Process Costing- Meaning and its Applications

 Meaning of Process Costing

Process Costing is a method of costing used in industries where the material has, to pass through two or more processes for being converted into a final product. It is defined as “a method of Cost Accounting whereby costs are charged to processes or operations and averaged over units produced”. A separate account for each process is opened and all expenditure pertaining to a process is charged to that process account. Such type of costing method is useful in the manufacturing of products. where the production process is continuous and the output of one process becomes the input of the following process till completion.

Process costing is that aspect of operation costing which is used to ascertain the cost of the product at each process or stage of manufacture. This method of accounting used in industries where the process of manufacture is divided into two or more processes. The objective is to find out the total cost of the process and the unit cost of the process for each and every process. Usually the industries where process costing used are textile, oil industries, cement, pharmaceutical, steel, paper, medicines soap, chemicals, rubber, vegetable oil, paints, varnish etc.

 Definitions Process costing

“Process cost accounts are applied to concerns which produce a commodity that has to go through several processes and which requires to know the cost of each process”. – Charles.

 “Process costing is used to ascertain the cost of each stage of manufacture where material is passed through various operations to obtain a final product to result, with by products in many cases at different stages. - Lunt and Ripley

Applications of Process Costing

a)      Identical Products Industries

Process costing is most often used when manufacturers release identical products. If mass produced televisions have the same parts, manufacturers can assign consistent prices to the products based on how much the products cost to manufacture overall.

b)     Industries with Multiple Departments

Businesses that have multiple departments usually use process costing so that management can assess the costs accumulated by each department. For example, one department can take the raw resources and refine them before turning them into finished parts, another department can assemble the parts and a third department can test the finished product to assess both quality and safety. Materials might need to be shipped from one department to another, which may incur additional costs. When the costs of production go up unexpectedly, process costing can allow management to quickly pinpoint the department responsible for the increased costs and identify the source of the increased cost.

c)      Industries with Interchangeable Parts

Process costing comes into play when a factory manufactures identical parts. For example, a computer manufacturing plant will create numerous components that are interchangeable among computers of the same model. Process costing allows manufacturers to sell individual parts separately to computer repair shops or individual buyers, since the manufacturers know the cost of the separate parts.

d)     Industries with Varying Product Features

Products that have multiple extraneous features can benefit from process costing. Manufacturers can release two versions of the product, with one version costing less but having fewer features and another product costing more but having more features. For example, a manufacturer might release two coffee pots, one with a timer and one without. Process costing lets the manufacturer know how much the timer costs to add to the coffee pot, which enables the manufacturer to gauge how much it must raise the price on the coffee pot with the timer.

e)      Innovative Industries

Process costs are important in industries that have high innovation. For example, manufacturers cannot determine an appropriate price for a new type of product without knowing how much the product will cost to manufacture overall. In addition, businesses cannot determine if a product will be profitable until they know the overall cost so they can estimate the maximum price that customers will pay for the product.

Process costing is employed in the following types of industries

1.    Food processes industries, e.g., flour mills, meat products, milk diary, confectionaries, fruits and vegetables processing etc.

2.    Other industries involving a sequence of processes, e.g., paper mills, cement works, coke works, canning factory, textile manufacture, cartoon making, etc.

3.    Metallurgical industries, e.g., iron and steel, aluminum, wire drawing and netting and polishing, alloy production etc.

4.    Chemical industries, e.g., drugs and pharmaceuticals, paints soap making, production of sugar, molasses and alcohol, breweries, distilleries, oil refining, etc.