Process costing is an accounting methodology that traces and accumulates direct costs, and allocates indirect costs of a manufacturing process. Costs are assigned to products, usually in a large batch, which might include an entire month's production. Eventually, costs have to be allocated to individual units of product. It assigns average costs to each unit, and is the opposite extreme of Job costing

Job costing

Job Costing involves the calculation of costs involved in a construction "job" or the manufacturing of goods done in discrete batches. These costs are recorded in ledger accounts throughout the life of the job or batch and are then summarized in the final trial balance before the preparing of the...

 which attempts to measure individual costs of production of each unit. Process costing is usually a significant chapter.

Process costing is a type of operation costing which is used to ascertain the cost

Cost

In production, research, retail, and accounting, a cost is the value of money that has been used up to produce something, and hence is not available for use anymore. In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it is counted as cost. In this...

 of a product at each process or stage of manufacture. CIMA

Chartered Institute of Management Accountants

The Chartered Institute of Management Accountants is a United Kingdom-based professional body offering training and qualification in management accountancy and related subjects, focused on accounting for business; together with ongoing support for members.CIMA is one of a number of professional...

 defines process costing as "The costing method applicable where goods or services result from a sequence of continuous or repetitive operations or processes. Costs are averaged over the units produced during the period".
Process costing is suitable for industries producing homogeneous products and where production is a continuous flow. A process can be referred to as the sub-unit of an organization specifically defined for cost collection purpose.

The importance of process costing

Costing is an important process that many companies engage in to keep track of where their money is being spent in the production

Production (economics)

In economics, production is the act of creating 'use' value or 'utility' that can satisfy a want or need. The act may or may not include factors of production other than labor...

 and distribution processes. Understanding these costs is the first step in being able to control them. It is very important that a company chooses the appropriate type of costing system

System

System is a set of interacting or interdependent components forming an integrated whole....

 for their product type and industry. One type of costing system that is used in certain industries is process costing that varies from other types of costing (such as
job costing

Job costing

Job Costing involves the calculation of costs involved in a construction "job" or the manufacturing of goods done in discrete batches. These costs are recorded in ledger accounts throughout the life of the job or batch and are then summarized in the final trial balance before the preparing of the...

) in some ways. In Process costing unit costs are more like averages, the process-costing system requires less bookkeeping than does a job-order costing system. So, a lot of companies prefer to use process-costing system.

When process costing is applied?

Process costing is appropriate for companies that produce a continuous mass of like units through series of operations or process. Also, when one order does not affect the production process and a standardization of the process and product exists. However, if there are significant differences among the costs of various products, a process costing system would not provide adequate product-cost information. Costing is generally used in such industries such as petroleum, coal mining, chemicals, textiles, paper, plastic, glass, and food.

Reasons for use

Companies need to allocate total product costs to units of product for the following reasons:

• A company may manufacture thousands or millions of units of product in a given period of time.
• Products are manufactured in large quantities, but products may be sold in small quantities, sometimes one at a time (automobiles, loaves of bread), a dozen or two at a time (eggs, cookies), etc.
• Product costs must be transferred from Finished Goods to Cost of Goods Sold as sales are made. This requires a correct and accurate accounting of product costs per unit, to have a proper matching of product costs against related sales revenue.
• Managers need to maintain cost control over the manufacturing
  Manufacturing
  Manufacturing is the use of machines, tools and labor to produce goods for use or sale. The term may refer to a range of human activity, from handicraft to high tech, but is most commonly applied to industrial production, in which raw materials are transformed into finished goods on a large scale...
  
   process. Process costing provides managers with feedback that can be used to compare similar product costs from one month to the next, keeping costs in line with projected manufacturing budgets.
• A fraction-of-a-cent cost change can represent a large dollar change in overall profitability
  Profit (accounting)
  In accounting, profit can be considered to be the difference between the purchase price and the costs of bringing to market whatever it is that is accounted as an enterprise in terms of the component costs of delivered goods and/or services and any operating or other expenses.-Definition:There are...
  
  , when selling millions of units of product a month. Managers must carefully watch per unit costs on a daily basis through the production process, while at the same time dealing with materials and output in huge quantities.
• Materials part way through a process (e.g. chemicals) might need to be given a value, process costing allows for this. By determining what cost the part processed material has incurred such as labor or overhead an "equivalent unit" relative to the value of a finished process can be calculated.