Student lecture notes

CHAPTER 20

PROCESS COSTING

Definition
Process costing is appropriate to a business or operation where there is a continuous
flow of a relatively high volume of similar products during a reporting period.

Definition
An equivalent unit of output is the amount of output, expressed in terms of whole
units, which is equivalent to the actual amount of partly or fully completed
production.

Steps of process costing

(a) Collect data for the period.

(b) Prepare a statement of physical flows and equivalent units of output for the
month.
(c) Ascertain total costs to be accounted for this period.
(d) Calculate cost per equivalent unit.
(e) Apportion cost between finished output and work-in-progress; and check that
all costs are accounted for.

Process costing illustration

Process costing where there is no opening work-in-progress

(a) Collect data for the period

Data in respect of month 1

No work-in-progress at start of month
60,000 units of raw materials introduced for conversion
40,000 units of output completed during the month
20,000 units of work-in-progress, 40% completed at end of month

Costs incurred on material, labour and overheads: 120,000

Financial and Management Accounting, Third Edition Student notes 20.1

P Weetman and P Gordon. Copyright Pearson Education Limited 2003
 (b) Prepare a statement of physical flows and equivalent units of output
for the month

Physical Equivalent
flow units of
(units) output
INPUT
Materials introduced

OUTPUT
Goods finished this month
Work-in-progress at end (40% completed)
Total equivalent units

(c) Ascertain total costs to be accounted for this period

Opening work-in-progress
Incurred this month
Total to account for

(d) Calculate cost per equivalent unit

Cost per equivalent unit = =

(e) Apportion cost between finished output and work-in-progress

Value of finished output 40,000 2.50
Work-in-progress 8,000 2.50
Total costs accounted for

Process costing where there is work-in-progress at the

start of the period

(a) Collect data for the period

Data in respect of month 2

20,000 units of work-in-progress at start, 40% complete
30,000 units of raw materials introduced for conversion
35,000 units of output completed during the month
15,000 units of work-in-progress, one-third completed at end of
month

Costs incurred on material, labour and overheads: 120,000

Financial and Management Accounting, Third Edition Student notes 20.2

P Weetman and P Gordon. Copyright Pearson Education Limited 2003
 (b) Prepare a statement of physical flows and equivalent units of output
for the month

Physical Equivalent
flow units of
(units) output
INPUT
Work-in-progress at start
Material introduced

OUTPUT
Goods finished this month
Work-in-progress at end (33.3% completed)
Total equivalent units

(c) Ascertain total costs to be accounted for this period

Opening work-in-progress brought forward
Incurred this month
Total costs to be accounted for

(d) Calculate cost per equivalent unit

Cost per equivalent unit = =

(e) Apportion cost between finished output and work-in-progress

Value of finished output 35,000 3.50
Work-in-progress 5,000 3.50
Total costs accounted for

Financial and Management Accounting, Third Edition Student notes 20.3

P Weetman and P Gordon. Copyright Pearson Education Limited 2003
Separate material and conversion costs

(a) Collect data for the period

Data in respect of the month of April

4,000 units work-in-progress at start, 100% complete in respect of
materials, 25% complete in respect of conversion
6,000 units of raw materials introduced for conversion
8,000 units of output completed during the month
2,000 units of work-in-progress, 50% complete in respect of
materials, 10% complete in respect of conversion
Value of opening work-in-progress, 60,000, consisting of 30,000
for materials and 30,000 for conversion costs
Costs incurred in the month on materials is 150,000 and on
conversion costs is 216,000

(b) Prepare a statement of physical flows and equivalent units of output

for the month

Physical Equivalent units

flow of output
(units)
INPUT Materials Conversion
Work-in-progress at start 4,000
Materials introduced 6,000
10,000
OUTPUT
Goods finished this month 8,000
Work-in-progress at end 2,000
Total equivalent units 10,000

(c) Identify total costs to be accounted for this period

Materials Conversion Total

Opening work-in-progress brought forward
Incurred this month
Total costs to be accounted for

Financial and Management Accounting, Third Edition Student notes 20.4

P Weetman and P Gordon. Copyright Pearson Education Limited 2003
 (d) Calculate cost per equivalent unit

Materials Conversion
Total costs to be accounted for
Number of equivalent units

Cost per equivalent unit

(e) Apportion cost between finished output and work-in-progress

Value of finished output 8,000
Work-in-progress:
Materials 1,000
Labour 200

Total costs accounted for

Joint product costs and by-products

Definition
Joint products are two or more products arising from a process, each of which
has a significant sales value.

