 1,000

$ 4,500

Output (finished goods 100 a/c) 920x (× $5)

20 1,020

Normal loss

4,600

Units

$

100

0

920

4,600

1,020

4,600

Units

$

20

100

ABNORMAL GAIN Units

$

20

100

Process a/c

Example: Abnormal losses and gains ■ During a four-week period, period 3, costs of input to a process were $29,070. Input was 1,000 units, output was 850 units and normal loss is 10%. ■ During the next period, period 4, costs of input were again $29,070. Input was again 1,000 units, but output was 950 units. There were no units of opening or closing inventory. ■ Required Prepare the process and abnormal loss or gain for each period.

Step 1 Determine output and losses Period 3 Units Actual output 850 Normal loss (10% × 1,000) 100 Abnormal loss 50 Input 1,000 Period 4 Units Step 2 Calculate cost per unit of output and losses Actual output For each 950 period the cost per unit is based on expected output. =Cost of input / Expected units of output Normal loss (10% × 1,000) = $29,070/ 900 100 = $32.30 per unit Abnormal gain (50) Step 3 Calculate total cost of output and losses Input Period 1,000 3 $ Cost of output (850 × $32.30) 27,455 Normal loss 0 Abnormal loss (50 × $32.30) 1,615 29,070 Period 4 $ Cost of output (950 × $32.30) 30,685

Step 4 Complete s

PROCESS Units

$

Units

$

100

0

Period 3 29,070 Cost of input

1,000

Normal loss Finished goods a/c

850

27,455

(850× $32.30) Abnormal loss a/c

50

1,615

(50× $32.30) 29,070

1,000

1,000

29,070

Period 4 29,070 Cost of input

1,000

Abnormal gain a/c

50

(50 × $32.30) ABNORMAL Period 3

Normal loss Finished goods 1,615 a/c

100

0

950

30,685

× $32.30) LOSS OR(950 GAIN

30,685 $ 1,050 Period 4

1,050

$30,685

Abnormal loss in process a/c

1,615 Abnormal gain in process a/c

1,615

Abnormal loss in process a/c

1,615 Abnormal gain in process a/c

1,615

Example :Cost of output ■ CFC Co manufactures a product in a single process operation. Normal loss is 10% of input. Loss occurs at the end of the process. Data for June are as follows. ■ Opening and closing inventories of work in progress Nil ■ Cost of input materials (3,300 units) $59,100 ■ Direct labour and production overhead $30,000 ■ Output to finished goods 2,750 units – The full cost of finished June was The output correct in answer is C. – A $74,250 – B $81,000 – C $82,500 – D $89,100

Step 1 Determine output and losses Units Actual output 2,750 Normal loss (10% × 3,300) 330 Abnormal loss 220 3,300 Step 2 Calculate cost per unit of output and losses =Cost of input / Expected units of output = $89,100 / 3,300 -330 = $30 per unit Step 3 Calculate total cost of output and losses $ Cost of output (2,750 × $30) 82,500 Normal loss 0 Abnormal loss (220 × $30) 6,600 89,100

Example: Abnormal gain ■ Y Co makes a product Emm which goes through several processes. The following information is available for the month of June. Kg ■ Opening WIP

5,200

■ Closing WIP

3,500

■ Input

58,300

■ Normal loss

400

■ Transferred to finished goods – What was the abnormal gain in June? ■ A 260 kg ■ B 300 kg ■ C 400 kg ■ D 560 kg

59,900

The correct answer is B. The abnormal gain is the balancing figure. 63,800 – 5,200 – 58,300 = 300

ING FOR SCRAP ■ Scrap is 'discarded material having some value'.

CIMA

Official Terminology

(a) Revenue from scrap is treated, not as an addition to sales revenue, but as a REDUCTION IN COSTS. The valuation of normal loss is either at scrap value or nil. It is conventional for the scrap value of normal loss to be deducted from the cost of materials before a cost per equivalent unit is calculated. (b) The scrap value of normal loss is therefore used to reduce the material costs of the process. DEBIT Scrap CREDIT Process with the scrap value of the normal loss. Abnormal losses and gains never affect the cost of good units of production. The scrap value of abnormal losses is not credited to the process , and the abnormal loss and gain units carry the same full cost as a good unit of

