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Process Costing: Definition & Examples

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  • 0:02 Process Costing
  • 1:55 Steps in Process Costing
  • 2:34 Examples
  • 8:53 Lesson Summary
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Lesson Transcript
Instructor: Sarah Bilant

Sarah has taught QuickBooks classes, has a Bachelor of Science degree in Accounting, and is a licensed CPA.

Costing techniques are used to determine how much it costs a company to manufacture a product. Process costing is the method used when comparable products are manufactured. In this lesson, learn what process costing is and how to use this technique.

Process Costing

Manufacturing companies need to know how much it costs to manufacture a product in order to set their sales price and determine if it's producing a profit. Product costing is the process of determining the business expenses associated with the manufacture of a product. When dissimilar products are manufactured by the same company, job costing techniques are used. These techniques determine the products' cost drivers, or activities that control the amount of costs incurred, then allocate expenses by dividing the expenses by their associated drivers.

For example, a company manufacturing both laptop computers and cell phones may allocate expenses based on the number of machine hours used to produce each product. This enables the company to determine the costs associated with each product type and cut costs as necessary per product.

However, job costing does not work for manufacturing companies that produce products that are identical, or very similar, such as food or oil, because each unit costs the same to produce. Instead, these companies use process costing. Process costing systems allocate expenses to products by adding total costs at each stage of the manufacturing process then dividing these costs by the total number of units produced. This enables these companies to determine the costs associated with the products at each stage of the manufacturing process and cut costs as necessary per stage of manufacture.

Typically, the cost per unit for each process will be calculated separately for direct materials and conversion costs. Direct materials are materials that are consumed during the manufacture of a product; and conversion costs are the costs incurred for direct labor, which is the labor involved in the manufacture of a product, and manufacturing overhead, which includes all other costs that are not directly involved in the manufacture of a product.

Steps in Process Costing

To determine a cost per unit in a process costing system, the specific manufacturing processes and associated expenses must first be identified. Once the processes and expenses are identified, total expenses per process for a period must be divided by the number of units produced during that period.

Total Expenses Incurred in Process ÷ Total Units Produced

After the expense per unit for each process is calculated, the results can be added together to obtain a total cost per unit. The result will be a dollar amount that can be used by the manufacturing company to set prices and determine if the products are producing a profit.

Examples

Now let's look at a couple of examples.

Example 1

ABC Wine Company crushes grapes to be used in winemaking. The company has asked you to determine its product cost per gallon for each stage of manufacture. You've been given the following information:

Manufacturing Stages

  • Crushing
  • Packaging

Expenses

  • Grapes purchased: $100,000
  • Grape press maintenance: $25,000
  • Packaging supplies: $75,000
  • Packager labor: $50,000

Other Information

  • Units produced: 50,000 gallons

The first step to calculating product cost per gallon is to determine what process each expense relates to. In this example, grapes purchased and grape press maintenance relate to the crushing process and packaging supplies and packager labor relate to the packaging process.

The next step is to calculate cost per unit for both direct materials and conversion costs for each stage of the process. As discussed earlier, direct materials are materials consumed during manufacture and conversion costs are direct labor costs and manufacturing overhead costs.

Crushing Cost per Unit

$100,000 grapes purchased ÷ 50,000 gallons juice = $2.00 of direct materials cost per gallon
$25,000 grape press maintenance ÷ 50,000 gallons juice = $0.50 conversion cost per gallon
$2.00 of direct materials cost + $0.50 conversion cost = $2.50 total crushing cost per gallon

Packaging Cost per Unit

$75,000 packaging supplies ÷ 50,000 gallons juice = $1.50 of direct materials cost per gallon
$50,000 packager labor ÷ 50,000 gallons of juice = $1.00 conversion cost per gallon
$1.50 direct materials cost + $1.00 conversion cost = $2.50 total packaging cost per gallon

Total Cost per Unit

$2.50 crushing cost per gallon + $2.50 packaging cost per gallon = $5.00 total cost per gallon

Upon completion of your project, you'll be able to tell ABC Wine Company that the total cost per gallon is $5.00, which consists of:

  • $2.00 crushing direct materials
  • $0.50 crushing conversion costs
  • $1.50 packaging direct materials
  • $1.00 packaging conversion costs

Example 2

Office Building Inc. manufactures paint base to be used in office buildings. The company has asked you to determine its product cost per gallon for each stage of manufacture. You've been given the following information:

Manufacturing Stages

  • Measuring
  • Mixing
  • Packaging

Expenses

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