What are the steps of process costing?

Understanding Process Costing: A Step-by-Step Guide

Process costing is a method of accounting used to determine the cost of production in businesses that operate on a continuous or mass production basis. In process costing, the cost of production is assigned to units of production as they move through various stages of the production process.

Steps Involved in Process Costing:

1. Evaluating Inventory:

• Determine the physical quantity of partially completed units (WIP) at the beginning and end of the accounting period.
• Assign a cost to each unit of WIP based on the amount of work completed to date.

2. Adjusting Incomplete Work:

• Calculate the equivalent units of production for WIP. This involves adjusting the units based on the percentage of completion of each unit.
• Multiply the equivalent units by the cost per equivalent unit to determine the cost of work in process for the period.

3. Totaling Expenses:

• Accumulate all manufacturing costs incurred during the period, including direct materials, direct labor, and manufacturing overhead.

4. Determining Cost per Finished Unit:

• Divide the total manufacturing costs by the total equivalent units of production. This provides the cost per unit for all units completed during the period.

5. Allocating Costs to Finished and Unfinished Products:

• Allocate the costs of completed units to finished goods inventory.
• Allocate the cost of incomplete units to work in process inventory.

Benefits of Process Costing:

• Provides accurate cost information for ongoing production processes.
• Facilitates inventory valuation and cost allocation.
• Helps in determining the efficiency and profitability of production processes.
• Allows for better control of production costs and inventory levels.

Example:

Consider a company that produces 100,000 units of a product in a month. The beginning inventory of WIP is 20,000 units, 60% complete. The ending inventory of WIP is 30,000 units, 40% complete. Direct materials cost $2,000,000, direct labor cost $1,000,000, and manufacturing overhead cost $500,000.

Cost per Finished Unit:

• Total manufacturing costs: $2,000,000 + $1,000,000 + $500,000 = $3,500,000
• Equivalent units of production: 100,000 units (finished units) + 20,000 units (60% of WIP) + 30,000 units (40% of WIP) = 150,000 units
• Cost per finished unit: $3,500,000 / 150,000 units = $23.33

By following these steps, businesses can effectively implement process costing and gain valuable insights into their production costs and inventory valuation.