Processing Expenses with the Process Cost System

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  • 0:04 Process Cost System Review
  • 1:15 The Flow of Expenses
  • 2:05 Example
  • 2:56 Recording Expense on…
  • 4:17 Transferred-In Costs
  • 5:20 Lesson Summary
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Lesson Transcript
Instructor: Christian George

Christian has a PhD in Business Management and an MA in Accounting & Financial Management

This lesson will review the process costing system and discuss how manufacturing companies track the flow of expenses through departments involved with the manufacturing process.

Process Cost System Review

If you own a business, you want to know how much it costs to make your product. If you owned a bike repair shop, you would do this on an individual, per job basis. But what if you worked in mass production, making thousands of one type of product each year?

In manufacturing, there are two different traditional costing methods that are used to determine and assign manufacturing costs to products. There is job order costing, which assigns costs to an individual unit or product (like in the bike shop) and there is process costing, which is a method used to assign costs to a mass quantity of a product (like in a factory making many of the same product).

In order to sell a product to a customer you have to manufacture it, and that takes money. In the process costing system, there are three costs that companies focus on and track throughout the manufacturing process. First, there's direct materials, or the materials used to make the product. Then there's direct labor, the wages for employees that make the product. And, finally, there is manufacturing overhead, which is the overhead directly related to the manufacturing of the product.

The Flow of Expenses

It takes money to make money. This old saying is always true in business, especially in the manufacturing companies. It takes a lot of money to pay for the materials, labor, and overhead associated with creating a product. These expenses are accumulated by a company as the product travels from department to department during the manufacturing process.

Expenses are the costs associated with making a product, including bank fees, salaries, or interest payments, as well as machinery and upkeep. These expenses are compared to revenue on the income statement to determine how much money the company made.

As a product goes through the manufacturing process, it moves from department to department, accumulating costs. Let's look at an example of a company that manufactures telephone wire.


XYZ, Inc. manufactures telephone wire through a three-step process with three different departments. Each of the departments has a specific role in the manufacturing process and adds its own costs associated with the process.

Department #1 adds $1,500 to the cost of the product. This is made up of the cost of raw materials used, labor to operate the machines, and manufacturing overhead for that department. Department #2 adds $8,000 to the cost of the product the same way that department #1 did. Department #3 follows suit and adds $500 to the cost.

Each department adds its costs until the product is complete and all of the costs of all of the departments are put together to get the actual manufacturing cost. In this case, it's $10,000.

Recording Expenses on the Journey

XYZ will record the expenses in journals through a journal entry as the costs are incurred through each department in the manufacturing process. A product is classified as a work-in-progress (WIP) as it moves through the manufacturing process. These entries will be moved to the general ledger at the end of the accounting cycle and then on to the financial statements. These illustrations will show the journey that the product takes through the eyes of the journal entries.

Department #1 adds $1,500 to the cost of production. The journal entry will show all of the manufacturing costs together.

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