A by-product is a product arising from a process where the sales value is

insignificant by comparison with that of the main product or products.

Data for use in allocation of joint costs

A chemical process requires input of materials costing 900 per batch. From
each batch there are two products, being 1,000 litres of perfume oil base
which sells for 2 per litre and 500 litres of oil for artists paint which sells at
1 per litre.

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P Weetman and P Gordon. Copyright Pearson Education Limited 2003
Joint costs allocated on the basis of physical measures

Perfume oil base Oil for artists paint

Sales 2,000 500
Joint costs allocated 600 300
Profit 1,400 200

Profit as % of sales 70% 40%

Joint costs allocated by relative sales value at the point of separation

Perfume oil base 2,000/2,500 900 720
Oil for artists paint 500/2,500 900 180
900

Statement of product profit for joint products: Relative sales value

Perfume oil base Oil for artists paint

Sales 2,000 500
Joint costs allocated 720 180
Profit 1,280 320

Profit as a % of sales 64% 64%

Further processing costs

A chemical process requires input of materials costing 900 per batch. From
each batch there are two products, being 1,000 litres of perfume oil base
which sells for 2 per litre and 500 litres of oil for artists paint which sells at
1 per litre. After the two products have been separated, further
processing costs are incurred, amounting to 600 per batch in the case of
perfume oil base and 100 per batch in the case of oil for artists paint.

Cost allocation based on notional sales value at the point of separation

(a) Calculation of notional sales value at the point of separation

Selling price per batch 2,000 500
Costs incurred after separation 600 100
Notional selling price before separation 1,400 400

Financial and Management Accounting, Third Edition Student notes 20.6

P Weetman and P Gordon. Copyright Pearson Education Limited 2003
(b) Allocation of joint cost based on notional selling price before separation

Perfume oil base 1,400/1,800 900 700
Oil for artists' paint 400/1,800 900 200
900

(c) Calculation of profit for each joint product

Perfume oil base Oil for artists paint

Sales 2,000 500
Joint costs allocated 700 200
Costs after separation 600 100
1,300 300
Profit 700 200

Profit as a % of sales 35% 40%

Treatment of by-products

By-products are items of output from a process which have a relatively minor sales
value compared with that of the main product.

The accounting treatment of by-products is similar to the accounting treatment of

scrap. The proceeds of sale are offset against the cost of the main product. This
section now gives an example of a process which leads to a by-product.

Process which creates a by-product

A chemical process requires input of materials costing 900 per batch. From each
batch there are two products, being 1,000 litres of perfume oil base which sells for
2 per litre and 500 litres of waste oil which sells at 10 pence per litre.

Joint cost allocation and profit calculation

Sales of perfume oil base, per batch 2,000
Joint costs 900
Less sales proceeds of waste oil (50)
by-product
Net cost per batch 850
Profit per batch 150

Financial and Management Accounting, Third Edition Student notes 20.7

P Weetman and P Gordon. Copyright Pearson Education Limited 2003
Relevance of allocating joint costs

Definition

Relevant costs are those future costs which will be affected by a decision to be
taken. Non-relevant costs will not be affected by the decision. The decision-
making process therefore requires careful selection of only those costs which
are relevant.

Decisions on joint products: sell or process further

Definition
Incremental costs are the additional costs that arise from an activity of the
organisation. To justify incurring incremental costs it is necessary to show
they are exceeded by incremental revenue.

Situation requiring a decision

In a company manufacturing personal care products, a process requires the input of

ingredients costing 400 per batch. Separation of the output from each batch yields
200 litres of hand cream which sells at a price of 1.60 per litre and 200 litres of soap
solution which sells at a price of 80 pence per litre. The soap solution in that form
is suitable for industrial use but, at a further cost of 50 per batch of 200 litres it
could be perfumed and sold for domestic use at 1.20 per litre.

Statement of incremental costs and revenues

Extra revenue 200 litres (1.20 0.80) 80
Extra cost 50
Extra profit per batch 30

Financial and Management Accounting, Third Edition Student notes 20.8

P Weetman and P Gordon. Copyright Pearson Education Limited 2003