Process costing is a cost allocation method used by companies that produce large quantities of similar goods. Costs are allocated to each production process, and three types of inventories (raw materials, work in process, and finished goods) are reported on financial statements.
Process costing is a management accounting cost allocation method used by companies that produce large quantities of homogeneous or extremely similar consumer goods. Examples of these types of businesses include food manufacturers, bottling companies, printers, and other similar businesses. Businesses use process cost to allocate business costs related to each production process, because allocating costs to each individual good is too difficult and time consuming. Under cost allocation methods, management accountants determine the cost of operating each individual function used in the production process. The total cost of the process is divided by the number of items produced during each specific function. The dollar amount resulting from this calculation is assigned to each good produced by the process.
The costs included in each process that the production system costs relate to the amount of direct materials used to produce goods, the direct labor of employees performing the process, and the amount of manufacturing overhead used in the production process. production. Manufacturing overhead often includes indirect materials, indirect labor, and the utilities used to run the production equipment. Each individual process has trade costs assigned to it as the goods enter the production process. Costs are tracked until the goods leave the process and move through the production system.
Although production systems generally depend on the type of goods a company produces, similar production processes may be involved in these types of systems. For example, in magazine production, production processes include printing, cutting, and stapling. Each process generally adds costs to the goods produced in a process costing system.
Process costing reports three types of inventories on a company’s financial statements: raw materials, work in process, and finished goods. Raw materials represent any economic resource or business input that has not yet been used in the production system. A work in progress is a detailed breakdown of goods that have passed through the production system but are not yet finished. Work-in-process inventories are valued by the number of processes the goods have gone through and the costs associated with producing the goods up to that point. Production companies may have various levels of work-in-process inventories listed on their balance sheet. Finished goods inventories are all produced goods that are available for sale to consumers. This number of inventories also includes goods that are waiting to be moved to distributors or wholesalers.
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