PRODUCT COSTING SYSTEM

A product costing system is a set of procedures used to account for an organization’s product
costs and to provide timely and accurate unit cost information for pricing, cost planning and
control, inventory valuation, and financial statement preparation

 To meet managers’ needs for cost information, it is necessary to have a highly reliable
product costing system specifically designed to record and report the organization’s
operations.

 The product costing system enables managers to track costs throughout the management
process.
 It provides a structure for recording the revenue earned from sales and the costs incurred
for direct materials, direct labour, and overhead.
Costing systems can usually be divided into two main types, (a) job costing, and (b) process
costing. These two main types of costing system may adopt either an absorption or marginal
costing approach, and may use FIFO or LIFO or AVCO methods of pricing issues from stock,
etc.

 Why Unit Cost is Important in the Management Process?

 The unit cost is important because it used:-
 During the planning process, having knowledge of unit costs helps managers of both
manufacturing and service companies set reasonable selling prices and estimate the cost
of their products or services.
 To measure the performance of the company. Managers make decisions every day about
controlling costs, managing the company’s activity volume, ensuring quality, and
negotiating prices. They use timely cost and volume information and actual unit costs to
support their decisions.
 When managers evaluate results, they watch for changes in cost and quality. They
compare actual and targeted total and unit costs, assess relevant price and volume
information, and then adjust their planning and decision-making strategies.
 As a communication tool in the company. Internal and external users analyze the data in
the performance evaluation reports prepared by managers to determine whether the
business is achieving cost goals their organization’s products or services

JOB ORDER COSTING SYSTEM

 A job order costing system is used by companies that make unique or special-order
products, such as personalized ice cream creations, specially built cabinets, made-to-
order draperies, or custom-tailored suits.
 Companies using a job order cost system are likely to be performing services or
manufacturing products according to specific customer orders and product specifications.
Construction contractors, manufacturers of special equipment, aircraft manufacturers,
CPA firms, attorneys, and hospitals all employ job order cost systems.
  It uses a single Work in Process Inventory account to record the costs of all job orders.
 It traces the costs of direct materials, direct labour, and overhead to a specific batch of
products or a specific job order (i.e., a customer order for a specific number of specially
designed, made-to-order products) by using job order cost cards.

 By definition, a job order costing system is a system that traces the costs of a specific
order or batch of products to provide timely, accurate cost information and to facilitate
the smooth and continuous flow of that information.

How to approach job order accounting questions

Steps:
1: identify the job to be selected as cost object
2: identify the direct cost for the job
3: select the method to allocate the indirect cost to the job
4: identify the indirect cost that is related to each costing method
5: calculate the unit cost of the indirect cost allocated to the job
6: calculate the indirect cost that is allocated to the job
7: add the total direct costs and indirect costs that are involved with the job to obtain the job cost

Example 1

Abby PTY LTD uses a job order costing system to control production costs in its two
departments. Accounting records for Job 433 show the following data:

Department A department B
Direct labour hours 1600 2280
Direct labour cost tshs 19200 tshs 319380
Raw materials cost tshs 7200 tshs 10320
Machine hours 120 168

The company applies overhead to production on the basis of direct labour cost in department A
and on the basis of machine hours in department B.at the beginning of the year, the company
estimated the following performance.
Department A department B
Direct labour hours 104,000 232,800
Direct labour cost tshs 1,248,000 tshs 1,970,800
Machine hours 15,600 16,280
Factory overhead tshs 1,497,600 tshs 488,400

Required
a) Calculate the overhead rate for each department
b) Calculate the total cost of job 433
Example 2
Kinrana Sdn Bhd has two departments, which are the Assembly and Packaging Departments.
The company uses the job order costing system to calculate the overhead allocation rate for both
the departments. The Assembly Department uses the machine hour rate and the Packaging
Department uses the direct labour rate. In the beginning of the year, the company estimates the
following:
Department
Assembly Packaging
Direct labour hours (hours) 6,000 30,000
Machine hours (hours) 48,000 5,000
Manufacturing overhead costs (RM) 360,000 486,000
Direct labour costs (RM) 50,000 270,000

Job590 was started and completed in that year with the following data:
Department
Assembly Packaging
Direct labour hours (hours) 60 200
Machine hours (hours) 800 40
Direct materials (RM) 5,000 3,100
Direct labour (RM) 700 1,500
Based on the information given calculate:
a) Calculate the overhead allocation rate for each department.
b) Total overhead cost charged to Job 590.
c) Total cost charged to Job 590.

