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Process costing is a method of costing used mainly in manufacturing where units are continuously mass-produced through one or more processes. Examples of this include the manufacture of erasers, chemicals or processed food. In process costing it is the process that is costed (unlike job costing where each job is costed separately). The method used is to take the total cost of the process and average it over the units of production.
Cost per unit = Cost of inputs /
Expected output in units
Important terms to understand
In a manufacturing process the number of units of output may not necessarily be the same as the number of units of inputs. There may be a loss.
This is the term used to describe normal expected wastage under usual operating conditions. This may be due to reasons such as evaporation, testing or rejects.
This is when a loss occurs over and above the normal expected loss. This may be due to reasons such as faulty machinery or errors by labourers.
This occurs when the actual loss is lower than the normal loss. This could, for example, be due to greater efficiency from newly-purchased machinery.
Work in progress (WIP)
This is the term used to describe units that are not yet complete at the end of the period. Opening WIP is the number of incomplete units at the start of a process and closing WIP is the number at the end of the process.
Sometimes the outcome of a loss can be sold for a small value. For example, in the production of screws there may be a loss such as metal wastage. This may be sold to a scrap merchant for a fee. 2
This refers to a conversion of part-completed units into an equivalent number of wholly-completed units. For example, if 1,000 cars are 40% complete then the equivalent number of completed cars would be 1,000 x 40% = 400 cars. Note: If 1,000 cars are 60% complete on the painting, but 40% complete on the testing, then equivalent units will need to be established for each type of cost. (See numerical example later.)