CHAPTER

PROCESS COSTING
5.1.0 Introduction
Process costing as the method of costing is used where a series of sequential
processes produce identical units.
Process costing normally has the following characteristics:
a) Accumulation of all costs (material, labour and overheads) by process cost
centre.
b) Accurate recording of units and part units produced, and costs incurred by each
process.
c) Averaging the total costs of a process over the total production of that process.
d) Charging the cost of output of one process as the raw materials input cost of the
following process.
Process costing is widely used in industries such as: food manufacture, chemical and
drug manufacture, oil refining and so on.
However, there are three main problem areas in process costing.
(a) The problem of deciding how much cost should be attributed to work in process
at the end of a period, i.e., to that partly-processed material which has not yet
emerged as a finished product.
(b) The problem of accounting for process waste and sub-standard production.
(c) When more than one product emerges from a process, the problem of deciding
what proportion of input costs should be attributed to each of the products. This
will be dealt with under joint products and by-products.
The following terms occur frequently and it is important that you fully understand
them.
(a) Work in process. Work in process is also referred to as ‘work in progress’ or
abbreviated to WIP.

In any given period of time in the manufacture of a product (e.g., one week) one
can identify three distinct classifications of product.

(i) Opening work in process

At the start of the period some units of production will be only partially
completed – they will have been brought forward from the previous
period. These units will contain a percentage of the material, labour and
overheads that go into production of complete unit, i.e. 75% complete as
to material, 50% complete as to labour etc. There is no reason why the
percentage of completion should be the same for all the inputs.

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 (ii) Closing WIP
At the end of the period, some units will be partially made. This is the
closing WIP and again you will be given information as to its degree of
completion (75% complete as to material etc). Naturally the opening WIP
may have been completed and new units started that are not finished at
the end of the period.

(iii) Completed units

During the period units will be completed. Some of these will be the
opening WIP that has been completed, and some will be units that were
started and completed in the period.

(b) Effective units. It is important to be able to calculate how many units have been
produced in a given period and to apportion the costs incurred in the period over
those units. Some parts of the costs incurred in a period will therefore relate to
completed product and part to the uncompleted work in process.

To apportion costs to the work in process inventory it is necessary to describe.

(i) How many units of finished product will be obtained when that work is
completely processed;

(ii) What percentage of the material and work content has so far been
incurred.
Example 1
Consider the following situation
Total costs incurred in period K15,000
Finished units produced 6,000
Units in process at end of period:
3,000 which are assessed to be 50% complete i.e., 1,500 equivalent units,
There was no opening WIP. Total production is therefore 6,000 completed plus 1,500
equivalent units, i.e. 7,500 equivalent units. The average cost per equivalent units is
K15,000 ÷ 7,500 = K2 per unit.
The cost attributable to finished production is therefore 6,000 x K2 = K12,000.
The cost attributed to the work in process will be 1,500 x 2= K3,000.

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 Example 2
Now consider a development of the above example:
Total costs incurred in period:
Material input K13,500
Labour and associated costs 1,500
Total K15,000
Finished units produced – 6,000.
Units in process at the period end – 3,000.
There was no opening WIP.
In relation to these 3,000 units you are told that the whole amount of material
necessary for their completion has already been injected into the process (material is
‘100% complete’).but only half the necessary work has been done (labour and
associated costs are ‘50% complete’).
Required
Calculate the total equivalent units produced in the period and their total production
cost.
Solution
Work in process
Total
Complete % Equivalent Equivalent
Units Units complete units units
A B C D A+D
Material 6,000 3,000 100% 3,000 9,000
Labour & associated
Costs 6,000 3,000 50% 1,500 7,500

The average cost per equivalent unit is thus:

Material K13,500 ÷ 9,000 = K1.50
Labour K1,500 ÷7,500 = K0.20
Total K1.70

Therefore, the cost of finished production and work in process can thus be calculated:

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 Cost of cost of
Finished work in Total
Production process cost
K K K
Material – 6,000 x K1.50 9,000
3,000 x K1.50 4,500 13,500
Labour - 6,000 x K0.20 1,200
1,500 x K0.20 300 1,500
10,200 4,800 15,000
Note: The calculation of total equivalent units is now slightly more complex. The
material and labour costs have been treated separately because they have different
degrees of completion.
The above calculation is normally in tabular form as follows:
Cost Units Closing Cost Cost of Cost of
per completely WIP % Effective Total per completed closing
period processed Units complete units units unit units WIP
K K K K
Materia 13,500 6,000 3,000 100% 3,000 9,000 1.50 9,000 4,500
l
Labour 1,500 6,000 3,000 50% 1,500 7,500 0.20 1,200 300
15,000 1.70 10,200 4,800

6.2.0 Work in Process (WIP)

If there is work in process at the start of the period, there are further complications.
There are two normal methods of dealing with the opening work in process:
(a) The FIFO method
Under the FIFO method we assume that the opening work in process has entered
into the good production for the period, no part of it being carried forward as
closing work in process.

(b) The weighted average cost method

Under the weighted average cost method the value of opening work in process is
added to the costs incurred during the period to give a total cost which is then
distributed over completed units and closing work in process.
Consider the following example:

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 Example 3
Cost of opening WIP Costs incurred in
period
K K
Material 3,000 10,500
Labour 500 1,000
The opening WIP comprises 2,000 units. It is 50% complete as to material costs and
25% complete as to labour.
The closing WIP comprises 3,000 units. It is 100% complete as to material, and 50%
complete as to labour.
6,000 units were completed in the period 4,000 of which were both started and
completed in the period.
Compute the cost of good production and closing work in progress using both FIFO
and the weighted average cost methods.
Solution
(a) FIFO Metod

Opening WIP Started Closing WIP

Costs and Cost Cost of Cost of
Cost in complete Total per complete closing
elements period d Units unit d unites WIP

% Effective Effective
Units complete units Units % units
K K K K
Material 10,500 2,000 50% 1,000 4,000 3,000 100 3,000 8,000 1.3125 6,563 3,937
%
Labour 1,000 2,000 75% 1,500 4,000 3,000 50% 1,500 7,000 0.1429 786 214
7,349 4,151
3,500
10,849

(b) Weighted Average Cost Metod

Closing WIP
Cost Cost of
Cost Costs in Completed Effective Total per completed Cost of
elements period units Units % units Units unit unites closing WIP
K K K K
Material 13,500 6,000 3,000 100% 3,000 9,000 1.50 9,000 4,500
Labour 1,500 6,000 3,000 50% 1,500 7,500 0.20 1,200 300
15,000 1.70 10,200 4,151

6.3.0 Transfers from Previous Process

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 Many manufacturing processes involves more than one process. Consider the making
of metal valve. The finished product may typically pass through three processes – it is
ground to size, it is polished and it is plated. The polishing process will thus receive as
input the fully ground valves. It may add some material (the polishing paste) and it
will certainly involve labour and overheads. There will thus be four cost elements and
the table used to calculate the costs will typically start as follows:
Opening WIP
Total cost Units % Effective units
Cost elements K
Previous process 20,000 20,000 100 20,000
Material 1,000 20,000 50 10,000
Labour 7,000 20,000 25 5,000
Overheads 2,000 20,000 25 5,000
Note that the transfers from the previous process must always be 100% complete –
only completed units can be transferred into a subsequent process.
Do not confuse opening WIP and transfers from the previous process. Opening work
in progress is the units that are incomplete at the start of the period of the process
being considered and may well include transfers from the previous process that are
always 100% complete.
6.4.0 Process losses
In many process industries the quantity, weight or volume of the process output will
be less than the quantity, weight or volume of materials input. This loss is due to
various reasons including, evaporation, swarf, breakage, testing and so on.
If the losses are at standard levels they are termed normal process losses. If they are
above or below expectations they are known as abnormal process losses or gains. It is
necessary to find out whether there are normal or abnormal losses or abnormal
gains because the costing treatment varies according to the category.
Both terminology and accounting procedures are imprecise and inconsistent when
dealing with matters of losses, the three general types of loss can be identified.
(a) Spoilage – defective production which may be identified at the end of a process,
at some specific inspection point during a process or at any random time during a
process. Such spoilt production may just have to be thrown away, it could be sold
for scrap or with reworking could be rectified to become good production.

(b) Scrap – material which emerges from a process with little or no sale value. This
might include swarf, sediment, scum and residuals. It may or may not have any
scrap value.

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 (c) Weight loss – a loss in weight of input materials due to evaporation or perhaps
spillage.
6.4.1 Normal process losses
These are unavoidable losses arising from the nature of the production process so it
is logical that the cost of these inevitable losses is included as part of the cost of good
production. If any money can be recouped from the sale of the wastage this helps to
reduce total costs.
In most process industries it is possible to specify what output quantity or volume is
expected to emerge from a given quantity of material input.
Example 4
Let us look at the making of strawberry jam. One recipe for this product states that
for 3kg sugar and 3kg strawberries (total input weight 6kg) the weight of jam
obtained will be 4.5kg approximately. The loss or waste of about 1.5kg is caused in
this instance by:
i. The removal of stalks etc from the strawberries;
ii. Removal of impurities by washing;
iii. Removal of part of the water content of the fruit by heating and consequent
evaporation
iv. Removal of further impurities which appear as scum on the surface of the
boiling jam.
If the cost of the 6kg of ingredients has been K3.00 , then the cost of 4.5 kg of good
production is also K3.00 ( plus any cost of processing ),i.e., the cost of the normal loss
is charged to the good production .
Show the ledger entries.
Solution
Jam Process Account
Kg K Kg K
Material 6.0 3.0 Normal loss a/c 1.5 -
Finished Goods 4.5 3.0
6.0 3.0 6.0 3.0
b/d 4.5 3.0
Note: The normal loss is entered at nil value, thereby leaving all the costs to be borne
by the good production, which costs K0.67 per kg. In this case, there is no write off to
profit and loss account because the entire cost of this normal loss is charged to the
good production.
6.4.2 Abnormal process losses or gains

