The Chartered Institute of Management Accountants defines Process Costing as
“The method applicable where goods or services result from a sequence of continuous or repetitive operations or processes. Costs are averaged over the units produced during the period, being initially charged to the operation or process.”
Process costing is the opposite of activity based costing. This accounting methodology traces and accumulates direct costs, and allocates indirect costs of a manufacturing process to products in a large batch such as an entire month’s production, and then divides this total cost with the number of units to derive average cost of each unit.
The process costing methodology suits homogeneous products and continuous flow production situations and finds widespread application in manufacturing industries such as chemicals, petroleum, gas, textiles, steel, rubber, cement, flour, pharmaceuticals, shoes, plastics, sugar, and coal.
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Advantages of Process Costing
The primary advantage of process costing is the ease and simplicity of accounting. Process Costing is a simple and direct method of cost ascertainment that collects the overall costs from each department and ignores costs related to specific jobs within a department. This reduces the volume of data, and makes data collection easy and quick. The analysis is likewise simple and straightforward, and does not require any specialized skills other than normal accounting skills.
The uses of process costing extend to help establish effective control over the production process.
- Allows budgeting of uniform output and usage costs as standard costs, making it possible to track deviations from such standard costs with ease. It becomes possible to track the inefficiency or discrepancy to a specific process or department without checking each department or process.
- Facilitates easy and accurate tracking of inventory.
Process costing makes it easy to obtain and predict the average cost of a product, allowing accurate estimates to customers.
Compared to other costing methods, such as activity based costing, process costing is inexpensive and does not drain the organization’s time and resources.
Disadvantages of Process Costing
Process costing is ideally suited for homogeneous products, and fails to provide an accurate estimate of product costs when a single process produces many items or different versions of a same item. It also remains suitable only for bulk process works and not for customized orders. Apportionment of joint costs to diverse products may lead to irrational pricing decisions in such cases.
While process costing enables budgeting standard costs, the costs obtained are historic and not current, and their use for managerial decision-making remains limited.
Process costing makes it easy to offer estimates or quotations, it deviates from the standard product, or allowing options for any value-added service. Process costing also helps to fix standard costs of production, the accumulation of all costs and transferring them to units as average costs raise the possibility of concealment of inefficiencies in process. Process costing makes evaluation of the efficiency of individual processes or productivity of an individual worker difficult.
This review of the advantages and disadvantages of process costing indicates that process costing is a useful management accounting tool for large companies such as Coca Cola that mass produce homogeneous products.
Thompson, Tim. Management Accounting –Decision Management. Retrieved from https://www.cimaglobal.com/Documents/ImportedDocuments/fm_feb06_p37-43.pdf