Reference no: EM132146489

Question: Process costing is a management accounting function. Business owners use this function to accurately calculate and apply the business costs for producing specific types of goods. Process costing provides a costing system for homogenous goods, which usually have little differentiation from one item to the next. Paper, petroleum, chemical, textile, lumber and food processing industries commonly use process costing. The weighted average method is the most common process costing system used in practice. This method includes a few basic steps when costing products.

Flow of Units

Process costing relies on a very distinct flow of units through the company's production system. Homogenous goods usually flow through several various production processes. Each process has a specific amount of costs associated with producing products. Costs can include direct materials, production labor and manufacturing overhead. These items represent the direct costs related to the specific production of goods. Manufacturers may have different types of processes they use when producing goods. In the wine industry, production processes can include harvesting, crushing and pressing grapes, fermentation, aging, bottling, labeling and shipping.

Calculate Equivalent Units

Equivalent units represent the number of items completed during each stage of the production system. Process costing uses equivalent units as a measuring stick because inevitably some units will be incomplete at the end of an accounting period. Incomplete units are calculated based on the percentage of completion. For example, goods that have gone through four of five production processes will represent equivalent units that are 80 percent complete.

Unfinished equivalent units in process costing systems represent work-in-process. Companies report work-in-process on internal financial reports and their final balance sheet. The balance sheet represents an official figure regarding equivalent units.

Compute Unit Costs

Computing individual unit costs in process costing is a fairly basic process compared to other cost accounting methods. The basic cost calculation is work-in-process plus costs incurred for the month divided by total equivalent units. Companies often break down production costs into direct material costs and conversion costs. Conversion costs include the direct labor and manufacturing overhead for each production process. Work-in-process represents the incomplete equivalent units from the previous month. Only 100 percent complete equivalent units will be assigned full process cost.

Cost Analysis

The final stage of process costing is analyzing the total cost of the process costing system. Companies often review each production process to ensure all costs or properly allocated to each the equivalent unit. This analysis includes a review of the work-in-process account, which represents beginning inventories at the accounting period. The number of units processed and associated costs is also included in this process. This ensures no leftover costs remain in each production process.