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 Abnormal losses are those which are above the level expected. They cannot be
foreseen and are due to factors such as; plant breakdowns, inefficient working and
so on. Conversely there may be unexpectedly favourable conditions and actual losses
may be lower than ‘normal’ losses and thus an abnormal gain is made. The cost
effects of abnormal losses and gains are excluded from the process account which
will thus contain only normal costs (which include normal process losses).
Abnormal losses or gains are costed on the same basis as good production and so,
like good production, carry a share of normal losses.
Example 5
Consider again the example of jam process, but assume now that actual output
turned out to be only 3kg.
Show the relevant ledger accounts entries.
Solution
Jam Process Account
Kg K Kg K
Material 6.0 3.0 Normal loss a/c 1.5 -
Finished goods 4.5 3.0
6.0 3.0 6.0 3.0
b/d 4.5 3.0 Abnormal loss 1.5 1.0
Finished goods 3.0 2.0
4.5 3.0 4.5 3.0
In this layout the balance carried down (4.5 kg) represents the normal good
production anticipated from the input given. The normal loss is valued at the cost of
this normal good production (K0.67 per kg), and is written off to an abnormal loss
account and from there to the profit and loss account.
Abnormal Loss Account
Kg K Kg K
Jam process a/c 1.5 1.0 Profit & loss a/c 1.5 1.0

6.4.3 Sale of Scrap

If the residuals from a process can be sold, then the sale proceeds will be credited to
the process account and will thus reduce the cost of good production.
Consider the following example, involving both normal and abnormal losses that can
be sold for scrap.
Example 6
A division of a manufacturing company process 1,000 kg of material input costing
K10,000 in period 7. The normal loss is 10% of input which can be sold as scrap for K1

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per kg. In period 7, only 850 kg of good production results from the process. The
accounts will be as follows;

Process Account
Kg K Kg K
Material 1,000 10,000 Normal loss a/c (10%) 100 100
Finished goods 900 9,900
1,000 10,000 1,000 10,000
b/d 900 9,900 Abnormal loss (K11) 50 550
Finished goods (K11) 850 9,350
900 9,900 900 9,900
Loss Account
Kg K Kg K
Process a/c (NL) 100 100 Cash book 150 150
Process a/c (AL) 50 550 Profit & loss a/c 500
150 650 150 650

Note: the write off to profit and loss account is only K500. Although 50kgs were lost
which would have been worth K550 as good production, they are sold for K50 which
means that the company only loses K500.
Abnormal Gains
It is quite possible for a process to yield an abnormal gain.
Example 7
Consider example 6 above but assume that the good production is 950kg rather than
900kg. Show the revised ledger accounts.
Process Account
Kg K Kg K
Material 1,000 10,000 Normal loss a/c (10%) 100 100
c/d 900 9,900
1,000 10,000 1,000 10,000
b/d 900 9,900 Finished goods (K11) 950 10,450
Abnormal gain (K11) 50 550 .
950 10,450 950 10,450
Losses and Gains Account

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 Kg K Kg K
Process a/c (NL) 100 100 Cash 50 50
Profit and loss a/c 500 Process a/c (AG) 50 550
100 600 100 600

Note that only 50 kg are sold because only 50 kg of scrap result from the process.
Because only 50 kg are lost whereas the normal loss expected from the process is
100 kg, the company makes an abnormal gain of 50 kg. This results in an unexpected
gain of K500 in the profit and loss account as follows:
K
Value of 50 kg additional good production 550
Loss due to 50 kg of scrap not being sold (50 kg instead of 100 kg) (50)
Net gain 500
6.4.4 Losses with no work in process (WIP)
Example 8
A process for making lead shot involves melting ingots of lead, then pouring the melt
from a height, into a cooling bath. There is a loss of material due to spillage of the
melt and splatter by the bath. This material is sold for scrap. In a normal production
run 1kg of lead costing K40 would produce 0.95kg of shot with the scrap being sold
for K20 per kg.
In a week 100kg of lead was processed and 92kg of lead shot produced. Labour costs
of K550 were incurred and overhead costs are normally allocated at a rate of 4 times
labour costs.
Required
Calculate the cost per unit for lead shot and an amount to be written off in respect of
any abnormal loss. Also write up the process accounts.

