# Process Costing
## Meaning and Applicability
Process costing is the method used when material must pass through two or more processes to become a finished product. Common industries: crude oil refining, chemicals, sugar, textiles, paper.
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## Features of Process Costing
1. A separate account is maintained for each process
2. Output of one process becomes the input of the next
3. All processes are standardised
4. Costs are collected process-wise
5. Output of the last process becomes finished goods
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## Operation Costing — A Refinement
Operation costing ascertains cost for each operation within a process (more granular than process costing).
$$\text{Unit Operation Cost} = \frac{\text{Total Operation Cost}}{\text{Total Output}}$$
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## Process Losses and Gains
### Normal Process Loss
- Unavoidable; arises from the inherent nature of materials and the production process
- Estimable in advance from past experience
- Includes: normal waste, normal scrap, normal spoilage, normal defectives
- Accounting treatment: Cost of normal loss is absorbed by good units → cost per unit is inflated
### Abnormal Process Loss
- Loss in excess of normal loss (e.g., due to worker carelessness, machine breakdown)
- Cannot be estimated in advance
- Accounting treatment: Cost of an abnormal loss unit = Cost of a good unit; debited to Costing P&L A/c
### Abnormal Process Gain
- Occurs when actual output > expected output (actual loss < normal loss)
- Accounting treatment: Cost of abnormal gain unit = Cost of a good unit; credited to Costing P&L A/c
### Summary Comparison
| Attribute | Normal Loss | Abnormal Loss | Abnormal Gain |
|---|---|---|---|
| Cause | Inherent nature of process | Carelessness / breakdown | Better-than-expected output |
| Predictable? | Yes | No | No |
| Accounting treatment | Borne by good units (inflated cost) | Debited to Costing P&L | Credited to Costing P&L |
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## Equivalent Production Units
When production is continuous, period-end Work-in-Progress (WIP) is semi-finished. It is valued by converting to equivalent completed units.
$$\text{Equivalent Units} = \text{WIP Units} \times \text{Percentage of work completed}$$
Each element (material, labour, overhead) may have a different completion percentage and must be calculated separately.
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## Job Costing vs Process Costing
| Basis | Job Costing | Process Costing |
|---|---|---|
| Production trigger | Special customer order | Continuous / mass production |
| Product nature | Each job is unique | Homogeneous and standardised |
| Cost centre | Individual job | Individual process |
| Cost ascertainment | When the job is complete | At the end of each process |
| WIP | May or may not exist | Always exists |
| Transfer between units | Usually none | Output of one process → input of next |
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## Inter-Process Profit
When the output of a process is transferred to the next process at market value or cost + profit (rather than at cost), the difference is the inter-process profit.
Advantages:
- Tests whether process production cost is competitive with market price
- Each process operates as a profit centre enabling performance evaluation
Disadvantages:
- Introduces complexity in accounts and reconciliation
- Shows unrealised profits (stock still in pipeline has not been sold)