How to Use 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 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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Assign direct costs per unit to each unit of production. Suppose your company makes a widget that requires two yards of fabric. Suppose further that your company purchased 100 yards of fabric this month for a total of $200, or $2 per yard. In this example, the raw material cost per unit produced equals $2 per yard x 2 yards = $4.
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Total the indirect costs for the manufacturing period. Suppose your company's widgets are produced in a warehouse that costs $1,000 per month to operate. Suppose further that the salaries for the supervisors who run the plant are $2,000 per month. The total indirect manufacturing costs for the month of production would total $1,000 + $2,000 = $3,000.
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Divide the total indirect costs by the number of units produced. Suppose that your company produced 2,000 widgets this month. In this example, the total indirect costs per unit would equal $3,000/2,000 = $1.50.
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Add the direct costs per unit to the indirect costs per unit to calculate total costs per unit. In this example, the total cost per unit equals $4 + $1.50 = $5.50.
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Tips & Warnings
Many companies use accounting software to keep track of direct and indirect expenses. You should install a robust cost accounting software system in order to ensure that your company is accurately tracking the necessary costs. See the Resources section for a link to a buyers' guide for process costing software systems.
The simplified example above assumes only one type of direct costs (raw materials) and two types of indirect costs (manufacturing overhead and salaries) per unit. In reality, the products your company is producing will likely have numerous direct and indirect costs. Make sure that your accounting software accurately captures all the relevant costs when calculating the production costs of each item.
