what is process costing
Process costing is a cost accounting method used to calculate the average cost per unit when a company produces large volumes of similar or identical products in a continuous process, such as in chemicals, food, paper, or textiles.
Quick Scoop: Core Idea
- In process costing, you accumulate all production costs (materials, labor, and overhead) for a department or process over a period, then divide by the number of units produced to get an average cost per unit.
- It is used when individual units are indistinguishable from each other, so tracking the exact cost of each single unit is not practical.
- This method contrasts with job costing, which tracks costs for specific jobs or custom orders (e.g., specialized machinery, construction projects).
When is process costing used?
Typical situations:
- Continuous or repetitive production.
- Large volumes of homogeneous products.
- Products that pass through several stages (processes) like mixing, refining, bottling, etc.
Common industries:
- Oil refining, chemicals, paints.
- Food and beverages.
- Textiles and paper.
- Cement, bricks, glass.
| Feature | Process Costing | Job Costing |
|---|---|---|
| Type of production | Continuous, large volumes of similar units | [1][7]Customized, distinct jobs or batches | [2][1]
| Cost focus | Each process/department, then average per unit | [1][5]Each individual job or order | [2][1]
| Cost per unit | Computed by total process cost ÷ units produced | [9][5]Computed by total job cost ÷ units in that job | [3][2]
| Best for | Oil, food, chemicals, textiles | [5][9]Construction, consulting, custom manufacturing | [3][2]
How process costing works (simple steps)
A typical process costing cycle for a department:
- Analyze the physical flow of units
- Count units started, completed, and still in process during the period.
- Convert partly finished units into “equivalent units”
- For work-in-process (WIP), multiply units by percentage of completion to express them as finished-unit equivalents.
- Accumulate costs
- Add all direct materials, direct labor, and manufacturing overhead for that process in the period.
- Compute cost per equivalent unit
- Divide total process cost by total equivalent units to get cost per unit.
- Assign costs to finished and unfinished units
- Apply the per-unit cost to units completed and units still in WIP.
This allows the company to know both:
- Cost of goods completed (for the income statement).
- Cost of ending work-in-process inventory (for the balance sheet).
Types of process costing
Common variants you will see:
- Weighted-average method
- Combines beginning inventory costs with current period costs and averages everything together; simpler and widely used.
- FIFO (First-In, First-Out) method
- Separates prior-period work from current-period work; costs are layered so earlier work is costed first.
- Standard costing version
- Uses predetermined standard costs instead of actual costs, then records variances between standard and actual.
Simple illustration
Imagine a paper mill:
- In March, the “Pulping” department incurs 100,000 in total costs and produces 20,000 equivalent units of paper.
- Average cost per unit = 100,000 ÷ 20,000 = 5 per unit.
- That 5 is then transferred as the cost per unit to the next process (e.g., “Finishing”) for all units that leave Pulping.
This example shows how process costing smooths costs over all units instead of tracking each sheet individually. Bottom note: Information gathered from public forums or data available on the internet and portrayed here.