The design of a cost accumulation system must be compatible with the nature and type of operations executed by a manufacturing company. Examples of industries that use the process cost system are companies that produce paper, steel, chemicals, and textiles.
the-nature-and-characteristics-of-a-process-cost-systemCosting by processes.
Process costing is a system of accumulating production costs by department or cost center.
What is a department?
A department is a main functional division in a factory where manufacturing processes are executed.
When two or more processes are executed in a department, it may be convenient to divide the departmental unit into cost centers.
Each process is shaped as a cost center, the costs are accumulated by cost centers instead of by departments.
For example:
The “assembly” department of an electronic manufacturing company can be divided into the following cost centers:
- Disposition of materials. Wiring. Welding.
Process costing objective.
A process cost system determines how manufacturing costs incurred during each period will be allocated.
The allocation of costs in a department is only an intermediate step, the ultimate objective is to determine the total unit cost in order to determine income.
During a certain period some units will be started, but not all will be finished at the end of it. Consequently, each department determines what part of the costs incurred in the department can be attributed to the units in process and what part to the finished ones.
Let's see an example in this regard:
Suppose that during the month of April, 2000 units were put into process in Department A. The costs incurred during the month were as follows:
| materials | $ 2000 |
| Workforce | $ 1000 |
| Indirect Manufacturing | $ 500 |
At the end of the month, 1,000 units were completed and transferred to Department B.
The goal of a process cost system is to determine how much of the $ 2,000 of materials, $ 1,000 of labor, and $ 500 of manufacturing overhead applies to the 1,000 units completed and transferred, and how much applies to the other 1,000 units in process. Each department will prepare a production cost report.
Characteristics of a process cost system.
Process costing addresses the flow of units across multiple operations or departments, adding more additional costs as they go.
The unit costs of each department are based on the costs incurred in a period of time and the units completed in the same period.
A process cost system has the following characteristics:
- Costs are accumulated and recorded by department or cost center. Each department has its own work in process account in the general ledger. This account is charged with the process costs incurred in the department. Equivalent units are used to determine work in process in terms of units completed at the end of a period. Unit costs are determined by department in each period. finished and their corresponding costs are transferred to the next department or finished items. By the time the units leave the last department of the process, the total costs for the period have been accumulated and can be used to determine the unit cost of the finished items. The total and unit costs of each department are added periodically,analyzed and calculated through the use of production reports.
Production by departments.
In a process cost system, emphasis is placed on departments or cost centers.
Different processes or functions are performed in each department or cost center, such as mescaldo in Department A and refinement in Department B. A product generally flows through two or more cost departments or centers before it reaches the finished items.
The material, labor, and manufacturing overhead costs produced in each department are charged to separate work-in-process accounts. When the units are finished in one department, they are transferred to the next department in the process accompanied by their corresponding costs.
The finished unit in one department becomes the raw material of the next until they become finished items.
Unit cost generally increases when items flow through departments.
Departmental management of production costs is illustrated in the following example:
Data:
Company “X” produces product Z, which needs to be processed in departments A and B. During February, 4,500 units were put into production and finished during the month.
The costs were as follows:
Materials $ 9000
Labor $ 7875
Indirect costs: $ 5625.
Work in progress department A.
| Total cost | Unit cost | Unit cost computation. | |
| Materials put into production. | $ 9000 | $ 2.00 | ($ 9000/4500) |
| Workforce | $ 7875 | $ 1.75 | ($ 7875/4500) |
| Indirect manufacturing | $ 5625 | $ 1.25 | ($ 5625/4500) |
| Total | $ 22500 | $ 5.00 |
The unit cost is determined:
UNIT COST = TOTAL COST / FINISHED UNITS
When the initial 4500 units are completed, they are transferred to Department B. In this example there were no units in process at the beginning or end of the period, additional evaluations and calculation would have been necessary to allocate the ostos to the units in process and to the transferred to the next department.
At the end of the period, a production cost report is prepared in each department. The report (the one explained below) is used in the calculation of total and unit costs.
Physical flow.
In a process cost system, units and costs flow together.
The following equation summarizes the physical flow of the units in the department.
| Initial units in process | Units transferred outside | |
| + Units that start the process or are received from other departments. | = | + Units finished and not yet transferred |
| + Final units in process |
This equation shows how units received or started should be accounted for in a department. A department need not have all the components of the equation. If all completed units are transferred there will be no units “still on hand”. If all but one component are known, the unknown component can be calculated. The following example illustrates the flow of units within a department.
The Vinjoan company had 2,000 units in process in process at the beginning of the month in Department A, it started manufacturing with 6,000 units during the month and had 3,000 units in process at the end of the month. ALL units were transferred to department B. Replacing all known figures in the equation, the unknown component can be found (units transferred outside).
The following equation summarizes the physical flow of the units in the department.
| Initial units in process 2000 | Units transferred outside
? |
|
| + Units that start the process or are received from other departments. 6000 | = | + Units finished and not yet transferred
3000 |
| + Final units in process
? |
||
| 8000 | 3000 | |
| 8000-3000 | = | ? |
| 5000 | = | ? |
The entry and exit of costs is reflected in the work in process account of the department. Work in process is debited for production costs (materials, labor, manufacturing indirect) and costs transferred to the department. When completed units are transferred, work in process is credited for the costs associated with those completed units.
