Question

Provide an example, of a company that operates using (process costing), then describe how (process costing) will help a business owner manage the business better.

Answer 1

Process costing is a method of costing used to ascertain the cost of a product at each stage of production.There are certain industries in which one or more products are manufactured in a continuous flow or on mass production basis.The raw materials passes from process to process until the finished product comes out.So the output of the first company becomes the input of the second company.It is that form of operation costing that applies where standardized goods are produced.Some companies adopting process costing system are Chevron corporation(petroleum products),Wrigley company(chewing gum),Pittsberg paints(paints),Coco cola company etc.

  

The Production Process at Coca-Cola

The Coca-Cola Company is one of the world’s largest producers of nonalcoholic beverages. According to the company, more than 11,000 of its soft drinks are consumed every second of every day.

In the first stage of production, Coca-Cola mixes direct materials—water, refined sugar, and secret ingredients—to make the liquid for its beverages. The second stage includes filling cleaned and sanitized bottles before placing a cap on each bottle. In the third stage, filled bottles are inspected, labeled, and packaged.

Work in process begins with the first stage of production (mixing and blending), continues with the second stage (bottling), and ends with the third stage (inspecting, labeling, and packaging). When products have gone through all three stages of production, they are shipped to a warehouse, and the costs are entered into finished goods inventory. Once products are delivered to retail stores, product costs are transferred from finished goods inventory to cost of goods sold. Process costing system is used by companies that produce similar or identical units of product in batches employing a consistent process.

Next is the example of a wine company that utilizes process costing method:

ABC Wine Company crushes grapes to be used in winemaking. The company has asked you to determine its product cost per gallon for each stage of manufacture. You've been given the following information:

Manufacturing Stages

• Crushing
• Packaging

Expenses

• Grapes purchased: $100,000
• Grape press maintenance: $25,000
• Packaging supplies: $75,000
• Packager labor: $50,000

Other Information

• Units produced: 50,000 gallons

The first step to calculating product cost per gallon is to determine what process each expense relates to. In this example, grapes purchased and grape press maintenance relate to the crushing process and packaging supplies and packager labor relate to the packaging process.

The next step is to calculate cost per unit for both direct materials and conversion costs for each stage of the process. As discussed earlier, direct materials are materials consumed during manufacture and conversion costs are direct labor costs and manufacturing overhead costs.

Crushing Cost per Unit

$100,000 grapes purchased ÷ 50,000 gallons juice = $2.00 of direct materials cost per gallon
$25,000 grape press maintenance ÷ 50,000 gallons juice = $0.50 conversion cost per gallon
$2.00 of direct materials cost + $0.50 conversion cost = $2.50 total crushing cost per gallon

• 50,000 gallons juice = $2.00 of direct materials cost per gallon
  $25,000 grape press maintenance ÷ 50,000 gallons juice = $0.50 conversion cost per gallon
  $2.00 of direct materials cost + $0.50 conversion cost = $2.50 total crushing cost per gallon

• Packaging Cost per Unit

  $75,000 packaging supplies ÷ 50,000 gallons juice = $1.50 of direct materials cost per gallon
  $50,000 packager labor ÷ 50,000 gallons of juice = $1.00 conversion cost per gallon
  $1.50 direct materials cost + $1.00 conversion cost = $2.50 total packaging cost per gallon

  Total Cost per Unit

  $2.50 crushing cost per gallon + $2.50 packaging cost per gallon = $5.00 total cost per gallon

  Upon completion of your project, you'll be able to tell ABC Wine Company that the total cost per gallon is $5.00, which consists of:

• $2.00 crushing direct materials
• $0.50 crushing conversion costs
• $1.50 packaging direct materials
• $1.00 packaging conversion costs

It helps managers in better management of their firms through the following:

1. It helps the management in cost control over manufacturing process.Many companies engage in to keep track of where their money is being spent in the production and distribution processes. Understanding these costs is the first step in being able to control them.
2. Managers must carefully watch per unit costs on a daily basis through the production process, while at the same time dealing with materials and output in huge quantities.Process costing helps for this purpose.
3. Business owners use process costing because it creates a flexible production process. Companies needing to refine their process can simply add or remove a process as necessary. This also allows companies to lower their production cost for each good.
4. Management accountants must calculate equivalent units in the process costing system. Equivalent units represent the amount of unfinished goods left in a process at the end of an accounting period. This calculation may only be a best guess or an estimate by management accountants.
5. Process costing can create cost errors in the production system.Management accountants may also leave out production costs and create under-costed products. Under-costed products usually result in lower business profits because goods are actually more expensive than actually reported.
6. Process costing is an easier system to use when costing homogenous products compared to other cost allocation methods. Business owners allocate business costs according to the number of processes each good travels through in the production system and thereby creating a simple average cost of an item.