Why It Matters: Process Costing

In a job costing system, costs are assigned directly to each project. For instance, American Tugs, which builds custom yachts based on a tugboat mold, tracks direct costs for each project and allocates overhead so that each item manufactured also has a “cost card” that has every direct and indirect cost recorded. When the boat is sold, management can tell exactly how much money the company made or lost on that unique product.

A graphic titled Job Costing System is shown. On the left is a yellow area containing direct materials, direct labor and manufacturing overhead. To the right is an orange area labeled Work In Process Inventory. Within this area are three items: Job 1127, Job 1128, and Job 1129. Arrows point from the yellow area to these three jobs. To the right of that is a green area labeled Finished Goods Inventory, which contains two items: Job 1127 and Job 1128. Arrows are pointing from the corresponding jobs in the Work in Process Inventory area to these. To the right of that is a purple area labeled Cost of Goods Sold. It contains Job 1127, with an arrow pointing from the corresponding job in the Finished Goods Inventory area to it. The Work in Process and Finished Goods Inventory areas are labeled as being on the Balance Sheet, and the Cost of Goods Sold area is labeled as being on the Income Statement.

However, many businesses produce large quantities of a single product or similar products. Pepsi-Cola makes soft drinks, Exxon Mobil produces oil, and Kellogg Company produces breakfast cereals on a continuous basis over long periods. For these kinds of products, companies do not have separate jobs. Instead, production is an ongoing process. In these types of operations, accountants must accumulate costs for each process or department involved in making the product and then somehow assign those costs to the products.

Here is a short comparison of job order costing and process costing:

You can view the transcript for “Job Order Costing vs Process Costing” here (opens in new window).

A process cost system (process costing) accumulates costs incurred to produce a product according to the processes or departments it goes through on its way to completion, then those costs are allocated to the finished goods in some logical manner. This is what you will learn to do in this module.

A graphic titled Process Costing System is shown. On the left is a yellow area containing direct materials, direct labor and manufacturing overhead. To the right are three orange areas labeled Work In Process Inventory, which are further identified as Mixing, Molding, and Packaging. Arrows point from the yellow area to all three orange areas. Arrows also point from Mixing to Molding to Packaging. To the right of Packaging is an arrow pointing to a green area labeled as Finished Goods Inventory. To the right of that is an arrow pointing to a purple area labeled as Cost of Goods Sold. The Work in Process and Finished Goods Inventory areas are labeled as being on the Balance Sheet, and the Cost of Goods Sold area is labeled as being on the Income Statement.