(c) The scrap value of abnormal loss is used to reduce the cost of abnormal loss. DEBIT Scrap CREDIT Abnormal loss with the scrap value of abnormal loss, which therefore reduces the write-off of cost to the income statement. (d) The scrap value of abnormal gain arises because the actual units sold as scrap will be less than the scrap value of normal loss. Because there are fewer units of scrap than expected, there will be less revenue from scrap as a direct consequence of the abnormal gain. The abnormal gain should therefore be debited with the scrap value. DEBIT Abnormal gain CREDIT Scrap with the scrap value of abnormal gain. (e) The scrap is completed by recording the actual cash received from the sale of scrap. DEBIT Cash received CREDIT Scrap with the cash received from the sale of the actual scrap.

Example: scrap and abnormal loss A factory has two production processes. Normal loss in each process is 10% or gain and scrapped units sell for $0.50 each from process 1 and $3 each from process 2. Relevant information for costing purposes relating to period 5 is as follows. Direct materials added: Process 1 Process 2 units 2,000 1,250 cost $8,100 $1,900 Direct labour $4,000 $10,000 Production overhead 150% of direct labour cost 120% of direct labour cost

Output to process 2/finished goods 1,750 units 2,800 units Actual production overhead $17,800 Required: Prepare the s for process 1, process 2, scrap, abnormal loss or gain.

Step 1 Determine output and losses Process 1 Output Normal loss (10% of input) Abnormal loss Abnormal gain Input

Process 2

Units 1,750

Units 2,800

200

300

50 2,000

* 1,750 units from Process 1 + 1,250 units input to process.

(100) 3,000*

Step 2 Calculate cost per unit of output and losses Process 1 $ Cost of input – material – from Process 1 – labour – overhead Less: scrap value of normal loss Expected output 90% of 2,000 90% of 3,000 Cost per unit $18,000 ÷ 1,800 $40,500 ÷ 2,700

(150% × $4,000)

(200 × $0.50)

8,100 – 4,000 6,000 18,100 (100) 18,000

Process 2 $ 1,900 (1,750 × $10) 17,500 10,000 (120% × $10,000) 12,000 41,400 (300 × $3)

(900) 40,500

1,800 2,700 $10 $15

Step 3 Calculate total cost of output and losses

Process 1 Output

(1,750 × $10)

Normal loss

(200 × $0.50)*

Abnormal loss

(50 × $10)

Abnormal gain

$ 17,500 100

Process 2 (2,800 × $15) (300 × $3)*

$ 42,000 900

500

–

18,100

42,900

–

(100 × $15)

18,100

* that normal loss is valued at scrap value only.

(1,500) 41,400

Step 4 Complete s

PROCESS 1 Units Units

Direct material

2,000

$

$

Scrap a/c (normal 8,100 loss)

200

100

1,750 17,500 Direct labour

PROCESS 2 4,000

Production overhead a/c Direct materials: From process 1 Added materials

Process 2 a/c

Units $

Units 6,000 Abnormal loss a/c 50$ 500 1,750 17,500 Scrap a/c (normal loss) 300 2,000 90018,100 2,000 18,100 1,250 1,900 Finished goods a/c 2,800 42,000

Direct labour

10,000

Production o'hd

12,000 3,000 41,400

Abnormal gain

100

1,500

3,100 42,900

3,100

42,900

ABNORMAL LOSS $

$

Scrap a/c: sale of scrap of extra loss (50 units 500 @$0.50)

Process 1 (50 units)

Income statement

475

500

500

ABNORMAL GAIN $ Scrap a/c (loss of scrap revenue

$ Process 2 abnormal gain

due to abnormal gain,

25

1,500

(100 units)

100 units × $3)

300

Income statement

1,200 1500

1500

SCRAP $ Scrap value of normal loss Process 1 (200 units) @$0.50 Process 2 (300 units) @$3.00 Abnormal loss a/c (process 1)

$ Cash a/c - cash received

100

Loss in process 1 (250 units) @$0.50

125

900

Loss in process 2 (200 units) @$3.00

600

25

Abnormal gain a/c (process 2)

300

VALUING CLOSING WORK IN PROGRESS ■ When units are partly completed at the end of a period (ie when 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. •In the earlier problem we have looked at so far we have assumed that opening and closing inventories of work in process have been nil. •We must now look at more realistic issue and consider how to allocate the costs incurred in a period between completed output (ie finished units) and partly completed closing inventory.

