ICAI Notes: Process & Operation Costing | Cost and Management Accounting for CA Intermediate PDF Download

 Page 1


    
 
 
CHAPTER 
10 
 
LEARNING OUTCOMES 
 
PROCESS & OPERATION 
COSTING 
 
? State the meaning of Process and Operation Costing. 
? Discuss the treatment of process loss and gains in cost 
accounts.  
? Compute equivalent completed production units. 
? Discuss the various methods of valuation of work in process. 
? State the meaning and treatment of Inter-process profits. 
 
© The Institute of Chartered Accountants of India
Page 2


    
 
 
CHAPTER 
10 
 
LEARNING OUTCOMES 
 
PROCESS & OPERATION 
COSTING 
 
? State the meaning of Process and Operation Costing. 
? Discuss the treatment of process loss and gains in cost 
accounts.  
? Compute equivalent completed production units. 
? Discuss the various methods of valuation of work in process. 
? State the meaning and treatment of Inter-process profits. 
 
© The Institute of Chartered Accountants of India
COST AND MANAGEMENT ACCOUNTING 
 
10.2 
 
1. MEANING OF PROCESS COSTING 
Process Costing is a method of costing used in industries where the material 
has to pass through two or more processes for being converted into a final 
product. It is defined as “a method of Cost Accounting whereby costs are charged 
to processes or operations and averaged over units produced”. A separate account 
for each process is opened and all expenditure pertaining to a process is charged 
to that process account.  Such type of costing method is useful in the 
manufacturing of products like steel, paper, medicines, soaps, chemicals, rubber, 
vegetable oil, paints, varnish etc. where the production process is continuous and 
the output of one process becomes the input of the following process till 
completion. 
 
Process & Operation Costing
Meaning
Costing Procedure
Treatment of 
Process loss/ gain
Normal
Abnormal
Valuation of WIP
Process Costing 
Methods
Equivalent Units
Inter-process Profit
Operation Costing
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
Page 3


    
 
 
CHAPTER 
10 
 
LEARNING OUTCOMES 
 
PROCESS & OPERATION 
COSTING 
 
? State the meaning of Process and Operation Costing. 
? Discuss the treatment of process loss and gains in cost 
accounts.  
? Compute equivalent completed production units. 
? Discuss the various methods of valuation of work in process. 
? State the meaning and treatment of Inter-process profits. 
 
© The Institute of Chartered Accountants of India
COST AND MANAGEMENT ACCOUNTING 
 
10.2 
 
1. MEANING OF PROCESS COSTING 
Process Costing is a method of costing used in industries where the material 
has to pass through two or more processes for being converted into a final 
product. It is defined as “a method of Cost Accounting whereby costs are charged 
to processes or operations and averaged over units produced”. A separate account 
for each process is opened and all expenditure pertaining to a process is charged 
to that process account.  Such type of costing method is useful in the 
manufacturing of products like steel, paper, medicines, soaps, chemicals, rubber, 
vegetable oil, paints, varnish etc. where the production process is continuous and 
the output of one process becomes the input of the following process till 
completion. 
 
Process & Operation Costing
Meaning
Costing Procedure
Treatment of 
Process loss/ gain
Normal
Abnormal
Valuation of WIP
Process Costing 
Methods
Equivalent Units
Inter-process Profit
Operation Costing
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
PROCESS & OPERATION COSTING 
    
 10.3 
This can be understood with the help of the following diagram: 
1.1 Basic Features 
Industries, where process costing can be applied, have normally one or more of the 
following features: 
1. Each plant or factory is divided into a number of processes, cost centres or 
departments, and each such division is a stage of production or a process. 
2. Manufacturing activity is carried on continuously by means of one or 
more process run sequentially, selectively or simultaneously. 
3. The output of one process becomes the input of another process. 
4. The end product usually is of like units not distinguishable from one another. 
5. It is not possible to trace the identity of any particular lot of output to 
any lot of input materials. For example, in the sugar industry, it is impossible 
to trace any lot of sugar bags to a particular lot of sugarcane fed or vice versa. 
6. Production of a product may give rise to Joint and/or By-Products. 
2. COSTING PROCEDURE IN PROCESS COSTING 
The Cost of each process comprises the cost of: 
(i) Materials (ii) Employee Cost (Labour) 
(iii) Direct expenses, and  (iv) Overheads of production. 
Materials - Materials and supplies which are required for each process are drawn 
against Material Requisitions Notes from the stores. Each process for which the 
materials are used, are debited with the cost of materials consumed on the 
basis of the information received from the Cost Accounting department. The 
finished product of first process generally become the raw materials of second 
process; under such a situation the account of second process is debited with the 
cost of transfer from the first process and also with the cost of any additional 
material used in process. 
Raw 
Material
Process-I Process-II Process-III
Finished 
Goods
© The Institute of Chartered Accountants of India
Page 4


    
 
 
CHAPTER 
10 
 
LEARNING OUTCOMES 
 
PROCESS & OPERATION 
COSTING 
 
? State the meaning of Process and Operation Costing. 
? Discuss the treatment of process loss and gains in cost 
accounts.  
? Compute equivalent completed production units. 
? Discuss the various methods of valuation of work in process. 
? State the meaning and treatment of Inter-process profits. 
 
