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Technology makes it easy to track costs as small as one fastener or ounce of glue. However, if each fastener had to be requisitioned and each ounce of glue recorded, the product would take longer to make and the direct labor cost would be higher. So, while it is possible to track the cost of each individual product, the additional information may not be worth the additional expense. Managerial accountants work with management to decide which products should be accounted for as direct material and tracked individually, versus which should be considered indirect material and allocated to the departments through overhead application.

While both systems produce a cost of goods sold for a given period, Process Costing focuses on the product’s progression through various stages of production. Job-order costing focuses on a specific product or service produced for a given customer. Process costs represent a higher level of accuracy than job-order costing, but they are also more complex and time consuming to develop.

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Once products are completed, their overall costs are marked up and sold at a profit to customers. Process costing is used when large quantities of identical items are manufactured in a continuous flow on a first-in, first-out basis. Examples of products that would use process costing are Cheerios brand cereal, iPhones, or Toyota Camrys. While still in production, the work in process units are moved from one department to the next until they are completed, so the work in process inventory includes all of the units in the shaping and packaging departments. When the units are completed, they are transferred to finished goods inventory and become costs of goods sold when the product is sold.

Each Department inputs direct materials and further processes the products. Then the Packaging Department transfers the products to Finished Goods Inventory. Process costing and job order costing are both acceptable methods for tracking costs and production levels.

Process Costing Examples

The department’s costs would be allocated based on the number of cases processed. For example, assume a not-for-profit pet adoption organization has an annual budget of \(\$180,000\) and typically matches 900 shelter animals with new owners each year. Process costing is the most practical and efficient accounting method for determining product costs for specific types of firms. It can be difficult, for example, to appropriately attribute expenses to work in progress. Total the expenses for all phases of production, including direct materials and conversion costs. Next is to allocate costs for the completed and incomplete products to the corresponding accounts in order to determine how much money is tied up in the current work-in-progress products.

• Moreover, raw material needs to pass through multiple stages of production before turning into finished goods.
• It is difficult to tell the first drumstick made on Monday from the 32,000th one made on Thursday, so a computer matches the sticks in pairs based on the tone produced.
• Throughout the process it is stirred, cracked, and blended so that it is not possible to trace a tank of gasoline back to a specific barrel of oil.
• Cost drivers are the factors that cause changes in the total cost of producing a good or service.
• Besides that, It is also applicable to manufacturing that has many processes which cannot identify the cost of each production process.

While making drumsticks may sound simple, an immense amount of technology is involved. Rock City Percussion makes \(8,000\) hickory sticks per day, four days each week. The sticks made of maple and birch are manufactured on the fifth day of the week. It is difficult to tell the first drumstick made on Monday from the \(32,000\)th one made on Thursday, so a computer matches the sticks in pairs based on the tone produced. Texas Monthly reports that Sandy found a way to write unapproved checks in the accounting system.

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However there is one important difference, equivalent units of abnormal gain are given a Negative value and subtracted from the total equivalent units of output in the period. The finished material of one process constitutes the raw material of the next. Therefore, as the finished material is transferred to the next process, the cost of each process is also transferred, until it ends in the finished stock account.

This process costing method is the most complicated process costing method compared to the weighted average and standard cost methods. In a situation whereby costs change significantly from one period to the next, the FIFO method can be used to get a more precise product costing. By using this system, each department tracks its own costs and all those costs will be rolled up to arrive at a total cost to produce a specific number of products. Since all the expenses have to be summed up in a process costing system, they have to be reported in the same manner which brings about uniformity to reports and makes tracking costs over time easier. Process Costing is the cost accounting method in which production overhead is equally allocated to each product due to their similarity and mass production.

What are the benefits of process costing?

The company does not need to invest in an expensive accounting system just for product costing. Finally, the Packaging department, the place where shoes are matched by size and put into a retail box. The cost of direct labor in this department during March has only USD 30,000 and they complete the work for 12,000 pairs of shoes. Rock City Percussion makes 8,000 hickory sticks per day, four process costing examples days each week. It is difficult to tell the first drumstick made on Monday from the 32,000th one made on Thursday, so a computer matches the sticks in pairs based on the tone produced. This method tended to slightly distort the resulting unit cost, but in mass-production industries that made one product line, and where the fixed costs were relatively low, the distortion was very minor.

This follows the expense recognition principle because the cost of the product is expensed when revenue from the sale is recognized. There is no last in, first out (LIFO) costing method used in process costing, since the underlying assumption of process costing is that the first unit produced is, in fact, the first unit used, which is the FIFO concept. Understanding the full manufacturing process for a product helps with tracking costs. This video on how drumsticks are made shows the production process for drumsticks at one company, starting with the raw wood and ending with packaging.