Process costing

Purpose and scope

Process costing pools costs by process or department for similar output. Job-order costing accumulates costs for identifiable jobs. OpenStax, process versus job-order costing, §5.1

In the weighted-average example, 800 units transfer out and 200 remain in process. Closing units are 100% complete for material and 25% for conversion, so the totals are 1,000 material and 850 conversion equivalent units. At $5 and $4 per respective equivalent unit, $7,200 transfers out and $1,200 stays in work in process.

A process-cost report reconciles physical units and costs. Work in process (WIP) has consumed resources despite being incomplete, so it retains part of the process cost. OpenStax, initial-stage production cost report, §5.3

Physical units and equivalent units

Physical units are the actual count or quantity, such as pieces or kilograms. Equivalent units express the completed-work content of those units for a specified cost category:

Equivalent units = physical units × completion fraction for that category

Materials and conversion can have different completion fractions. Conversion normally groups direct labour and manufacturing overhead. If all material enters at the start but processing continues afterward, ending WIP can be 100% complete for materials and only 25% complete for conversion. Combining the categories into one undifferentiated percentage obscures that difference. Where material enters at several stages, use the relevant addition points rather than assuming all inputs arrive at the start. OpenStax, §5.3

Completion is relative to the department being costed. A unit complete in mixing may still require finishing and packaging. Its accumulated costs follow it into the next department; departmental transfer is not necessarily a customer sale. Subsequent-stage calculations must retain the transferred-in cost as well as costs added locally. OpenStax, subsequent processing stages, §5.4

Weighted average versus FIFO

The methods differ in their treatment of opening WIP, not in the number of physical units present:

For FIFO, work already performed before the period is excluded from current equivalent production. Do not divide a blended opening-plus-current cost by a FIFO current-work denominator: that mixes methods. When there is no opening WIP, this particular distinction disappears. Open Cost Accounting, chapter 6, §§6.3–6.5

Reconciled weighted-average example

Original illustrative assumptions: one initial department, one month, USD; identical units; no losses, scrap, rework or transferred-in costs. Material is added at the start, and conversion is incurred evenly. Opening WIP is 200 units, 100% material-complete and 50% conversion-complete. During the month, 800 units are started; 800 units are completed/transferred out. Closing WIP is 200 units, 100% material-complete and 25% conversion-complete.

Physical flow reconciles independently of dollars:

200 opening + 800 started = 800 transferred + 200 closing = 1,000 units

The 200 physical closing units do not become 50 physical units; they contain 50 equivalent units of conversion work.

Completed output receives 800 × ($5 + $4) = $7,200. Closing WIP receives 200 × $5 materials plus 50 × $4 conversion = $1,200. Costs reconcile:

$1,400 opening + $7,000 added = $7,200 transferred + $1,200 closing = $8,400

The completed-unit departmental cost is $9. Applying that whole amount to closing WIP would incorrectly value 200 incomplete units at $1,800, overstating WIP by $600 under these assumptions.

What FIFO changes in the same example

Assume the 200 opening units are completed first. Of the 800 completed units, 600 are started and completed this month. FIFO's current-period equivalent work is:

Current rates are $4,000 ÷ 800 = $5 material and $3,000 ÷ 750 = $4 conversion. Completing opening WIP costs its carried $1,400 plus 100 × $4 = $400, or $1,800. Newly started/completed output costs 600 × $9 = $5,400. Thus transferred costs are again $7,200, and closing WIP $1,200. The methods happen to agree because these particular opening costs and completion fractions imply the same category rates as current production. Different opening rates can yield different valuations; identical results here do not make the methods interchangeable.

Losses require a separate model

Normal loss is expected wastage under usual conditions; abnormal loss is additional loss beyond that expectation. An abnormal gain describes actual loss below the expected amount, rather than extra physical production from nowhere. ACCA's June 2011 article also shows that scrap proceeds affect process and loss accounts. State the normal-loss basis, actual loss, detection point and scrap recovery before assigning costs; the no-loss example above does not silently accommodate spoilage. ACCA, Process costing, June 2011, pp. 1–5

A model with losses needs its own physical-flow and cost reconciliation, including the work consumed by rejected units. Distinguish management yield measures from inventory capitalization. For Australian reporting, AASB 102 paragraph 16 excludes abnormal wasted materials, labour and other production costs from inventory. AASB 102, December 2021 compilation, paragraph 16

Using the report

Retain the department, period, unit of measure, method and completion estimates. Reconcile both units and costs. A cost per equivalent unit is an allocation result, not a physical output count or a customer selling rate. OpenStax, production cost reporting, §5.3

Related references

• Cost structure and cost bases
• Job-order costing
• Actual costing
• Scrap recovery credits