Finding the right costing system is very important for a business. Process costing is one type of costing system that is useful for many industries.
Costing is an important process that many companies engage in to keep track of where their money is being spent in the production and distribution processes. Understanding these costs is the first step in being able to control them. It is very important that a company chooses the appropriate type of costing system for their product type and industry. One type of costing system that is used in certain industries is process costing. Process costing varies from other types of costing (such as job-order) in some ways, yet is similar in other ways.
What is Process Costing?
Process costing is a type of costing system that is used for uniform, or homogeneous, products. Process costing averages the costs over all units to come to the per unit cost. This is in contrast to other types of costing systems, such as job-order costing that is used for products that are in differentiated batches. Unlike job-order costing, process costing is tracked using a work-in-process account for each department, rather than through subsidiary ledgers.
Process Costing Procedures
Process costing systems follow specific procedures, and while exact procedures may vary by company or by industry, they will generally follow these steps:
- While other types of costing start with a sales order, a sales order is not needed for process costing as it is a continuous process
- The work-in-process accounts are divided by department and are named as such – for example: Work-in-process – Department Name
- The first department in the process makes the first entry into the work-in-process account, generally for the direct raw materials
- As the products move from department to department, entries are made to each work-in-process department account
- Direct labor costs are recorded by period
- Actual overhead costs are recorded; no contra-account is needed because there is no over- or under-applied overhead due to the actual cost being applied
- Indirect costs are applied to the overhead account in actual amounts
- Normal spoilage is recorded as a cost to the work-in-process account; abnormal spoilage is removed from the work-in-process account and applied to a separate account so it can be addressed by management.
When is Process Costing Appropriate?
Process costing is appropriate when products are homogeneous (or identical). Where job-order and other types of costing seek to find the cost per unit for batches of differentiated products, process costing seeks to find the average cost of all units over a period of time. Therefore, process costing is only appropriate when all units are the same. For example, a manufacturing company that produces only one homogeneous product may elect to use process costing.
Related Articles:
