Question

Process costing serves two related purposes. First, it measures the cost of goods manufactured on both a total and per-unit basis. This information is used in valuing inventories and in recording the cost of goods sold. But process costing also provides management with information about the per-unit cost of performing each step in the production process. This information is useful in evaluating the efficiency of production departments and often draws attention to potential cost savings. Milton Manufacturing uses a process costing system. Products are processed successively by Department × and Department Y and are then transferred to the finished goods warehouse. Shown below is cost information for Department Y during the month of May: The assignment for this unit will consist of two parts, in a word document of 1-2 pages, address the following questions. 1. Briefly explain the operation of process costing, including the way the unit costs of finished goods are determined. 2. Discuss how managers will use the information obtained from process costing.

Answer 1

(1) Operation of process costing, including the way the unit costs of finished goods are determined.

Process costing is a method of costing used i industries where the material has to pass through two or more process for being converted into 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 like steel, paper, medicines,soaps, chemicals, rubber,vegetable oil,paints,paints etc. where the production process is continuous and the output of one process becomes the input of the following process till completion.

Basic Features of Of process costing are as follows;

Industries, where process costing can be applied have normally one or more of the following features;

• Each plant or factory is divided into a number of processes, cost centres or departments, and each such division into a stage of production or a process.
• Manufacturing activity is carried on continuously by means of one or more process run sequentially, selectively or simultaneously
• The output of one process becomes the input of another process
• The end product usually is of like units or distinguishable from one another
• It is not possible to trace the identity of any particular lot of output to any lot of input materials. For example, in the sugar industry, it is impossible to trace any lot of sugar bags to a particular lot of sugarcane fed or vice versa.
• Production of a product may give rise to joint and/or By-products.

Costing Procedure: The cost of each process comprises the cost of;

1. Materials
2. Labour
3. Direct Expenses
4. Overheads of production

• Materials- Materials and supplies which are required for each process are drawn against material requisitions from stores. Each process for which the above drawn materials will be used should be debited with the cost of materials consumed on the basis of the information received from the Cost Accounting management Department. The finished product of first process generally become the raw materials of second process; under such a situation the account of second process, be debited with the cost of transfer from the first process and the cost of any additional material required under this second process.
• Labour - Each process account should be debited with the labour cost or wages paid to labour for carrying out the processing activities.Sometimes the wages paid are appointed over the different processes after selecting appropriate basis.
• Direct Expenses - Each process account should be debited with direct expenses like depreciation, repairs, maintenance, insurance etc associated with it.
• Overheads of Production - Expenses like rent , power expenses, lighting bills, gas and water bills etc are known as production overheads. These expenses cannot be allocated to a process. The suitable wayout to recover them is to apportion them over different processes by using basis. Usually, these expenses are estimated in advance and the processes debited with these expenses on a pre-determined basis.

(2) .How managers will use the information obtained from process costing.

• Cost Containment : A business that implements a process costing system can better contain manufacturing expenses. Under this system, each department is assigned a cost center. A cost center is a number or code that identifies the purchases made by a single department. As financial expenditures, such as the acquisition of supplies and employee salaries, are made throughout the production process, each group creates a report highlighting purchases that have been made under its respective cost center.

  These reports are compiled and reviewed by senior management. This data allows them to identify inefficiencies within the supply chain. For example, a cost center report may indicate that 50 percent of production costs come from the procurement department. Management can then dictate steps that the procurement team must take to minimize costs.

• Inventory Control : The Internal Revenue Service requires all businesses that maintain an inventory to meticulously track and report its supply. The IRS uses this information to accurately value the business so that tax estimates can be made. Tracking inventory can be a cumbersome task for very large corporations. This process can be simplified, however, through the implementation of a process costing system.

  Throughout the manufacturing process, each department documents any materials purchased. In addition, each good is valued and added to the cost center report. Management includes this information on the company’s income tax returns.

• Uniformity : Many organizations allow each of their departments to operate autonomously. For example, the procurement department will have policies and procedure that are completely unique and independent of those of the supply chain group. This can be an incredibly ineffective way for a business to operate.

  Each department, in this scenario, may have its own jargon, making interdepartmental communication difficult. Furthermore, maintaining separate systems and policies means that additional money and time must be spent to cross-train employees. Through the implementation of a process costing system, a company will ensure that every department, regardless of function, operates in a uniform manner. This will allow members of the manufacturing supply chain to be in sync with one another.

• The average cost can be easily determined when the methods of production are standardized. Price quotations can be submitted more promptly with standardization of processes.

• The performance analysis and managerial control is facilitated to a greater extent because of the availability of cost data in the form of prompt and accurate cost reports.

• Allocation of expenses can be easily made and the costs in each process accurately determined.