Example: valuation of closing inventory ■ Tim Co is a manufacturer of processed goods. In March 20X3, in one process, there was no opening inventory, but 5,000 units of input were introduced to the process during the month, at the following cost. $ – Direct materials 16,560 – Direct labour 7,360 – Production overhead 5,520 29,440 ■ Of the 5,000 units introduced, 4,000 were completely finished during the month and transferred to the next process. Closing inventory of 1,000 units was only 60% complete with respect to materials and conversion costs.

■ Solution: ■ (a) The problem in this example is to divide the costs of production ($29,440) between the finished output of 4,000 units and the closing inventory of 1,000 units. It is argued, with good reason, that a division of costs in proportion to the number of units of each (4,000:1,000) would not be 'fair' because closing inventory has not been completed, and has not yet 'received' its full amount of materials and conversion costs, but only 60% of the full amount. The 1,000 units of closing inventory, being only 60% complete, are the equivalent of 600 fully worked units. ■ (b) To apportion costs fairly and proportionately, units of production must be converted into the equivalent of completed units, ie into equivalent units of production. Equivalent units are 'notional whole units representing incomplete work. Used to apportion costs between work in progress and completed output …' CIMA Official Terminology

Step 1 Determine output For this step in our framework we need to prepare a statement of equivalent units. STATEMENT OF EQUIVALENT UNITS Total

units

Step 2 Calculate cost per unit of output, and WIP For this step in our framework we need to prepare a statement of costs per equivalent unit because equivalent units are the basis for apportioning costs.

Equivalent Completio n

units

Fully worked units

4,000

100%

4,000

Closing inventory

1,000

60%

600

5,000 Step 3 Calculate total cost of output and WIP

4,600

For this step in our framework a statement of evaluation may now be prepared, to show how the costs should be apportioned between finished output and closing inventory.

STATEMENT OF COSTS PER EQUIVALENT UNIT =Total costs / Equivalent units = $29,440 /4,600 . = Cost per equivalent unit $6.40 Step 4 Complete s The process would be shown as follows. PROCESS Units

STATEMENT OF EVALUATION Equivalent Item Fully worked units Closing inventory

units 4,000 600 4,600

Units

$

$

Cost per equivalent unit $6.40 $6.40

Valuation $

Direct materials

16,560 5,000

Output to next process

4,00 25,600 0

Closing inventory c/f

1,00 0 3,840

25,600 3,840 29,440

Direct labour Production o'hd

7,360 5,520

A few hints on preparing s: When preparing a process , it might help to make the entries as follows. 29,440 5,00 29,440 (a) Enter the units first. The units columns are simply memorandum columns, but they help you 5,000 0 to make sure that there are no units uned for (for example as loss). (b) Enter the costs of materials, labour and overheads next. These should be given to you. (c) Enter your valuation of finished output and closing inventory next. The value of the credit entries should,

Example: changes in inventory level and losses The following data have been collected for a process. Opening Output to finished inventory none goods 2,000 units Input units 2,800 units Closing inventory 450 units, 70% complete Cost of input $16,695 Total loss 350 units Normal loss 10%; nil scrap value Required: Prepare the process for the period.

Step 1 Determine output and losses STATEMENT OF EQUIVALENT UNITS Equivalent units of work done this Total units Completely worked units

2,000

period (× 100%)

2,000

Step 2 Calculate cost per unit of output, losses and WIP STATEMENT OF COST PER EQUIVALENT UNIT = Costs incurred/ Equivalent units of work done = $16,695 / 2,385 Cost per equivalent unit = $7

(× 70%) Closing inventory

450

315

Normal loss

280

0

(× Abnormal loss 70 100%) 70 Step 3 Calculate total cost of output, losses and WIP 2,800 2,385 STATEMENT OF EVALUATION Equivalent units Completely worked units Closing inventory Abnormal loss

2,000 315 70 2,385

Step 4 Complete s PROCESS

$ 14,000 2,205 490 16,695

Opening inventory

Input costs

Units

$

–

–

2,800

Normal loss

16,69 5 Finished goods a/c Abnormal loss a/c Closing inventory c/d

2,800

16,69 5

Units

$

280

0 14,000

2,000 70

490

450

2,205 16,695

2,800