MI · Certificate Level
Process Costing
Process costing for continuous production environments: process accounts (the ledger format), normal and abnormal losses and gains, the concept of equivalent units for work in progress, the weighted average and FIFO methods for valuing equivalent units, joint products and by-products (definitions, accounting treatment, split-off point), methods of apportioning joint costs to joint products (sales value at split-off, net realisable value, physical measure), and further processing decisions. All with comprehensive worked examples.
Learning Objectives
- •Explain when process costing is appropriate and distinguish it from job costing
- •Prepare a process account in ledger format showing inputs, outputs, and losses
- •Distinguish between normal and abnormal losses, and account for abnormal gains
- •Calculate equivalent units of production for incomplete work in progress
- •Apply the weighted average method and the FIFO method to value output and closing WIP
- •Distinguish between joint products and by-products and explain their accounting treatment
- •Apportion joint costs to joint products using sales value at split-off, net realisable value, and physical measure methods
- •Apply the further processing decision rule at the split-off point
Process Costing — When and Why
Process costing is used when products are manufactured in a continuous or repetitive process, producing large quantities of identical or near-identical units. Individual units are indistinguishable from each other — it is impossible (or impractical) to trace costs to individual units.
Examples: Oil refining, chemical manufacturing, cement production, food and beverage processing, paper manufacturing, paint production, pharmaceuticals.
Contrast with job costing:
| Feature | Job costing | Process costing |
|---|---|---|
| Production type | Unique, customised products (individual jobs) | Identical, mass-produced products (continuous flow) |
| Cost accumulation | Costs traced to each specific job/order | Costs accumulated for the entire process over a period, then averaged over units produced |
| Unit cost | Different for each job | Average cost per unit (total process cost ÷ units produced) |
| Examples | Construction projects, legal cases, printing orders, custom furniture | Oil refining, chemicals, cement, food processing |
Process Accounts
A process account is a ledger account that records all inputs (materials, labour, overheads) on the debit side and all outputs (finished goods transferred to the next process or to finished goods inventory, plus losses) on the credit side. The account must balance.
Basic process account format:
| Process Account (Debit side — inputs) | Process Account (Credit side — outputs) | ||||
|---|---|---|---|---|---|
| Units | £ | Units | £ | ||
| Materials | X | X | Finished goods (output) | X | X |
| Labour | X | Normal loss | X | X (scrap value) | |
| Overheads | X | Abnormal loss | X | X | |
| Closing WIP | X | X | |||
| Total | X | X | Total | X | X |
Units in = Units out (including losses). Total cost in = Total cost out (the account must balance in both units and value).
Normal Losses, Abnormal Losses, and Abnormal Gains
Normal loss:
- The expected, unavoidable loss that occurs as part of the production process (e.g., evaporation, chemical reactions, cutting waste, spoilage)
- Set as a percentage of input based on historical experience or technical specification
- Normal loss is not a cost in its own right — its cost is absorbed into the cost of good output. The cost of normal loss is spread across the good units produced.
- If the normal loss has a scrap value (the spoiled units can be sold for a small amount), the scrap proceeds are credited to the process account, reducing the net cost of the process.
- Cost per unit of good output = (Total process cost − Scrap value of normal loss) ÷ Expected good output
- Expected good output = Input units − Normal loss units
Abnormal loss:
- Loss that exceeds the normal (expected) level — the difference between actual loss and normal loss
- Abnormal losses are unexpected and controllable — they should be investigated (machine malfunction, poor quality materials, operator error)
- Valued at the same cost per unit as good output (because abnormal losses should have been good output)
- Transferred OUT of the process account to an abnormal loss account, and ultimately written off to the income statement as a separate expense (so it is visible to management). Not hidden in production cost.
Abnormal gain:
- Occurs when actual loss is less than normal loss — the process produces more good output than expected
- Valued at the same cost per unit as good output
- Transferred to an abnormal gain account and credited to the income statement as a separate item
- Effectively: more units came out of the process than expected, so the entity benefits. But the scrap value of the "missing" normal loss units is not realised (because fewer units were actually lost than expected), so the abnormal gain account is debited with the lost scrap revenue.
Equivalent Units and Work in Progress
When there is work in progress (WIP) at the end of a period — units that are partially complete — the process account must account for both fully complete output and partially complete WIP.
Equivalent units convert partially complete units into an equivalent number of fully complete units, based on their degree of completion.
Equivalent units = Physical units × Degree of completion
Example: 200 units of closing WIP that are 60% complete in terms of conversion costs represent: 200 × 60% = 120 equivalent units of conversion cost.
Important: Materials and conversion costs (labour + overheads) may have different degrees of completion. Materials are often added at the start of the process (so WIP is 100% complete for materials, regardless of its stage of processing). Conversion costs are incurred evenly throughout the process (so the degree of completion depends on how far through the process the WIP has progressed).
The two main methods for dealing with opening WIP are the weighted average method and the FIFO method.
Weighted Average Method
The weighted average method merges opening WIP with current period inputs. It does not distinguish between units started last period and units started this period — all units are treated as part of one pool.
Steps:
- Calculate total equivalent units = Completed output (fully equivalent) + Closing WIP equivalent units. Opening WIP is NOT shown separately — it is merged into the completed units.