A product can influence through the factory by different routes or routes until its completion. The best known product flows are sequential, parallel, and selective.
The same process cost system can be used in all product flows.
In a SEQUENTIAL FLOW of the product, the initial raw materials are located in the first department of the process and flow through each department of the factory, the additional materials may or may not be added in the other departments. All items produced go to the same processes, in the same sequence.
Diagram of the sequential flow of the product. (See PDF)
A parallel flow of the product, the starting raw material is added during different processes, starting in different departments and then joining in a process or processes end.
In a SELECTIVE FLOW of the product, various items are produced from initial raw materials. The final product is determined in the process it goes through. Each process will produce a different finished product.
The cost of the materials to be loaded can be obtained by several methods:
- Individual requisitions of materials can be sent to the departments, therefore the total of all requisitions is the total cost of the materials. The cost of the used materials can be determined by adding the purchases to the initial inventory and subtracting the final inventory, the difference is the spent materials.When there is continuous use of identical materials, daily or weekly use can be obtained from consumption reports.In some industries, such as pharmaceuticals and energy-related, specifications or formulas can be used to determine the type and quantity of materials used.
The method of computing the cost of materials does not affect the accounting for the cost of materials in the work in process account.
Let's look at the accounting entries in the labor record.
The entry to distribute the labor costs of $ 5000 in Department A, $ 6200 in Department B, and $ 4800 in Department C is as follows:
| Concept | Partial | Should | To have |
| Work in progress | 16000 | ||
| Department A | 5000 | ||
| Department B | 6200 | ||
| Department C | 4800 | ||
| Payroll | 16000 |
Indirect manufacturing.
In a process cost system, manufacturing overhead can be applied using either of the following two methods.
The first: Apply manufacturing overhead to work-in-process based on a predetermined rate, the seat would remain.
| Concept | Partial | Should | To have |
| Work in progress | 24000 | ||
| Department A | 7500 | ||
| Department B | 9300 | ||
| Department C | 7200 | ||
| Indirect production costs | 24000 |
A manufacturing overhead rate is appropriate when the volume of production or manufacturing overhead fluctuates substantially from month to month.
Using the predetermined rate eliminates distortions in monthly unit costs caused by such situations.
The second method applies the actual manufacturing overhead costs incurred to the work in process. This method is suitable when production volume and manufacturing overhead remain relatively constant from month to month.
Any method can be used in a process cost system when there is continuous production.
The cost of production report.
The cost of production report is an analysis of the activities of the department or cost center during a period. All costs attributable to a department or cost center are presented according to the cost elements.
The cost of production report generally contains the following three relationships:
- Quantities (input and output units) Costs to be accounted for (entry cost) Costs accounted for (production cost)
Example of a production cost report:
Company X
| Department A | Department B | |
| Units | ||
| Start of the process | 60000 | |
| Received from the apartment TO | 46000 | |
| Transferred to department B | 46000 | |
| Transferred to the finished items department. | 40000 | |
| Units at the end of the process | ||
| Dept. A 0.40 termination for labor and indirect | 14000 | |
| Dept. B 0.33 termination by labor and indirect. | 6000 | |
| Costs | ||
| materials | 31200 | 0 |
| Workforce | 36120 | 35700 |
| Indirect | 34572 | 31920 |
Quantities:
It accounts for the physical flow of the units inside and outside the departments.
Equivalent production (units):
The equivalent production concept is basic in process costing. In most cases all units are not completed during the period. Then there are units that are still in process at different stages of production. All units must be expressed in terms of finished units, to determine the unit costs. Equivalent output is the presentation of incomplete units in terms of finished units.
Since the level of completion of materials and conversion costs is hardly the same, two separate computations of equivalent production are required.
Materials are added at a specific point in production or at the beginning or end of the process. If materials are added at the beginning, all work-in-process units will have the full materials costs. For labor costs and manufacturing indirect it is assumed that they are applied uniformly throughout the process.
The total equivalent units of production for each cost element is found by adding the number of units completed with the equivalent units of work in progress.
Total equivalent units = Number of units completed + equivalent units of work in process
Units in process are converted to equivalent units by multiplying units in process by the completion percentage.
Equivalent units = units in process * the percentage of completion.
Costs to account for.
This section of the cost of production report indicates what costs were accrued by the department. These may have been transferred to you during the period and / or added by the department during the same. Unit costs discriminated by elements are also presented in this section.
The unit cost computations for the first department of the process are as follows:
| 1.Unitary cost of materials = | Cost of materials added during the period / equivalent units per material. | |
| 2.Unit cost of labor = | Cost of aggregate labor during the period / equivalent units per labor. | |
| 3.Unit indirect costs = | Indirect manufacturing costs added in the period / equivalent units by indirect. | |
| 4.Total unit cost = | 1 + 2 + 3 |
Unit cost calculations for the following departments are computed as follows:
| COST OF PREVIOUS DEPARTMENT.
1.Unitary cost transferred to you = |
Cost per units that have been transferred in the period / total units in the department. | |
| COST OF THIS DEPARTMENT
2.Unitary cost of materials = |
Cost of materials added during the period / equivalent units per material. | |
| 3.Unit cost of labor = | Cost of aggregate labor during the period / equivalent units per labor | |
| 4.Unit indirect costs = | Indirect manufacturing costs added in the period / equivalent units by indirect. | |
| 5.Total unit cost = | 1 + 2 + 3 + 4 |
