OBJECTIVES:
- Distinguish between process costing and labor costing. Explain the accounting treatment for normal and abnormal losses. Normal and abnormal loss and abnormal profit accounts when there is no work in progress closure. Calculate the value of work in progress. Complete production and abnormal loss using weighted average and PEPS. Recognize that normal losses should be charged only on the amount of units that have passed the inspection point. Determine differences between the costs per unit necessary for the valuation of inventories, taking decisions and performance reporting for cost control.
The process costing system is used in industries where the final products are more or less identical. With this system no attempt is made to allocate the manufacturing cost to a specific order, instead, the cost of an individual order for each unit can be obtained by dividing the production costs for a particular period by the number of units produced for that period. In other words, the cost of the order is assumed as the average cost of all the units produced during the period.
A process costing system is used to compute the costs of a product for a mass or a current production system. Product costs can be determined by adding the average unit costs for each operation periodically, to measure benefits and inventory valuation it is necessary to value the work in progress (WIP), which has accumulated for each sequence of activities. At each stage of the production process, WIP can be valued by conversion into equivalent units and applying the average cost per unit of product to the operation.
In the process of industrial production costs it moves from one process to the other until the final completion occurs, each production department performs some part of the total operation and transfers its completed production to the next department, where it becomes the input for processing. additional. The completed production of the last department is transferred to the finished product inventory.
The cost accrual procedure follows the production flow, control accounts are established for each process, and direct manufacturing costs and overhead are allocated to each process. The cost when transferred from process to process becomes cumulative as a production procedure and the addition of last department costs determines the total cost.
NORMAL AND ABNORMAL LOSSES
The safe losses that are inherent in the production process and cannot be eliminated, these losses occur under efficient operating conditions called normal losses.
There are also some losses that are not expected to occur under efficient operating conditions, these losses are not an inherent part of the production process, they are called abnormal losses.
Normal and abnormal losses require a different accounting treatment, abnormal loss is treated separately as a characteristic cost outside profit and loss at the end of the period.
In other words, the normal losses are a proportion calculated through different periods and are absorbed by the production, while the abnormal losses are cost separately in the process.
COST ELEMENTS WITH DIFFERENT DEGREES OF COMPLETION
The different elements of the cost can have different degrees of completion, when they are transferred from one process to another they are one hundred percent complete, while the work in process has been in transformation, since its component elements have not come out of said process.
The materials that are introduced at the beginning of the process and the conversion costs are applied throughout the process, the closing of the work in process is estimated.
The initial inventory of products in process is assumed to be completed during the period, the costs of the period will include the cost of completion of the IIPP and the cost of PP will be included in the total cost, in other words we have to assume that the IIPP is mixes with period production to form a homogeneous production group.
PEPS
The PEPS costing method assumes that the IIPP is the first group of units processed and completed during the period. The IIPP is charged separately to complete production and the cost per unit is based solely on costs and production for the period, IFPP is assumed to return to new units started during the period.
EQUIVALENT PRODUCTION AND NORMAL LOSSES
We established that normal loss should be considered as part of the cost of normal production. However, we need to know to what stage in the process the loss has occurred in order to determine to what extent some of the losses are also charged to the IFPP. If the loss occurs near the end of the process, or is discovered at the inspection point, it should be charged with the cost of the loss, alternatively the loss could be assumed to have occurred at a specific point at the beginning of the process.
Generally, it is assumed that the normal loss takes place in the termination part where the inspection occurs, it will not be charged with the IFPP.
EQUIVALENT PRODUCTION AND ABNORMAL LOSSES
Where abnormal losses are incurred the correct procedure is to produce the reported normal unit cost but with the addition of separate columns for loss units, one for normal losses and one for abnormal. Normal loss should therefore be valued at cost per unit of normal sales.
COSTS CONTROL
Regarding cost control, we must be sure that the current costs that are included in a compliance report are the costs incurred for the current period only and do not include some costs that are and come from previous years.
The objective of cost control is to compare the current cost of the current period with the budgeted cost for the equivalent units produced during that period. The equivalent units produced during the current period are calculated by deduction of equivalent units produced during the previous period from the total number of equivalent units, that is, the costs of the current current period should be compared with the budgeted cost for the production of the current period.
SUMMARY
In this chapter we have examined cost accumulation, the procedures required for a cost system for inventory valuation processes, and their measure of profit. The cost system is an average used by several industrial companies where the input and output units are the same. Individual order costing for particular units can be obtained merely by dividing the production costs of a period by the units produced during the period.
The accounting treatment for normal and abnormal losses has been explained. Normal losses are inherent in the production process and cannot be eliminated, abnormal losses are avoidable and the cost of these should not be charged to the products.
If there are work-in-process inventories, it is necessary to convert these units into homogeneous output units to work them as linear units of equivalent production.
We have discussed and examined two alternatives of distributing work-in-process costs in production, the weighted average and the PEPS, finally we have contrasted the different ways in which cost information should be accumulated for decision-making and cost control..
COST OF JOINT PRODUCTS AND BY-PRODUCTS
Joint products and by-products arise in situations where the production of one product makes the production of other products worthwhile. When a group of individual products are simultaneously produced and each product has a significantly relative value of sales, production is usually called joint products, these products are part of a simultaneous production process. When these have a lower sales value and are compared with joint products having little significance, they are called by-products.
the by-products are unforeseen, therefore they are subject to the production of the sets, having a small effect on the group prices of the main products.
For the external reports of the products, it is necessary that the inventory valuation include a proration of the joint production costs, as well as some additional attribution to the cost of the sale process.
METHODS OF PROPORTIONING JOINT COSTS TO JOINT PRODUCTS
If total production for a particular period was sold, the problem of allocating joint product costs may not exist. Inventory valuation may not be necessary and profit calculation may simply require deduction of total cost from total sales, however inventories are in stock at the end of the period, prorating product costs is necessary.
The methods that can be used to prorate are as follows:
1. Assumed methods to measure benefits received from the cost of the joint product for the individual products based on physical measures such as weight, volume, etc.
With this method, costs are a simple apportionment of cost in proportion. Each product is assumed to receive similar benefits from the joint cost and before carrying this portion of the total cost proportion.
2. Assumed methods to measure the ability to absorb joint costs based on apportionment of joint costs relative to the market values of the products or sales valuation.
When the sales valuation method is used, joint costs are allocated in joint costs in proportion to the estimated sale value of production, at higher sales prices, higher costs.
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