Process costing

Process costing is used where identical units flow continuously through one or more processes — paint, cement, bottled drinks, flour. There are no separate jobs to trace costs to, so costs are collected by process (department) for a period and averaged over the output.

The difficulty is the work left half-finished at the end of the period. 6,000 litres of paint that are half mixed haven't used as much conversion effort as 6,000 finished litres. Equivalent units (EU) express partly completed units as the number of whole units of work they represent: 6,000 units 50% converted = 3,000 equivalent units of conversion.

Costs are usually split into two categories because they're added at different stages: - Direct materials — often all added at the start (100% complete in closing WIP), sometimes at the end (0%). - Conversion costs (labour + overhead) — usually added evenly through the process.

The weighted-average method (as used here) pools the cost of opening WIP with costs added in the period and averages over all the work done to date. Its steps: 1. Physical flow: opening WIP + units started = units completed + closing WIP. 2. Equivalent units for each cost category = units completed (counted in full) + closing WIP × % complete. 3. Total cost per category = opening WIP cost + cost added this period. 4. Cost per EU = total cost ÷ equivalent units. 5. Assign: completed units × total cost per EU go to the next process or finished goods; closing WIP EU × cost per EU stay in WIP. The two must add back to total cost.

Under the FIFO method (not covered in this lesson's calculations) opening WIP is kept separate, and only work done this period is costed. Weighted average is simpler; FIFO gives a cleaner measure of this period's efficiency.

Losses in process. Some loss is expected — evaporation, offcuts, rejected batches. A normal loss is part of the cost of good output: it gets no equivalent units, so its cost is spread over the good units (any scrap proceeds reduce the cost). An abnormal loss — anything above the expected level — is costed like good output and written off to profit or loss as a separate line, so it is visible to management. External reporting agrees: IAS 2.16 excludes abnormal amounts of wasted materials, labour and other production costs from inventory.