Illustrating Process Costing

Learning Objective: Identify the situations in which process-costing systems are appropriate

Difference Between Job-costing and Process-costing systems

Process-Costing: Assigns cost by dividing total costs by the number of units, creating $/Unit. This is because in a mass manufacturing process, each unit receives the same or similar treatment (costs).

This process of treating each unit of production the same or similarly is actually the main difference between Job-costing and Process-costing. In a Job-costing system, each product produced does not receive the same or similar amount of products or work. Thus if you try to take an average of all the products and assign them to each job like Process-costing does, the measurement for each individual job is going to be inaccurate.

Some jobs mix both homogenous processes and unique jobs. These will be covered under "hybrid" costing systems in a later Learning Objective.

Direct-Cost vs Indirect-Costs (Direct Materials+Conversion Costs)

Although the chapter isn't actually clear what differentiates Direct-Costs and Indirect-Costs, the examples given are Direct Materials and Conversion Costs. A quick look online clarifies that Direct-Costs tend to be the variable costs in a system, where as Indirect-Costs tend to be fixed or period costs.

For example, let's say I have a Simple Meal plant where the main expenses are Corn which I buy from a nearby farm, a team of colonists who live on the plant, and the upkeep of the plant itself. The Corn I buy would be my Direct-Costs, the Direct Materials to produce Simple Meals, whereas the Colonists and the Plant would be Indirect-Costs, in this case the required Conversion to turn Corn into Simple Meals. It should be noted that if demand for Simple Meals changes, my demand for Corn changes as well (making Corn a variable cost), but the costs of the Colonists and Plant are Period and Fixed costs respectively, meeting the earlier clarification.

Process-costing systems separate costs into cost categories according to when costs are introduced into the process

Typically, Direct-Costs are applied right at the start of the process while Indirect-Costs are applied throughout the process based on completion.

Let's say we have an order for 100 Simple Meals. I order 1000 Corn for $1000, and let's say it will cost another $1000 to convert all of the Corn into 100 Simple Meals. The moment I receive my order for 1000 corn, the process records the costs of all "Simple Meals" in production at this point as costing $1000, applying the Direct-Cost upfront. Let's then say over the course of two days, I produce 50 Simple Meals. At this point of time, I'm only 50% done with Conversion (Indirect Costs). If I were to record the value of my "100" Simple Meals at this point, it would be the $1000 in Corn + half of the Conversion Costs for the order, in this case $500, for a total of $1,500 of Simple Meals at this point of time.

More complicated processes will have multiple different Direct and Indirect Costs throughout the process, however the rules still generally follow if you break these more complicated processes into steps. At the beginning of each step, if Direct Materials are added into the system, those costs are always recorded right away. Through the completion of the product, Indirect Costs for that step of Conversion or Completion are only added as a percentage of completion.

Under what conditions is a process-costing system used?

Process-costing systems are best used when dealing with large amounts of homogeneous products produced mostly or entirely the same throughout their production process. Process-costing will then record the cost of these products based on a function of Direct and Indirect Costs.