A process cost system is a method of accounting in which the costs associated with manufacturing a product are tracked and allocated over the period of time it takes to make the product.
These costs are tracked as inventory, which may be in the form of raw materials, finished goods, or intermediate products that take time to produce. This inventory can be costly, and even more costly if it is not managed correctly.
Managing inventory can be difficult because it requires constant monitoring and re-checking of how much inventory you have left, how much it cost you to make it, and how much more time it will take to produce more.
This can get very complicated very quickly depending on the type of production process your organization has. How well you can manage this will affect how well your organization can capitalize on its profitability.
An organizational structure called a production department is one that many organizations use. This department has specific individuals who are tasked with managing all stages of production for an organization.
Calculate the cost of the ending work in process inventory
Once the cost of materials is determined, the next step in manufacturing accounting is to calculate the cost of the ending work in process inventory.
This includes calculating the cost of the parts that are currently being produced and adding the cost of all the parts that are waiting to be produced.
These two costs are then combined to get the total cost of work in process inventory. As mentioned before, this method gives more weight to current production and less weight to parts that are waiting to be produced.
By doing this, it accounts for the fact that some products take longer to produce than others, so there will always be some work in process inventory. Accounting for this element helps generate more accurate financial statements.
On top of that, having a lower amount of work in process inventory means that there is less invested material waiting to be produced. This helps with accounting for lost productivity due to production issues.
Calculate the total costs incurred during the period
After the total value of the production period is known, the next step is to calculate the total cost incurred during the period.
This includes calculating the total cost of materials used, plus any additional expenses such as labor, overhead, and selling expense.
In a process cost system, all costs are divided into two categories: direct costs and indirect costs. Direct costs are those that can be easily linked to a product or service. These include materials, outside services, and internal labor.
Indirect costs are those that cannot be easily linked to a product or service. These include overhead expenses like rent or utilities, equipment maintenance, and administrative duties like filling out paperwork. All of these must be allocated in some way to products and services to accurately represent their cost.
In general, all of these costs are tracked for a given period of time (usually a month). At the end of that period, all of these numbers are added up to get an accurate picture of what it cost your organization to produce in that time.
Divide the total costs incurred by the number of units produced
In this system, the cost of the work in process inventory is based on the costs incurred to produce each unit. These costs can be direct materials, direct labor, and overhead.
In this system, as units move through the production process, accounting software will track how much each unit costs to produce. This cost is divided by the number of units produced to get a cost per unit.
Then, these costs are added up for all of the units produced to get an average cost per unit. This is what the finished product is valued at by this system.
The problem with this system is that it does not take into account how long each unit has been in production. It only recognizes how many units have been produced, which can lead to a lot of waste. This is why this system is also known as a ‘low-end’ systems (Wiki).
Multiply step 4 by step 3 to get an average cost per unit
Once you have the total cost for all of the units completed, you can then calculate the average cost per unit.
This is done by multiplying the total cost for all of the units by the number of units completed. Then, divide that number by the number of units completed.
For example, if it cost $1,000 to complete 100 units and the company had a surplus of 10 incomplete units, then the average cost per unit is $1,000/110=$9.82.
In this case, there were no steps in between completing one unit and starting on the next one, so you would only have to take one average. However, if there were intermediate steps between each unit, then you would have to take an average of those steps as well to get an accurate average cost per unit.
Subtract step 5 from step 1 to get the ending work in process inventory value
In this example, the beginning work in process inventory value is 2,000 units and the ending work in process inventory value is 1,800 units. Subtracting the ending work in process inventory value from the beginning work in process inventory value gives you a negative inventory of -200 units.
This means that 200 fewer units were produced than were planned for. In most cases, this is not a good thing. Production managers like to see plenty of finished goods ready to be shipped or sold.
A negative inventory indicates that production was slowed down somehow and that there are not as many products ready to be sent out into the world. There might have been some issues with production that caused this to happen.
In general, having less work in process inventory at any given time is better than having more. Less work in process inventory indicates that there are fewer steps left before the product can be shipped or sold.
Repeat steps 2-6 for beginning work in process inventory value
Once this new starting work in process inventory value is determined, the next step is to add the value of newly completed items to this starting work in process inventory value.
The next stage of production is to add newly started production orders to the beginning work in process inventory, and then calculate the new ending work in process inventory value. This new ending work in process inventory value is then added to the beginning work in process inventory to get the next stage of production’s working inventory.
In a Production Cost System, cost accounting uses the units of production cost incurred during a given time period (typically a month) to determine what the cost of goods sold should be. In other words, cost of goods sold is calculated by taking the total costs incurred for production and dividing that by the number of units produced during that period.