Definition of Process Costing
Process costing is a term used in cost accounting to describe one method for collecting and assigning manufacturing costs to the units produced. A processing cost system is used when nearly identical units are mass produced. (Job costing or job order costing is a system used to collect and assign manufacturing costs to units that vary from one another.)
Example of Process Costing
Let’s assume that a company manufactures large quantities of an identical product. The product requires several processing operations, each of which occurs in a separate department. In the first department, the following processing costs were incurred during the month of June:
- Direct materials of $150,000
- Conversion costs of $225,000
If the equivalent of 100,000 units were processed in June, the per unit costs will be $1.50 for direct materials and $2.25 for conversion costs. These costs will then be transferred to second department where its processing costs will be added.
Job Order Costing vs Process Costing
Job Order Costing
Job order costing or job costing is a cost accounting system typically used to accumulate the manufacturing costs of expensive products such as a special machine, yacht, building, system, or for a batch of products.
Generally, job costing is used when each job (or batch) is sufficiently different from other jobs and the costs are significant. (If identical products are mass produced in large continuous quantities, the process costing system is more appropriate.)
Process Costing
Process costing is a cost accounting system for calculating the manufacturing costs (direct materials, direct labor and manufacturing overhead) of similar or identical products that are mass produced through a continuous process or series of processes.
When there is a series of processes, each process is likely to occur in a separate production department or cost center. Common examples of production departments include:
- casting
- molding
- forming
- cutting
- mixing
- refining
- trimming
- assembling
- finishing
- packing
For each accounting period, a unit cost is developed for the units processed in each production department. This is done by dividing the department’s costs by the units processed.
