Process costing - a worked example
| by Lesley Buick
01 Aug 1999
Process Costing is a topic which is viewed by many candidates with trepidation and, quite often, despair as they plough their way through numerous calculations in the hope that their final process accounts will balance. Terms such as “abnormal losses”, “work in progress” and “equivalent units” frequently bemuse candidates, resulting in panic and a reluctance to even attempt any question set on this topic.
This article, relevant to paper B2, is designed to show candidates how to approach a Process Costing question by working through a detailed example, including such difficulties as how to treat losses and the calculation of equivalent units.
Before looking at the worked example you should refer to the study manuals to familiarise yourself with the definitions of the key terms including Opening and Closing Work In Progress (WIP), Normal and Abnormal Losses, Scrap Value and Equivalent Units.
A detailed worked example
The following example illustrates how to approach a Process Costing question, paying particular attention to presentation and calculation. Candidates should always strive to present their solutions as neatly and methodically as possible, not only to help the marker follow the calculations, but also to allow themselves to check that they have not missed out a vital step. The data for the question is shown in Figure 1.
Jammy Ltd is a manufacturing organisation with two processes. Information for the period ended 31 July 1999 is as follows:
Normal losses are expected to be 5% of input for each process. Losses in Process 1 have no scrap value, whilst losses in Process 2 can be sold for £10 per kg. Losses are deemed to arise at the end of the process.
Opening WIP is 60% complete with regard to Labour and Overheads. Closing WIP in Process 1 is 100% complete with regard to Material and 50% complete for Labour and Overheads. Closing WIP in Process 2 is 50% complete with regard to Labour and Overheads.
Prepare the Process Accounts for each process.
The best way to approach this question is to concentrate on Process 1 first, as Process 2 cannot be completed until we know the value of the items transferred into this process from Process 1. The first step is to draw up a process account in typical ‘T’ account fashion. Each side of the account should have a column for ‘Units’ and a column for ‘£’. You should then enter all the information given in the question. This will make it clear as to which items have to be calculated — these items are numbered in this example for illustrative purposes.
Process 1 Account
The Normal Loss figure is 5% of the 1000kg input. No cost is assigned to Normal Loss as the cost is absorbed into the "good" units. Abnormal Loss is the difference between the total units on the debit side and the total units on the credit side.
The next step is to draw up an Equivalent Units Statement to determine the cost per unit of the equivalent “whole” units produced.
Equivalent Units Statement
Closing WIP is 50% complete for Labour and Overheads, which is equivalent to 200 x 50% = 100 “complete” units.
The information calculated in the Equivalent Units Statement is then used to construct a Cost Allocation Statement. The layout of this statement is exactly the same as the Equivalent Units Statement.
Each entry in the above statement is calculated using the cost per unit calculated in the Equivalent Units Statement and the relevant equivalent units. For example, the Material Cost of Units transferred to Process 2 (£18,900) is calculated by multiplying the Material Unit Cost (£27) by the equivalent units transferred to Process 2 in respect of Material (700). This gives us £18,900. The Labour Cost of Abnormal Loss is calculated by multiplying the Labour Unit Cost (£15) by the equivalent units of Abnormal Loss in respect of Labour (50). This gives us £750, and so on.
You will notice that the total of each column (Material, Labour and Overhead) is the same as the figures appearing in the Process Account for each of these costs.
The final step is to complete the Process Account by using the figures calculated in the ‘Total’ column of the Cost Allocation Statement. Those figures labelled (1) – (3) are the figures to be slotted into the spaces similarly numbered in the Process Account in Step 1. Your final Process Account should now look thus:
Process 1 Account
We are now in the position to go through the whole “process” again for Process 2. The main differences between the two processes are the existence of Opening WIP and scrap value of losses in Process 2. Explanations for the figures in Process 2 are only given where the concepts have not been explained already in Process 1.
Construct Process Account:
Process 2 Account
Losses can be sold at £10 per kg, therefore Normal Loss is assigned a monetary value of 50 x £10 = £500.
Construct Equivalent Units Statement:
Equivalent Units Statement
Opening WIP is already 60% complete with regard to Labour and Overheads, therefore only 40% remains to be completed in this period. Equivalent units completed in this period are therefore 300 x 40% = 120kg.
Opening WIP in respect of “Transferred Costs from Process 1” are always NIL as they were transferred in a previous period and therefore do not form part of the cost of the units transferred from Process 1 in this period.
Units started and completed during the period is the difference between the units transferred to finished goods (shown in the Process Account as 800) and the units already started at the beginning of the period (Opening WIP of 300).
The period cost given for “Transferred Costs from Process 1” has been calculated by deducting the scrap value of Normal Loss (£500) from the total transferred cost (£34,300).
Construct Cost Allocation Statement:
Cost Allocation Statement
(*) The calculation of the cost of units transferred to Finished Goods is slightly different when there is Opening WIP. The cost of units transferred includes 3 elements: the cost of Opening WIP brought forward from the previous period (£13,000), the cost to complete the Opening WIP in this period (£1,800) and the cost of the units started and completed in this period (£33,500). This gives us a total of £48300 to be slotted into the Process Account.
Complete the Process Account:
Process 2 Account
Process Costing is best tackled with a methodical approach. Given the number of calculations involved, it will help if workings are presented neatly. Try to get into the habit of following a particular approach and layout, rather than trying to confuse yourself with different methods of presentation and calculation. The approach given above is by no means the only way of tackling process costing, but is very useful in the respect that it tackles all the calculations in a logical order. Work through the example again without looking at the solution — it is the best way of testing whether you understand the concepts. Good luck!
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