Question

Which types of companies would most likely use a process costing system? Provide examples of two Compagnies.

Explain the methods with which the cost per unit will be calculated for this type of companies. Explain how the different items of inventory will be evaluated?

Answer 1

Companies which are engaged in mass production and standardised items for sale usually adopt process costing. The products manufactured usually do not have separate identity from one to another unlike job costing.

Examples:

· Chemical industry

· Paint industry

· Sugar industry

The cost per equivalent unit is adopted to calculate the cost of work transferred to finished goods or to next department. The cost per equivalent unit is calculated by computing equivalent units of production for opening stock and closing stock. There are 2 method one if FIFO and another one is weighted average method.

· FIFO calculates equivalent units by adding work uncompleted on opening WIP plus units completed during the period and work competed on closing stock. The current period cost is divided by the equivalent units to calculate cost per equivalent unit

· Weighted average does not take into account the opening units of unfinished work. It takes into account units started and completed plus closing units work completed only. The opening WIP cost and current period cost is added and divided by the equivalent units to calculate cost per equivalent unit

Different items of inventory valuation

· FIFO- in FIFO method opening WIP is valued for opening WIP cost plus work done during the period. The unfinished work on opening stock is multiplied by cost per equivalent unit. The closing stock is valued at equivalent units in ending WIP multiplied by cost per equivalent unit. Units completed and transferred is sum of opening WIP plus work completed on opening WIP during the period and units completed during the period.

· Weighted average method – In Weighted average method the cost of opening WIP is added with current period cost and weighted average cost per unit is calculated and this cost per equivalent unit is used to calculate the ending WIP inventory. Opening inventory is not separately valued. Units completed and transferred is multiplied by cost per equivalent unit for valuing finished units or units transferred to next department