© The Institute of Chartered Accountants of India
COST AND MANAGEMENT ACCOUNTING 
 
10.2 
 
1. MEANING OF PROCESS COSTING 
Process Costing is a method of costing used in industries where the material 
has to pass through two or more processes for being converted into a final 
product. It is defined as “a method of Cost Accounting whereby costs are charged 
to processes or operations and averaged over units produced”. A separate account 
for each process is opened and all expenditure pertaining to a process is charged 
to that process account.  Such type of costing method is useful in the 
manufacturing of products like steel, paper, medicines, soaps, chemicals, rubber, 
vegetable oil, paints, varnish etc. where the production process is continuous and 
the output of one process becomes the input of the following process till 
completion. 
 
Process & Operation Costing
Meaning
Costing Procedure
Treatment of 
Process loss/ gain
Normal
Abnormal
Valuation of WIP
Process Costing 
Methods
Equivalent Units
Inter-process Profit
Operation Costing
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
PROCESS & OPERATION COSTING 
    
 10.3 
This can be understood with the help of the following diagram: 
1.1 Basic Features 
Industries, where process costing can be applied, have normally one or more of the 
following features: 
1. Each plant or factory is divided into a number of processes, cost centres or 
departments, and each such division is a stage of production or a process. 
2. Manufacturing activity is carried on continuously by means of one or 
more process run sequentially, selectively or simultaneously. 
3. The output of one process becomes the input of another process. 
4. The end product usually is of like units not distinguishable from one another. 
5. It is not possible to trace the identity of any particular lot of output to 
any lot of input materials. For example, in the sugar industry, it is impossible 
to trace any lot of sugar bags to a particular lot of sugarcane fed or vice versa. 
6. Production of a product may give rise to Joint and/or By-Products. 
2. COSTING PROCEDURE IN PROCESS COSTING 
The Cost of each process comprises the cost of: 
(i) Materials (ii) Employee Cost (Labour) 
(iii) Direct expenses, and  (iv) Overheads of production. 
Materials - Materials and supplies which are required for each process are drawn 
against Material Requisitions Notes from the stores. Each process for which the 
materials are used, are debited with the cost of materials consumed on the 
basis of the information received from the Cost Accounting department. The 
finished product of first process generally become the raw materials of second 
process; under such a situation the account of second process is debited with the 
cost of transfer from the first process and also with the cost of any additional 
material used in process. 
Raw 
Material
Process-I Process-II Process-III
Finished 
Goods
© The Institute of Chartered Accountants of India
COST AND MANAGEMENT ACCOUNTING 
 
10.4 
Employee Cost (Labour) - Each process account should be debited with the 
labour cost or wages paid to labour for carrying out the processing activities. 
Sometimes the wages paid are apportioned over the different processes after 
selecting appropriate basis.
Direct expenses - Each process account should be debited with direct expenses
like depreciation, repairs, maintenance, insurance etc. associated with it. 
Production Overheads- Expenses like rent, power expenses, lighting bills, gas and 
water bills etc. are known as production overheads. These expenses cannot be 
allocated to a process. The suitable way out to recover them is to apportion them 
over different processes by using suitable basis. Usually, these expenses are 
estimated in advance and the processes debited with these expenses on a pre-
determined basis. 
ILLUSTRATION 1 
From the following data, PREPARE process accounts indicating the cost of each 
process and the total cost. The total units that pass through each process were 240 
for the period. 
 Process I (`) Process II (`) Process III (`) 
Materials 1,50,000 50,000 20,000 
Labour 80,000 2,00,000 60,000 
Other expenses 26,000 72,000 25,000 
Indirect expenses amounting to ` 85,000 may be apportioned on the basis of wages. 
There was no opening or closing stock. 
SOLUTION 
Dr. Process- I Account Cr. 
Particulars Per 
unit 
(`) 
Total (`) Particulars Per 
unit (`) 
Total 
(`) 
To Material 625 1,50,000 By Process -II 
A/c 
1,150 2,76,000 
” Labour 334 80,000 (Transfer to 
Process-II) 
  
© The Institute of Chartered Accountants of India
Page 5


    
 
 
CHAPTER 
10 
 
LEARNING OUTCOMES 
 
PROCESS & OPERATION 
COSTING 
 
? State the meaning of Process and Operation Costing. 
? Discuss the treatment of process loss and gains in cost 
accounts.  
? Compute equivalent completed production units. 
? Discuss the various methods of valuation of work in process. 
? State the meaning and treatment of Inter-process profits. 
 
© The Institute of Chartered Accountants of India
COST AND MANAGEMENT ACCOUNTING 
 
10.2 
 
1. MEANING OF PROCESS COSTING 
Process Costing is a method of costing used in industries where the material 
has to pass through two or more processes for being converted into a final 
product. It is defined as “a method of Cost Accounting whereby costs are charged 
to processes or operations and averaged over units produced”. A separate account 
for each process is opened and all expenditure pertaining to a process is charged 
to that process account.  Such type of costing method is useful in the 
manufacturing of products like steel, paper, medicines, soaps, chemicals, rubber, 
vegetable oil, paints, varnish etc. where the production process is continuous and 
the output of one process becomes the input of the following process till 
completion. 
 
