Process Costing: Meaning and Advantages

Process costing is a cost accounting method used in industries with continuous mass production. It calculates the average cost per unit by spreading the total production costs evenly over all units produced during a specific period. It provides a standardized cost for each unit. This method simplifies cost tracking for homogenous products but may not account for variations in individual unit costs.

Process costing is a cost accounting method companies use that involves the mass production of standardized and homogenous goods. It can be used in chemicals, steel, textiles, sugar, etc. Here, the cost of producing each separate unit is very similar. Meanwhile, the cost of producing each good is very high. For example, it can be used in bakeries, where they produce bread using the same procedure, or textile industry, where the same cloth is manufactured using the same method.

It is assumed that the average cost presents the cost per unit. The cost of production during a particular period is divided by the number of units produced to arrive at the cost per unit. Let's understand this essential cost accounting method in detail with examples. 

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Table of Content

• What is Process Costing?
• Example of Process Costing
• Advantages of Process Costing
• How to Implement Process Costing

What is Process Costing?

Process costing is a method in which all costs can be gathered together for each stage of production or process. Divide the cost of each process by the normal output of that process at each production stage to determine the cost per unit. Here, we do not track the production for the individual units of the product.

This method contrasts with other accounting methods such as product costing, job costing, and operating costing methods. The process costing method is suitable only for certain conditions. It works by dividing the production process into different stages called processes. The cost of producing a product is then allocated to each process based on the cost elements such as labour, materials, and overhead.

The cost of each process is then divided by the number of units produced to determine the cost per unit. Process costing is a method manufacturers use to determine the cost of producing a product or service. A costing system allocates the product cost to each production unit. This blog will discuss the basics of process costing, its benefits, and how it can be implemented in different industries.

Example of Process Costing

Company XYZ manufactures soft drinks in large quantities using a continuous production process. In a month, the company incurs total production costs, including ingredients, labor, and factory overhead, amounting to ₹500,000. During the same month, the company produces 50,000 bottles of soft drinks.

To calculate the cost per bottle using process costing:

Cost per Bottle = Total Production Costs/ Number of Bottle Produced
Cost per Bottle= 50,000bottles/ ₹500,000​ = ₹10perbottle

Using process costing, the company determines that the cost per bottle of soft drink is ₹10, making it easier to manage costs and set prices accordingly for their mass-produced beverages.

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Advantages of Process Costing

Accurate cost calculation: It allows manufacturers to calculate production costs by assigning costs to each production process. This helps manufacturers to identify the cost of each unit produced and ensure the final cost of the product is competitive.

Consistency: It ensures consistency in the cost of production, as the same cost is assigned to each unit produced. This helps manufacturers to make informed decisions regarding production volume and pricing.

Easy to implement: It is relatively easy to implement. It requires the calculation of the cost of production for each process. This makes it a popular method for manufacturers that produce large quantities of standardized products.

Efficiency: Process costing can help manufacturers identify inefficiencies in the production process and reduce waste. By tracking the cost of each process, manufacturers can identify areas where costs can be reduced. It helps to improve efficiency and profitability.

Budgeting: It helps manufacturers to develop accurate budgets for production. By tracking the cost of each process, manufacturers can identify areas where costs can be reduced, which helps improve profitability and budget planning.

Performance measurement: Process costing can be used to measure the performance of each production process. This can help manufacturers to identify areas where improvements can be made and develop strategies to increase productivity and profitability.

How to Implement Process Costing

Process costing can be implemented in any manufacturing industry producing large quantities of goods. The implementation of this method may vary depending on the industry and the manufacturing process.

The following steps can be used as a general guideline for implementing process costing in manufacturing:

Divide the production process into processes: The first step in implementing this method is to divide the production process into different processes. Each process should be distinct and have separate input and output.

Identify the cost drivers for each process: The next step is to identify the cost drivers for each process. Cost drivers are the resources used in each process, such as labour, materials, and overhead.

Calculate the total cost of each process: The total cost of each process should be calculated by adding the cost of the cost drivers for each process.

Allocate the total cost of each process to the units produced: The total cost of each process should be allocated to the units produced in that process. The cost per unit can be calculated by dividing the total cost of each process by the number of units produced in that process.

Calculate the total cost of production: The total cost of production can be calculated by adding the total cost of each process.

Calculate the cost per unit: The cost per unit can be calculated by dividing the total cost of production by the total number of units produced.

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Conclusion

Process costing is a valuable tool for manufacturers to determine production costs accurately. Manufacturers can identify areas where costs can be reduced and make better pricing, production volumes, and product mix decisions. It can done by dividing the production process into different processes and allocating costs to each process. The implementation of this method may vary depending on the industry and the manufacturing process. Still, the general steps outlined above can be used as a guideline for implementing process costing in any manufacturing industry.