Introduction to Process Costing

What you will learn to do: understand the characteristics of process costing

Many different paint cansA 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. Companies making paint, gasoline, steel, rubber, plastic, and similar products use process costing. In these types of operations, accountants must accumulate costs for each process or department involved in making the product.

Items enter production in batches rather than individually. A batch is defined as each time a quantity of materials is added to the first point of production to keep the workflow going. Direct costs accumulate and indirect costs are applied to the batches as they move through the production processes. A unit is one of the products that is manufactured in a batch. Eventually, costs are averaged over the units produced during the period to determine the cost of one item.

The next graphic shows the cost flows in a process cost system. Products begin in a mixing department. From mixing, the products go to baking, and from baking to packaging. The finished products are transferred to storage until they are sold.

Graphic showing flow of Process Costing System. Direct Materials, Direct Labor, and Manufacturing Overhead all flow into the Work in Process Inventory in the various departments--Mixing, Baking, then Packaging. This then flows into Finished Goods on the Balance sheet, which then flows into Cost of Goods Sold on the Income Statement.

 

The continuous flow of products makes job costing impractical. Instead, accountants compute the cost per unit by first accumulating costs for the entire period (usually a month) for each process or department. Second, they divide the accumulated costs by the number of units produced (tons, pounds, gallons, or feet) in that process or department.

When you are done with this section, you will be able to:

  • Identify circumstances most appropriate for process costing
  • Describe the flow of costs through a process costing system
  • Understand and calculate equivalent units of production

Learning Activities

The learning activities for this section include the following:

  • Reading: Application of process costing
  • Self Check: Application of process costing
  • Reading: Flow of Costs
  • Self Check: Flow of Costs
  • Reading: Equivalent Units of Production
  • Self Check: Equivalent Units of Production