What is Process costing? Pros and Cons of process costing
The process is a series of stages that must be followed in order to finish a given task. The method of preserving cost records for each procedure is referred to as costing.
It refers to the cost accounting approach in which expenses are accrued for all interdependent processes.
After going through a series of processes, raw materials are transformed into final commodities in manufacturing companies that employ process pricing. Examples of commodities that could be manufactured and accounted for using a form of the process costing method include soft drinks, petroleum products, and even chairs, given that the company does not customise its end products for particular consumers.
Charter Institute of Management Accountants (CIMA), London defines “process costing is that form of operating costing where standardized goods are produced.”
Process costing is the ideal costing approach when identical items are manufactured using a standardised process and the direct material, direct labour, and manufacturing overhead cannot be tracked back to a given unit economically or readily. The use of process costing is particularly prevalent in batch production. Each department, production process, and batch process keeps track of their direct material and direct labour costs, as well as the number of units produced.
The actual cost to produce each unit using a process costing system varies, but the average result provides a sufficient estimate of the unit cost. Examples of commodities that could be manufactured and accounted for using a form of the process costing method include soft drinks, petroleum products, and even chairs, given that the company does not customise its end products for particular consumers.
Process costing is mostly utilised by manufacturers. This method of costing is utilised by the textile, biscuit, cement, paper, and oil refining sectors, among others. As indicated in the accompanying diagram, the output of the first process becomes the input of the second process, and so on.
Pros of Process Costing
Here are some of the advantages of process costing:
Accurate costing: Process costing provides an accurate picture of the cost of producing a product. This is because it takes into account all of the costs associated with the production process, including direct materials, direct labour, and manufacturing overhead.
Easy to understand: Process costing is relatively easy to understand compared to other cost accounting methods. This is because it focuses on the cost of each process in the production chain, rather than the cost of each individual product.
Better cost control: Process costing helps businesses identify areas where costs can be reduced or eliminated. By tracking the cost of each process, businesses can identify areas where waste occurs or where efficiencies can be gained.
Facilitates budgeting: Process costing helps in budgeting as it provides an estimate of the cost of production for a specific period. This information can be used to create accurate budgets and to track performance against those budgets.
Provides valuable information: Process costing provides a wealth of information that can be used by businesses to make better decisions. For example, businesses can use this information to set prices, make decisions about production levels, and identify new product opportunities.
In addition to these advantages, process costing is also relatively cost-effective and easy to implement.
Cons of Process Costing
Process costing has some disadvantages, which include:
Inaccurate costing for complex products: Process costing can be less accurate for complex products, such as those with multiple variations or that are produced in batches. This is because it is difficult to allocate costs accurately to each unit of product.
Complexity: Process costing can be complex to implement and use. This is because it requires businesses to track the costs of each process in the production chain and to calculate equivalent units.
Difficulty detecting cost fluctuations: Process costing can make it difficult to detect cost fluctuations due to changes in production volume or product mix. This is because it averages costs over a period of time.
Difficulty tracking costs for specific customers: Process costing can make it difficult to track costs for specific customers. This is because it focuses on the cost of each process, rather than the cost of each individual product.
Conclusion
Process costing is the ideal costing approach when a standardised process is used to make identical items and the direct material, direct labour, and manufacturing overhead cannot be tracked to a given unit simply or economically. The use of process costing is particularly prevalent in batch production. Each department, production process, and batch process keeps track of their direct material and direct labour costs, as well as the quantity of units produced. The actual cost to produce each unit using a process costing system varies, but the average result provides a sufficient estimate of the unit cost.
