Process costing is a method of accounting where costs are charged to processes or operations and averaged over units produced. It is used for mass produced, homogeneous products made through continuous production processes that may involve different stages. Work-in-progress (WIP) represents the costs incurred to partially complete products as they flow through the production process. WIP can be valued using different methods, such as FIFO, which assumes opening units are completed first, average cost, or LIFO, which assumes most recently started units are finished first.
2. Process costing is….
According to Kohler,
“A method of accounting
whereby costs are charged to processes or
operations and averaged over units produced; it is
employed principally where a finished product is
the result of a more or less continuous operation, as
in paper mills, refineries, canneries and chemical
plants; distinguished from job costing, where costs
are assigned to specific orders, lots or units.”
3. Features
It is used when identical units are mass produced.
The output consists of products which are
homogeneous.
Production is carried on in different stages having a
continuous flow.
Normal and Abnormal losses may arise in the
processes.
The output of a process may also be saleable in
which case the process may generate some profit.
4. limitations
• Process costing is based on historical cost and thus
may not be useful for future managerial decision-
making.
• Process costing system is based on average costs.
And average costs do not always reflect the true
costs.
• Unfinished units at the end of the period are
expressed in equivalent production units. This
introduces subjectivity in cost determination.
5. Work-in-progress (WIP)
It is the sum of all costs put into the production
process to manufacture products that are partially
completed.
This concept is used to describe the flow of
manufacturing costs from one area of production to
the next.
The balance in WIP represents all production costs
incurred for partially completed goods.
6. Valuation of work-in-progress under FIFO
Method:
• Under this method it is assumed that new units
issued to the work-in-progress pass through the
finished goods on the FIFO basis which means that
unfinished work in the opening stock is completed
first and thereafter new units introduced in the
process are taken up. This method is suitable when
prices of raw materials and rates of direct labour
and overheads are relatively stated.
7. Valuation of Work-in-Progress under
Average Method:
• under average method the average process
cost is obtained by adding the cost of opening
WIP and current cost and dividing the total by
total equivalent units. It is not presumed that
opening units will be completed first.
8. Valuation of Work-in-Progress under Last-
in-First out Method:
• According to this method, units entering in the
process at last are first to be completed. The
completed units will be shown at the current cost
and closing inventory of work-in progress will be
valued at the cost of opening inventory of work in
progress because units representing opening
inventory are to be completed at last.
If there is an error in cost determination in one process, it will affect the cost estimation in subsequent processes as well as the cost of work in process and finished products.