Example 3
Ashford Paving Company uses a predetermined overhead rate to apply overhead to jobs, and the
company employs a job order costing system. Overhead is applied to jobs in the Mixing
Department based on the number of machine hours used, whereas Paving Department overhead
is applied on the basis of direct labor hours. In December 2000, the company estimated the
following data for its two departments for 2001:
Mixing Department Paving Department
Direct labor hours 1,000 3,500
Machine hours 7,500 1,500
Budgeted overhead cost $60,000 $98,000

Job #116 was started and completed during March 2001. The job cost sheet shows the following
information:
Mixing Department Paving Department
Direct material $5,800 $700
Direct labor cost $60 $525
Direct labor hours 12 60
Machine hours 80 22
Required:
a) Compute the predetermined overhead rate that should be used in each department of the
Ashford Paving Company.
b) Compute the overhead applied to Job #116 for each department and in total.

Example 4
The Houston Custom Tile Corporation has two departments: Mixing and Drying. All jobs go
through each department, and the company uses a job order costing system. The company
applies overhead to jobs based on labor hours in Mixing and on machine hours in Drying. In
December 2001, corporate management estimated the following production data for 2002 in
setting its predetermined overhead rates:
Mixing Drying
Machine hours 7,200 104,000
Direct labor hours 88,000 12,400
Departmental overhead $374,000 $494,000

Two jobs completed during 2002 were #2296 and #2297. The job order cost sheets showed the
following information about these jobs:
Job #2296 Job #2297
Direct material cost $4,875 $6,300
Direct labor hours—Mixing 425 510
Machine hours—Mixing 40 45
Direct labor hours—Drying 20 23
Machine hours—Drying 110 125
Direct labor workers are paid $9 per hour in the Mixing Department and $22 per hour in Drying.
Required:
a) Compute the predetermined overhead rates used in Mixing and Drying for 2002.
b) Compute the direct labor cost associated with each job for both departments.
c) Compute the amount of overhead assigned to each job in each department.
d) Determine the total cost of Jobs #2296 and #2297.

PROCESS COSTING SYSTEM

Meaning
It is a method of costing adopted to find out the cost of those goods which are manufactured in
stages. Each stage is called a process. The output of each process becomes the input for the next
process and so on. The product becomes a finished product only after it passes through all the
process.

By definition, a process costing system is a product costing system used by companies that
make large amounts of similar products or liquid products or that have long, continuous
production runs of identical products
Process costing is a method of costing under which all costs are accumulated for each stage of
production or process, and the cost per unit of product is ascertained at each stage of production
by dividing the cost of each process by the normal output of that process.

Process costing is applicable to product like sugar industry, oil industry, and paper industry. Etc.

On account of processing, certain losses occur at each process. There are two types of losses in
process costing

A. Normal Loss
1. It is a loss due to internal factors like heating, boiling, evaporation, etc.
2. It is an expected loss.
3. It is a predetermined % on the input quantity.
4. It is unavoidable and therefore it is uncontrollable loss.
5. It is normally of two types: (a) Scrap: It has realizable value. (b) Weight loss: It has no
realizable value because it is an invisible process.
6. It is credited to Process A/c and calculated as a % on the input quantity.

B. Abnormal Loss
1. It is loss due to external factors like natural calamity, loss by fire or theft, strikes,
breakdown of machine, etc.
2. It is unexpected loss.
3. It is avoidable to some extent and therefore controllable.
4. It is credited to Process A/c as balancing figure in the quantity column.

Abnormal Gain/Profit
1. When actual loss is less than the expected loss, it is called an abnormal gain.
2. It is due to superior quantity of R/M, efficient labour, advanced technology, etc.
3. Recorded on debit side of Process A/c as a balance figure in the quantity column.

Scrap value
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.

