The Process Costing System for Accounting
Manufacturing companies choose between two main systems for determining product costs. Job order costing systems calculate product costs when each product is unique and manufactured individually. Process costing systems calculate product cost when each product is identical and manufactured continuously. Process costing systems must consider the challenge of determining product cost when the production of each product cannot be separated.
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Manufacturing Process
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Companies that use process costing systems use a continuous manufacturing process where identical products are produced. Examples of these products include pens, candy bars or oatmeal boxes. Products often complete several manufacturing processes, transferring from one production department to another before the product is final. The costs accumulate in each department and transfer to the next department. These individual departments might include a mixing department, an assembly department and a packaging department.
Inventory Accounts
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Process costing systems incorporate three different inventory accounts. These accounts include raw materials inventory, work-in-process inventory and finished goods inventory. Raw materials inventory includes the entire inventory received from suppliers and stored until the production department is ready to use it. Work-in-process inventory includes any items that have started the production process, but have not been converted into final products yet. Finished goods inventory includes all items that are ready to ship to customers.
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Advantages
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Process costing systems offer companies a couple of advantages when incorporating these systems. Process costing allows companies to calculate unit costs when the production of one unit cannot be separated from other units being manufactured. Process costing systems also allow management to monitor production efficiency. In order for the company to meet its product cost goals, the manufacturing process must maintain a specific level of efficiency. When one step in the process declines in efficiency, management can isolate that step and address the problem.
Disadvantages
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Process costing systems also incur disadvantages. Process costing systems rely on estimated production standards and estimated costs. If the estimates were inaccurate or based on faulty information, the product costs used in the system will not be correct. Also, incomplete production at the end of the period requires the accounting staff to perform additional work calculating the cost of partial units.
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