Forums Accounting What is process costing?

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    Ayush Nair

    What is process costing?

    Ayush Nair

    Process costing: Weighted average approach and first-in-first-out approach

    Weighted Average Method– It is used in such companies wherein inventories are difficult to be distinguished. For example, chemicals that are bought two months back cannot be differentiated from the one bought today as they are mixed well. So we work out an average cost for all chemicals that we have in our possession. The method specifically involves working out an average cost per unit at each point in time after purchase.

    FIFO– It is one of the common methods used to calculate inventory at the end of the year. In this method, inventory purchased first is sold out first rather than inventory purchased last. For example, inventory purchased on Jan 1, 2018, will be sold first rather than inventory purchased on Jan 20, 2018. Thus, the cost of older inventory is assigned to cost of goods sold and that of newer inventory is assigned to ending inventory.

    Process costing: Spoilage, scrap and reworked products

    Spoilage– Spoilage is the waste that is generated in the process of production. The term is most commonly applied to raw materials that have a short life span, such as food used in the hospitality industry. Normal spoilage is generally unavoidable and it is the standard amount of waste generated in the process. Whereas abnormal spoilage exceeds the normal spoilage and it is avoidable.

    Scrap– There are 3 options for the accounting treatment of Scrap

    1- Nominal sales price realized out of negligible scrap is treated as other income in cost account.

    2- A scrap account is opened with the full amount of a scrap of the process or job if such a scrap value is significant. Process account or job account is given credit by the value of scrap. The scrap account is closed by the balance either of profit or loss to the profit or loss account.

    3- Net sales value of scrap after deduction of selling and distribution costs is deducted either from the overhead amount or from the material cost. Deduction out of overheads is made to adjust the overhead ratio if scrap is not possible to identify in relation to a process or a job.

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