Features of Process Costing

In the case of process costing, production follows a series of sequential processes. Since the
product manufactured passes through various processes, production is a continuous activity.
Units produced are uniform and, therefore, product differentiation is not possible. Following are
the main features of process costing:
1. Process costing is used by the industries where the goods are produced through the
sequence of several processes. Process costing is suitable for industries like paint, oil
refining, rubber, chemicals, sugar, paper, soap-making, textiles, etc. This method is also
employed where it is not possible to ascertain the prime cost of specific order.
 2. Units of production are uniform and homogeneous. As a result, unit cost of each process
is obtained by averaging the total cost of each process.
3. Costs are ascertained for each process at the end of the cost period.
4. Costs follow the production process, i.e., costs incurred in one process are transferred to
the next process along with the output.
5. The entire production activity is characterized by a number of stages of production, i.e.,
processes. Each process includes a number of operations. The boundaries of the process
are determined by similarity of work performed, supervision and physical location of
men and machines in the plant.
6. The products and processes are standardized.
7. Production is in continuous flow and the output of Process I become the input of Process
II and so on until the finished product is obtained.
8. Total cost of the process is adjusted with normal losses, abnormal losses, abnormal gains
and scrap of the process.

Costing Procedure under Process Costing

For the purpose of costing, the factory is divided into various departments, each department
representing a particular process. A supervisor is appointed for each department to supervise the
functioning of his department. Each process is a cost centre and, thus, costs are accumulated for
each process. A separate account is maintained for each process to which costs of material,
labour, direct expenses and overheads are recorded. Following are the main elements of cost in
process costing:
1. Materials: Materials required for each process are drawn from the stores by way of
material requisitions. No distinction is made between direct and indirect materials. The
value of materials issued is debited to the process account. When the output of first
process becomes the raw material of the next process, the account of the receiving
process is debited with the cost of transfer in addition to the cost of additional materials,
if any, added to that process.
2. Labour: Wages of workers engaged wholly in a particular process are debited to that
process. If the workers are engaged in a number of processes, the wages are apportioned
to different processes on the basis of time spent. Generally, the direct labour cost is a very
small part of the cost of production in case of process costing.
3. Direct Expenses: Direct expenses are the expenses which can be easily identified with
the process. Depreciation, insurance, electricity, repairs and maintenance etc. are some of
the examples of direct expenses which may be directly attributed to a process and, thus,
are debited to the process concerned.
4. Production Overhead: Production overhead is the major constituent of the cost of
production in case of process costing. Production overheads are the expenses which are
common to more than one process, i.e., which cannot be directly allocated to any process.
Production overheads include rent. Telephone, lighting, gas, water charges etc. Generally,
production overheads are recovered at predetermined rates based on direct wages or
prime cost. Thus, process cost does not include office and administrative overheads and
selling and distribution overheads.
Process account
There is a process account for each production process. A process account has two columns on
each side. One column is for volume and the other one is for cost. The balance of the volume
column and cost column should be the same on both sides.

How to approach process accounting questions

Step 1 Draw up a T account for the process account. (There may be more than one process, but
start with the first one initially.) Fill in the information given in the question.
Step 2 Calculate the normal loss in units and enter on to the Process account. (The value will be
zero unless there is a scrap value – see Step 4).
Step 3 Calculate the abnormal loss or gain (there won’t be both). Enter the figure on to the
Process account and open a T account for the abnormal loss or gain.
Step 4 Calculate the scrap value (if any) and enter it on to the Process account. Open a T account
for the scrap and debit it with the scrap value.
Step 5 Calculate the equivalent units and cost per unit.
Step 6 Repeat the above if there is a second process.

Example 1
The manufacturing company has two processes in its manufacturing factory. Output of process I
become the input for process II and process II production is ready for sale.

Expected loss in each process is expected to be at 10% of input material of each process and
scrap value is tshs. 2 per unit

Relevant information for Period Y is given below.

Process 1 Process II
Unit’s tshs Units tshs
Input materials 2,000 8,100
Transferred to Process II 1,750
Material from process I 1,750

Added materials 1,900

Labor& overheads 10,000 22,000
Output to finish goods 1,600

Prepare the following accounts

a) Process I
b) Process II
c) Normal Loss/ Scrap
d) Abnormal Loss
e) Abnormal Gain
Example 2
Mr. Bean’s chocolate Wiggly bars pass through two processes. The data for the
Month just ended are:
$ Kg $
Process 1 Ingredients 5,000 4,000 Process 2 Packaging 10,000
Labor and Overhead 6,000 Labor and overhead 9,000

Mr. Bean allows the staff to eat 5% of the chocolate as they work on Process 1.
There was no work in progress at the month end. There is a heat wave and staffs have eaten less
chocolate. At the end of Process 1, 3,810 units are transferred to Process 2.

Required
Prepare the two process accounts and calculate the cost per kg.