## Process Costing
### Definition
A method of costing where material passes through two or more processes before becoming a finished product. Costs are accumulated per process per period.
### Industries Where Process Costing Applies
Look for these features:
1. Factory divided into distinct processes/cost centres (each = a stage of production)
2. Manufacturing is continuous — processes run sequentially, selectively, or simultaneously
3. Output of one process = Input of the next
4. End products are identical / homogeneous units
5. Lot identity cannot be traced (e.g., sugar from sugarcane — impossible to link a bag of sugar to a specific cane lot)
6. Production may yield joint products and/or by-products
Examples: Sugar, chemicals, cement, textiles, petroleum refining, pharmaceuticals
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### Five Steps in Process Costing
| Step | Action |
|---|---|
| 1 | Analyse physical flow of units: opening WIP + fresh inputs → completed + closing WIP + losses |
| 2 | Calculate equivalent units for each cost element (materials, labour, overheads separately) |
| 3 | Determine total cost for each cost element for the period |
| 4 | Compute cost per equivalent unit = Total cost ÷ Equivalent units |
| 5 | Assign costs: to completed units, units transferred, closing WIP, abnormal loss/gain |
#### Equivalent Units — Critical Concept
WIP is partially complete. Convert to equivalent completed units:
- Materials (often added at start): WIP units × % material added (often 100%)
- Labour & Overheads: WIP units × % of completion
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### Two Methods for WIP Valuation
| Method | Approach | Use When |
|---|---|---|
| FIFO | Opening WIP costs kept separate; current period costs applied only to current work | Costs change significantly between periods |
| Weighted Average | Opening WIP costs + current period costs pooled; average rate computed | Simpler; costs are relatively stable |
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### Inter-Process Profits
When goods transfer between processes above cost (at market value or cost + profit %):
- Each process acts as a profit centre
- Enables comparison: process output cost vs. market price at that completion stage
| Detail | |
|---|---|
| Advantage | Facilitates performance evaluation; incentivises efficiency per process |
| Disadvantage | Creates unrealised profits (stock not yet sold shows profit in accounts); adds complexity |
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### Operation Costing (Hybrid System)
- Used when a company produces multiple product variants with different materials but similar conversion activities
- Also called: Hybrid product costing system
| Cost Type | Treatment |
|---|---|
| Material costs | Tracked separately per variant (job-order / batch / unit basis) |
| Conversion costs (labour + OH) | Accumulated by department/process; applied via predetermined rate |
Example: A shoe manufacturer makes Deluxe (leather) and Regular (synthetic) models. Same cutting/stitching process → pool conversion costs. Different materials → track separately.
Industries: Ready-made garments, shoes, jewellery, any multi-variant manufacturer with shared conversion.