Process Costing - Elements/Components of Cost, Recording/Accounting Methodology

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Process Accounts

Where the process costing method is being used, the total activity involved in the production process is divided into one or more sequential activities each called a process.

All the information relating to a process is collected at a single place in an entity named a Process a/c which has a format similar to a ledger account used in financial accountancy.

Process a/c
DrCr
Particulars Quantity
(in Units) 		Amount Particulars Quantity
(in Units) 		Amount
 

Values and Quantities

The ledger account has columns for providing information both in terms of quantities and values.

Naming the process accounts

Where there are more than one process, the name is suffixed/prefixed with a number or alphabet to indicate the order of the process or any word or phrase representing the process.
  • Process 2 a/c
  • Process IV a/c
  • Process A a/c

A name indicating the activity relating to the process may also be used either with or without the word Process is also used.

  • Grinding Process a/c
  • Machining a/c
  • Finishing Process a/c

The needs of the organisation and the naming conventions followed in the industry in consideration would decide the names used for the processes.

Process account ≡ Ledger Account

A Process account is similar to a Ledger account and all the information that is presented in the Process a/c is similar to ledger postings. It is similar to and not exactly a ledger account in some cases.

In accounting, taking the proof of a transaction, we record the journal entry and post it to the ledgers that are affected by the entry. Every ledger posting should have a journal support. No journal no ledger. Thus, the ledger postings in the Process a/c should also be having a journal support.

Whether the Process a/c is a ledger account having a journal support or not is dependent on where the information relating to the process is being picked from.

  • Information from records not following accounting mechanism

    Where the information relating to the process is being collected in simple records that do not follow the accounting mechanism, the Process a/c would be a Memorandum account. It would be a statement prepared in an account format. As such the rule that every ledger posting should have a journal support would not apply.

    But for the fact that there is no journal supporting the information (postings) in the Process a/c, all other interpretation of the information can be made as if the Process a/c is a ledger account.

  • Information from records following accounting mechanism

    Where the information relating to the process is being collected and obtained either as a part of the accounting records (integrated accounting) or in records that follow the accounting mechanism (cost ledger accounting), then the Process a/c is a ledger account and all the information in the account would be ledger postings which will have a journal support.

    Direct Ledger Postings

    In learning many topics in accounting related topics especially in problem solving, we see ledger accounts being prepared directly. Direct preparation of ledger accounts should not drive us to the understanding that there is no need for the journal. It is only for lessening the burden in the process of learning that we skip preparing the journal and prepare the ledgers directly.

    We can always derive the journal entry from a ledger posting by reading the posting starting with the name of the ledger account in which the posting appears.

Process account is a nominal account

A process account which is similar to a ledger account in financial accounting is an equivalent of a nominal account. The rules of debit and credit relevant to a nominal account are applicable in the case of Process a/c.
  • Debit all expenses and losses
  • Credit all incomes and gains

Elements/Components of Cost

The total expenditure relating to the process is classified under the following heads like under any other method of cost accounting.

  1. Direct Materials

    Expenditure incurred on materials that can be directly attributed and allocated to a process is identified as direct material cost for the process. Such material whose cost is identified as direct material cost is classified into two as

    • Primary Material

      Material introduced in the initial process which gets passed on to the subsequent processes as a part of output on completion of processing.

    • Secondary Material

      Materials which are introduced in the first or subsequent processes in addition to the primary material. This gets mixed up with the primary material and is passed on to the subsequent processes as a part of output on completion of processing.

  2. Direct Labour/Labor

    Expenditure incurred on labor/labour that can be directly attributed and allocated to a process is identified as direct labor/labour cost for the process.

  3. Direct Expenses

    Expenses in addition to Direct Material and Direct Labor/Labour that can be directly attributed and allocated to a process is identified as direct expense for the process.

  4. Production Overheads

    Production expenses other than Direct costs which are not capable of being attributed and allocated to a specific process directly are collected under the head overheads and are to be apportioned to the processes in an amicable manner under some rational basis.

All these being expenses are debited to the Process a/c or they appear on the debit side of the Process a/c based on the principle for nominal accounts.

Process a/c
DrCr
Particulars Quantity
(in Units) 		Amount Particulars Quantity
(in Units) 		Amount
To Primary Material
To Secondary Material
To Direct Labour/Labor
To Production Overheads



There are other debits to the Process a/c like Abnormal Gains, Opening Stocks that we would be learning about later on.

Custom classification of costs

The classification of costs into Direct Material, Direct Labor/Labour, Direct Expenses and Overheads is an indicative classification that is most commonly followed in most organisations. This is not a rigid classification and it is not a requirement that these should be the only elements into which the costs have to be classified.