Process & Operation Costing
Meaning
Costing Procedure
Treatment of 
Process loss/ gain
Normal
Abnormal
Valuation of WIP
Process Costing 
Methods
Equivalent Units
Inter-process Profit
Operation Costing
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
PROCESS & OPERATION COSTING 
    
 10.3 
This can be understood with the help of the following diagram: 
1.1 Basic Features 
Industries, where process costing can be applied, have normally one or more of the 
following features: 
1. Each plant or factory is divided into a number of processes, cost centres or 
departments, and each such division is a stage of production or a process. 
2. Manufacturing activity is carried on continuously by means of one or 
more process run sequentially, selectively or simultaneously. 
3. The output of one process becomes the input of another process. 
4. The end product usually is of like units not distinguishable from one another. 
5. It is not possible to trace the identity of any particular lot of output to 
any lot of input materials. For example, in the sugar industry, it is impossible 
to trace any lot of sugar bags to a particular lot of sugarcane fed or vice versa. 
6. Production of a product may give rise to Joint and/or By-Products. 
2. COSTING PROCEDURE IN PROCESS COSTING 
The Cost of each process comprises the cost of: 
(i) Materials (ii) Employee Cost (Labour) 
(iii) Direct expenses, and  (iv) Overheads of production. 
Materials - Materials and supplies which are required for each process are drawn 
against Material Requisitions Notes from the stores. Each process for which the 
materials are used, are debited with the cost of materials consumed on the 
basis of the information received from the Cost Accounting department. The 
finished product of first process generally become the raw materials of second 
process; under such a situation the account of second process is debited with the 
cost of transfer from the first process and also with the cost of any additional 
material used in process. 
Raw 
Material
Process-I Process-II Process-III
Finished 
Goods
© The Institute of Chartered Accountants of India
COST AND MANAGEMENT ACCOUNTING 
 
10.4 
Employee Cost (Labour) - Each process account should be debited with the 
labour cost or wages paid to labour for carrying out the processing activities. 
Sometimes the wages paid are apportioned over the different processes after 
selecting appropriate basis.
Direct expenses - Each process account should be debited with direct expenses
like depreciation, repairs, maintenance, insurance etc. associated with it. 
Production Overheads- Expenses like rent, power expenses, lighting bills, gas and 
water bills etc. are known as production overheads. These expenses cannot be 
allocated to a process. The suitable way out to recover them is to apportion them 
over different processes by using suitable basis. Usually, these expenses are 
estimated in advance and the processes debited with these expenses on a pre-
determined basis. 
ILLUSTRATION 1 
From the following data, PREPARE process accounts indicating the cost of each 
process and the total cost. The total units that pass through each process were 240 
for the period. 
 Process I (`) Process II (`) Process III (`) 
Materials 1,50,000 50,000 20,000 
Labour 80,000 2,00,000 60,000 
Other expenses 26,000 72,000 25,000 
Indirect expenses amounting to ` 85,000 may be apportioned on the basis of wages. 
There was no opening or closing stock. 
SOLUTION 
Dr. Process- I Account Cr. 
Particulars Per 
unit 
(`) 
Total (`) Particulars Per 
unit (`) 
Total 
(`) 
To Material 625 1,50,000 By Process -II 
A/c 
1,150 2,76,000 
” Labour 334 80,000 (Transfer to 
Process-II) 
  
© The Institute of Chartered Accountants of India
PROCESS & OPERATION COSTING 
    
 10.5 
” Other expenses 108 26,000    
” Indirect expenses* 83 20,000    
  1,150 2,76,000  1,150 2,76,000 
Dr. Process- II Account Cr. 
Particulars Per 
unit 
(`) 
Total (`) Particulars Per 
unit (`) 
Total (`) 
To Process-I A/c 1,150 2,76,000 By Process-III 
A/c 
2,700 6,48,000 
” Material 208 50,000 (Transfer to 
Process-III) 
  
” Labour 834 2,00,000      
” Other 
expenses 
300 72,000     
” Indirect 
expenses* 
208    50,000     
2,700 6,48,000   2,700 6,48,000 
Dr. Process- III Account Cr.
Particulars Per 
unit (`) 
Total 
(`) 
Particulars Per 
unit (`) 
Total (`) 
To Process-II A/c 2,700 6,48,000 By Finished 
Stock A/c 
3,200 7,68,000 
Material 83 20,000 (Transferred)   
” Labour 250 60,000      
” Other 
expenses 
104 25,000     
” Indirect 
expenses* 
63 15,000     
 3,200 7,68,000   3,200 7,68,000 
* Apportionment of Indirect expenses among Process-I, Process-II and Process-III 
Total Wages to processes (I + II +III) = ` 80,000 + ` 2,00,000 + ` 60,000 =  
` 3,40,000 
© The Institute of Chartered Accountants of India