6.4.5 Losses part way through a process

Sometimes you may be required to deal with losses that occur part way through a
process.
Example 9
Shown below is the previous month’s operating data for process 3, the final
manufacturing operation is the production of standard sized insulation blocks.
Work in progress Opening stock 400 blocks value K1,240
Closing stock 500 blocks

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The degree of completion of both opening and closing stocks of work in progress
was;
Previous process costs 100%
Process 3 materials 80%
Conversion costs 60%
During the month 4,500 blocks were transferred from process 2 at a total cost of
K9,000. Other costs charged to process 3 during the month were; materials K4,360;
labour and overhead (conversion costs) K2,125.
Process inspection occurs when process 3 materials are 60% complete and
conversion costs 30% complete and normally no losses are expected at this stage.
However, during the month 300 blocks were rejected at inspection and sold as scrap
for K1 each. The company operates the FIFO method of charging opening stock to
production.
Solution
Workings

1. You must obtain a clear picture of how the particular process given in a
question operates. The analysis below will help:

Input Output
Opening From Finished Loss Closing
work in process goods (abnormal) work in
process 2 process
400 + 4,500 = 4,100 + 300 + 500
(bal fig)
Degree of
completion %
Prior process 100 100 100 100
80 - 60 80
Conversion 60 - 30 60
cost

All 4,900 units input are accounted for the output side of the equation.
One tricky point in this question is the source of the abnormal loss – was it from
opening work in progress or goods received from process 2 this period? This is easily
resolved as we can see that opening work in progress had already passed the
inspection point as it has reached a more advanced stage of completion than the
units scrapped.
Thus the output of 4,100 units includes the 400 units started in the previous period
and the remaining 3,700 units must have been fully processed in the period.

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 a) Conversion costs refer to the labour and overheads expended in the period in
process 3 to convert the process 2 input into finished goods, closing WIP and
normal and abnormal losses.

b) The degree of completion of the previous process input is always 100% because
however muck work has been done in the current process to a particular unit
that work is always being done to a unit that is 100% complete as regards the
previous process.

2. Calculation of effective units (EU)

Started
and
Opening WIP finished Abnormal loss Closing WIP Total EU
Units % EU EU Units % EU units % EU

Previous process 400 - - 3,700 300 100 300 500 100 500 4,500

Process 3 material 400 20 80 3,700 300 60 180 500 80 400 4,360

Conversion costs 400 40 160 3,700 300 30 90 500 60 300 4,250

Note that the percentage refers to the work done in the period.

3. Calculation of costs per units and value of abnormal loss and closing WIP
Total Cost in Cost per Abnormal loss C/WIP
EU period EU EU EU
(W2) K K (W2) K (W2) K
Previous process 4,500 9,000 2.00 300 600 500 1,000
Process 3 material 4,360 4,360 1.00 180 180 400 400
Conversation cost 4,250 2,125 0.50 90 45 300 150
3.50 825 1,550

4. Value of finished goods:

K
Opening WIP: costs brought forward 1,240
Opening WIP: completion cost
Process 3 material 80 @ K1 80
Conversion costs 160 @ K0.50 80 160
Wholly completed during period 3,700 @ K3.50 12,950
14,350

The answer proper may now be presented as required:

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 Process 3 account

Blocks K Blocks K
Opening WIP b/f 400 1,240 Abnormal loss (W3) 300 825
Transfer from Finished goods (W4) 4,100 14,350
process 2 4,500 9,000 Closing WIP (W3) 500 1,550
Additional materials 4,360
Conversion cost 2,125
4,900 16,725 4,900 16,725

Abnormal loss account

Blocks K Blocks K
Process 3 300 825 Cash 300 300
Profit and loss account 525
300 825 300 825

Using FIFO method

You are required to prepare the process 3 account and abnormal loss account
recording the data shown above. Include a detailed working paper showing all your
calculation.
Using weighted average cost
If the weighted average method is to be used, added information must provide a
split of the valuation of opening stock over the constituent parts of the work.
For the above example 9 it might be given as follows:
Opening stock as valued at K1,240 being split as:
K
Previous 800
Process 3 material 320
Conversion costs 120
1,240
Given this information these costs would be added to those of the period and the
production of all the opening work in progress is also incorporated thus effectively
moving the cut-off point back to the moment production of last month’s closing work
in progress was commenced, for both production and costs.
The question would be answered as follows:

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