The information needs of the organisation decide into how many elements the costs are to be divided into. The naming conventions followed in the industry in consideration would decide the names used for such elements.

Credits to the Process account

The following would be found credited to a process account.

Output

The activity in the process would result in the manufacture of the output. The value of the output would be credited to the Process a/c. The posting would be dependent on where the value is transferred i.e. on what has been done with the output.

The output may be

  • transferred to a subsequent process as an input for that process.

    The output is debited to the process to which it is transferred

    Journal
    Particulars
    Receiving Process a/c
    To Sending Process a/c
    		Dr
    Process I a/c
    DrCr
    Particulars Quantity
    (in Units)     		Amount Particulars Quantity
    (in Units)     		Amount
    To Primary Material
    To Secondary Material
    To Direct Labour/Labor
    To Production Overheads



    		By Process II a/c
    Process II a/c
    DrCr
    Particulars Quantity
    (in Units)     		Amount Particulars Quantity
    (in Units)     		Amount
    To Process I a/c



  • transferred to a warehouse for being stored and used subsequently.

    The output is debited to the current Process Stock a/c

    Journal
    Particulars
    Process Stock a/c
    To Process a/c
    		Dr
    Process A a/c
    DrCr
    Particulars Quantity
    (in Units)     		Amount Particulars Quantity
    (in Units)     		Amount
    To Primary Material
    To Secondary Material
    To Direct Labour/Labor
    To Production Overheads



    		By Process A Stock a/c
    Process A Stock a/c
    DrCr
    Particulars Quantity
    (in Units)     		Amount Particulars Quantity
    (in Units)     		Amount
    To Balance b/d
    To Process A a/c



    		By Process B a/c
    By Process A Sale a/c
    By Balance c/d

    The output in the stock account is either transferred to the subsequent process or sold. In such a case, transactions relating to transfer to subsequent process and sale would affect the stock account instead of the process account.

  • sold

    The output is debited to the Sales a/c or any other relevant account to which the sale proceeds of the output is credited.

    Journal
    Particulars
    Process Sale a/c
    To Process a/c
    		Dr
    Process I a/c
    DrCr
    Particulars Quantity
    (in Units)     		Amount Particulars Quantity
    (in Units)     		Amount
    To Primary Material
    To Secondary Material
    To Direct Labour/Labor
    To Production Overheads



    		By Process Sale a/c
    Process Sale a/c
    DrCr
    Particulars Quantity
    (in Units)     		Amount Particulars Quantity
    (in Units)     		Amount
    To Process I a/c



There are other credits to the Process a/c like Normal Losses, Abnormal Losses, Closing Stocks that we would be learning about later on.

Resemblance to Financial Accounting

For understanding the debits and credits to the process account, consider the following resembances of a process account to ledger accounts used in final accounting in financial accounts.

Process account = Manufacturing account

The process account is an equivalent of manufacturing account prepared during the process of final accounting in financial accounting.
Manufacturing a/c
DrCr
Particulars Amount Particulars Amount
To Opening Stock of Materials
To Purchase of Materials
To Carriage Inwards
To Manufacturing Wages
To Manufacturing Expenses
To Manufacturing Gross Profit

 By Finished Goods (?)
By Normal Loss
By Abnormal Loss
By Closing Stock of Materials

All direct expenses relating to the manufacturing process are debited to the Manufacturing a/c. Losses and closing stocks of inputs are credited to obtain the value of finished goods transferred to the Trading a/c as the balancing figure.

Process account ≡ Trading account

If you do not know about Manufacturing a/c in financial accounting, then consider the Process account to be an account similar to Trading account prepared during the process of final accounting in financial accounting.
Trading a/c
DrCr
Particulars Amount Particulars Amount
To Opening Stock
To Purchases
To Carriage Inwards
To Wages
To Direct Expenses
To Gross Profit

 By Cost of Goods Sold
By Normal Loss
By Abnormal Loss
By Closing Stock

All direct expenses relating to the trading activity are debited to the Trading a/c. Losses and closing stocks of goods are credited to obtain the value of cost of goods sold as the balancing figure.

We will find opening stocks, closing stocks, normal losses, abnormal losses in process accounting also. We will learn about them later on.

A simple Process Account

Process I a/c
DrCr
Particulars Quantity
(in Units) 		Amount Particulars Quantity
(in Units) 		Amount
To Primary Material
To Secondary Material
To Direct Labour/Labor
To Production Overheads
 10,000
 4,00,000
50,000
1,20,000
54,000 		By Process II a/c 10,000 6,24,000
  10,000 6,24,000   10,000 6,24,000

This is a process account with minimal information.

The illustration in the following pages would help us have a better understanding of the various terms that we come across in process costing.

Author : The Edifier
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