Process Costing System
A process costing system is a method of cost accounting that accumulates production costs by process or department rather than by individual product. It is used when nearly identical units are mass produced.
In a process costing system, costs are accumulated over a set period of time rather than being tracked per unit or per job. At the end of the period, the total costs are divided by the number of units produced to obtain the average cost per unit.
Here’s a step-by-step overview of how a process costing system works:
- Accumulate Costs: All costs associated with a particular process or department, including direct materials, direct labor, and manufacturing overhead, are accumulated over a specific period.
- Measure Production: The number of units produced by each process or department during the period is determined. This includes both completed units and, in some cases, partially completed units.
- Calculate Cost Per Unit: The total costs for each process or department are divided by the total units produced to calculate the average cost per unit.
Industries such as oil refining, chemical manufacturing, food processing, and textile industries commonly use process costing systems. In these industries, it’s often impractical or impossible to trace costs to specific units of product, and the products being produced in each batch are identical or nearly identical.
Example of a Process Costing System
Let’s consider a company that produces orange juice. They have three main processes: squeezing, pasteurizing, and packaging.
The costs for each process during the month of March are as follows:
- Squeezing: This involves extracting juice from oranges. The costs involved include the cost of oranges, labor costs for the workers operating the machines, and the machine operating costs. Let’s say these costs total $20,000 for the month.
- Pasteurizing: This process involves heating the juice to kill bacteria and extend the juice’s shelf life. This process’s costs include the labor cost for workers overseeing the process and the cost of the energy needed to heat the juice. These costs total $10,000 for the month.
- Packaging: The juice is then packaged into cartons, which involves costs for the cartons themselves, the labor for the workers operating the packaging machines, and the machine operating costs. These costs total $15,000 for the month.
So, the total production cost for the month of March is $20,000 (squeezing) + $10,000 (pasteurizing) + $15,000 (packaging) = $45,000.
Now, let’s say the company produced 50,000 cartons of orange juice in March. The cost per carton is then calculated as the total cost divided by the total output, which in this case is $45,000 ÷ 50,000 = $0.90.
So, the company’s process costing system has determined that it costs $0.90 to produce one carton of orange juice in the month of March. This cost can then be used for various purposes, such as setting selling prices, controlling costs, or making strategic decisions about production levels.