How to Improve Process Costing
Process costing is an accounting convention that traces and totals the direct costs and allocates the indirect costs of a manufacturing process across the number of units produced. Manufacturing costs are assigned to products that are manufactured in large batches, and costs are assigned to manufactured units on an average cost basis. Process costing involves certain assumptions about standard costs and can be subjective; therefore, process costing is only appropriate for companies that make large numbers of units (thousands or millions of units per month). Developing a robust and accurate process costing system is important because inaccurate costs will distort the financial picture of your company.
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Instructions
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Determine more accurate direct costs per unit produced. Install systems that track the number of labor hours per unit as well as the quantity of raw materials produced per unit. Your existing inventory management and payroll systems should be able to tell you the hourly wages of the workers who produced the units as well as the purchase price of the raw materials used. This information will allow you to develop a more accurate picture of the direct costs per unit of production.
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Update your standard costs frequently. Some companies go for months or even years without updating their standard costs. You should determine total actual indirect costs each month and allocate these indirect costs to the actual number of units produced in that month. The resulting per-unit cost should be your standard cost for the following month.
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Use an activity-based costing system to determine the inputs per unit of production. Activity-based costing will base all costs on the amount of time spent on a specific process in the manufacturing supply chain. Hence, units that require more labor or a larger number of activities to produce will be assigned higher costs.
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Separate activities that do not add value to the manufacturing process, and do not assign costs based on these activities. Some companies inadvertently include non-value add activities (such as tool changeover time or machine maintenance) in the manufacturing process, which can inflate the per-unit manufacturing cost.
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Produce units in larger batches, which will lower the amount of manufacturing downtime and ensure that the manufacturing plant is operating close to full capacity. An increased level of activity will create a more accurate picture of the true manufacturing cost per unit since it will minimize distortions due to non-manufacturing costs and activities.
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Tips & Warnings
It will be much easier to implement the steps outlined above if you have a strong accounting information system. Be sure that your company has a robust process costing software program that can accurately track the direct and indirect costs of production. See Resources for a buyers' guide to process costing software systems.
