5.1 Process Costing System Overview

Process costing is a method for assigning costs to mass-produced, identical products. It's used in industries like oil refining and food processing, where large quantities of uniform goods are made continuously. This system averages costs over total units, focusing on departments rather than individual jobs.

Process costing differs from job order costing in key ways. It's ideal for standardized, high-volume production, while job order suits custom products. Process costing uses department-wide reports and calculates average costs, whereas job order tracks specific job costs on individual sheets.

Process Costing System Fundamentals

Characteristics of process costing

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• Process costing assigns costs to identical or similar units of product manufactured in large quantities through continuous production flow
• Averages costs over total units produced minimizing need for detailed individual unit tracking
• Accumulates costs by department or process stage rather than by specific jobs or orders
• Calculates per-unit costs by dividing total departmental costs by total equivalent units produced
• Focuses on processes or departments as cost objects instead of individual jobs or batches
• Suits industries with standardized high-volume production of homogeneous goods (oil refining, food processing)

Process costing vs job order costing

• Job order costing tracks costs for unique customized products while process costing accumulates costs for homogeneous mass-produced items
• Job order uses individual job cost sheets but process costing employs departmental production cost reports
• Job order calculates product costs specific to each job whereas process costing determines average cost per unit across all units in a period
• Job order assigns costs as jobs finish while process costing allocates costs at period end
• Job order suits diverse product lines (custom furniture) but process costing fits standardized production (paper manufacturing)

Applications of process costing

• Oil refining and petrochemicals produce large volumes of standardized fuels and chemicals
• Food and beverage companies mass produce identical consumer goods (soft drinks, snack foods)
• Textile manufacturers create bulk quantities of uniform fabrics and garments
• Paper mills generate massive amounts of indistinguishable paper products
• Cement plants produce vast quantities of standardized construction materials
• Pharmaceutical companies manufacture large batches of identical medications and drugs
• Ideal for high-volume continuous production of goods indistinguishable from each other
• Useful when individual unit cost tracking impractical or unnecessary due to product uniformity

Cost flow in process costing

• Direct materials added at process start or throughout, costs assigned to relevant department
• Direct labor applied continuously, costs accumulated by department based on hours or wages
• Manufacturing overhead allocated using predetermined rates (utilities, depreciation)
• Work in process inventory represents partially completed units, costs tracked by department
• Completed units and associated costs transfer between departments as production progresses
• Finished goods inventory accumulates costs of fully completed units from final department
• Cost of goods sold represents production costs of units sold to customers
• Cost flow process:

1. Accumulate costs by department
2. Calculate equivalent units of production
3. Determine cost per equivalent unit
4. Assign costs to completed units and ending WIP
5. Transfer costs to next department or finished goods