Process costing is a crucial tool used in bookkeeping for small businesses and is especially useful for production managers to monitor product prices in sectors dealing with large quantities of manufactured items that are prone to frequent price variations because of the manufacturing process and many production lines. The cost of goods manufactured (COGM) figure obtained from process costing is frequently displayed on your company’s income statement.
Process Costing Explained
Process costing is crucial since it aids businesses in several ways such as consistently and accurately providing data from each department, having control over inventory levels, and the ability to distribute correctly and track profits to determine exactly how much they are spending and generating.
The process costing approach offers benefits and drawbacks, it is less expensive, and simple to use. It also has additional drawbacks, like a lack of ability to measure each department and a lower level of financial accuracy. With this approach, the accounting division can decide which sort of process costing is most appropriate for the circumstance.
A corporation can calculate the overall expenses incurred before, during, and after production, as well as the total number of units produced, using a variety of different process costing techniques:
Standard process costing:
It is used to simply compute production costs.
Activity-based costing:
concerned with allocating the process's indirect overhead costs.
FIFO (first-in, first-out):
calculates unit costs as they are begun and finished.
Weighted average:
The overall costs of a procedure are fairly distributed among all the units made.
Products that are homogeneous cannot be identified from one another, such as a pack of identical pens of the same size and type. During the course of production, these related items all typically pass through a number of phases. Companies calculate the direct costs and manufacturing overhead for each of those processes in order to employ the process costing method in accounting.
Direct and indirect expenditures are involved in these phases. Raw materials and the salary of direct labours are examples of direct production expenses. Indirect expenses like facility rent and electricity are sometimes included in overhead, along with salaries paid to administrative workers who aren’t directly involved in producing the goods.
Direct materials and conversion costs are two common breakdowns used by businesses. Conversion costs are expenses associated with the process, such as labour costs and overhead in the production process, whereas direct materials are the materials used at each stage.
The process is often handled by a different department at many businesses. The expenses of each department’s direct materials, direct employment/labour, and applicable industrial overhead are listed. When examining the entire cost of the product, the company then aggregates these statistics. Process costing flow is shown above for a better understanding.
Example of process costing:
When the product units are uniform, process cost accounting is functional. View a graphic that illustrates how it works in these fictional businesses.
Let’s take an example of the wind tunnel system of Aero labs designed to meet the needs of educators and researchers like NASA. Typically, 7-8 wind tunnels are produced and sold in a single year. To create the final product, Aero labs needed raw materials including Fans, Vanes, Base EWT Parts, motors as well as Paint & Hardware. Continuous flows of raw materials such as Fans and vanes are used throughout the production process, which culminates in the creation of identical wind tunnels. This month they get an order for 1 unit which is going to be used by NASA. $91,267 worth of raw material $ 14,000 in direct labour and $ 60,000 in overhead expenditures such as power, maintenance, and Indirect expenses for one-unit cost goes $165,267.
The importance of process costing
A process costing system is especially important in the oil, chemical, lumber, textile, and food processing industries. These businesses can evaluate the appropriate prices for their products and whether costs are tracking in line with expectations by getting a handle on manufacturing costs. They can assess the expenses associated with each stage of the production and distribution process using a process costing and then utilize it. This helps to Monitor profit margins, inventory control, and uniformity in reporting. Easy to track the number of units passing through the production during a time period and collect cost information for each stage and then use the collected information to calculate the per-unit cost.
An Outsourcing process costing is the practice of assigning the cost of producing a product or service to the specific product or service being produced or provided. This allows a company to determine the true cost of each product or service, which can be useful for cash flow management and forecasting as well as decision-making.
Outsourcing process costing helps bookkeepers focus on other important tasks, such as maintaining accurate records and ensuring compliance with financial reporting standards. This can help to ensure that the process is completed accurately and efficiently, and can provide valuable insights and data that can be used to improve operations and make a more informed business decision. Your search for bookkeeping services for small businesses provider has come to a conclusion. IBN Tech , an outsourcing bookkeeping service provider, Has clients in US, UK, Mexico, and Canada. Having been in business process outsourcing for more than 22 years, IBN Tech has extensive experience in this field.
Conclusion
It may be challenging or impossible for these businesses to directly assign expenses to each product as it is manufactured. By adding up the costs associated with each stage of the production process and dividing by the number of things, process costing enables businesses to estimate item costs. Companies must accurately allocate expenses to work in progress at each stage and only include product-related expenditures from each department involved in the process in order to assure accuracy. Tracking costs by department and generating overviews are both possible with financial management software, particularly platforms incorporated into a larger ERP solution.