- Calculate total costs = Opening WIP cost (b/f) + Costs added this period (for each cost element: materials, conversion).
- Cost per equivalent unit = Total cost ÷ Total equivalent units (separately for materials and conversion).
- Value completed output = Completed units × Cost per EU (materials + conversion).
- Value closing WIP = Closing WIP equivalent units for materials × Materials cost per EU + Closing WIP equivalent units for conversion × Conversion cost per EU.
Advantage: Simpler — no need to track opening WIP separately.
Disadvantage: Blends costs from two periods, which may mask period-specific cost changes.
FIFO Method
The FIFO method keeps opening WIP costs separate from current period costs. It assumes the opening WIP is completed first, followed by units started and completed this period, then closing WIP.
Steps:
- Calculate equivalent units of CURRENT PERIOD WORK ONLY:
- Opening WIP: only the work done this period to complete them (e.g., if opening WIP was 40% complete, the current period does the remaining 60%)
- Units started and completed this period: 100% equivalent
- Closing WIP: equivalent units based on degree of completion
- Calculate cost per equivalent unit using CURRENT PERIOD COSTS ONLY (exclude opening WIP brought-forward costs).
- Value completed output:
- Opening WIP: b/f cost + (current period EU to complete × current period cost per EU)
- Started and completed: full EU × current period cost per EU
- Value closing WIP: Closing WIP equivalent units × current period cost per EU.
Advantage: More accurate — current period costs are not diluted by prior period costs. Better for performance measurement and cost control.
Disadvantage: More complex to calculate.
Joint Products and By-Products
In some processes, two or more products emerge simultaneously from a common process up to a split-off point.
Joint products: Two or more products that are produced simultaneously from the same process, each having significant sales value relative to the total. Examples: petrol, diesel, and kerosene from crude oil refining; cream and skimmed milk from whole milk processing.
By-products: Products with relatively insignificant sales value compared to the main joint products. They are incidental to the main production process. Example: sawdust from timber processing, whey from cheese production.
Accounting treatment:
- Joint products: Joint process costs (costs incurred before split-off) must be apportioned between the joint products for inventory valuation and profit reporting (see methods below). After split-off, each product's further processing costs are treated as separable costs.
- By-products: Two common treatments: (a) Net revenue method: The net revenue from the by-product (sales value less any further processing/selling costs) is deducted from the joint process cost before apportioning to joint products. The by-product itself is not assigned any joint costs. (b) Other method: The by-product is valued at NRV and shown as inventory; the NRV is deducted from joint costs.
Methods of Apportioning Joint Costs
| Method | Basis of apportionment | Advantages | Disadvantages |
|---|---|---|---|
| Sales value at split-off | Apportion joint costs in proportion to the sales value of each product at the split-off point | Simple, objective (uses market prices at split-off), widely used | Only works if all products have a sales value at split-off (some may only be saleable after further processing) |
| Net realisable value (NRV) | Apportion in proportion to the final sales value minus further processing costs for each product | Can be used when products have no market value at split-off (must be processed further). Reflects the ultimate value of each product. | More complex, requires estimation of further processing costs and final selling prices, which may be uncertain |
| Physical measure (weight/volume) | Apportion in proportion to the physical quantity (kg, litres, tonnes) of each product at split-off | Simple, objective, does not require market prices | Ignores the relative value of products — a high-value product gets the same cost allocation per kg as a low-value one. May distort profitability. |
Important: The method of apportioning joint costs does NOT affect decision-making at the split-off point. Joint costs are sunk at the split-off point — they have already been incurred regardless of what happens to the products. The apportionment is for inventory valuation and financial reporting only, not for decision-making. Decisions (such as whether to process further) should be based on incremental costs and revenues beyond split-off.
Examiner Focus
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Key Definitions
Process costing
A costing method for continuous, mass-production processes where identical units are produced. Costs are accumulated per process and averaged over units. Used when individual units cannot be separately identified.
Process account
A ledger account recording all inputs (debit: materials, labour, overheads) and outputs (credit: finished goods, losses, closing WIP) for a process. Must balance in both units and value.
Normal loss
The expected, unavoidable loss inherent in the production process (evaporation, spoilage, cutting waste). Its cost is absorbed into the cost of good output. Not shown as a separate cost.
Abnormal loss
Loss exceeding the normal expected level — unexpected and controllable. Valued at the cost per unit of good output. Transferred to an abnormal loss account and written off to the income statement as a visible, separate expense.
Abnormal gain
When actual loss is less than normal loss — more good output than expected. Valued at cost per unit of good output. Credited to the income statement. The "missing" scrap revenue (from fewer losses than expected) is debited.
Equivalent units
Partially complete units converted into a notional number of fully complete units based on degree of completion. Used to value closing WIP. Example: 200 units 60% complete = 120 equivalent units.
Weighted average method
Merges opening WIP costs with current period costs. Total cost ÷ total equivalent units (opening WIP merged into completed output). Simpler but blends two periods' costs.
FIFO method
Keeps opening WIP costs separate from current period costs. Equivalent units reflect only current period work. More accurate for cost control and performance measurement, but more complex.
Joint products
Two or more products produced simultaneously from the same process, each with significant sales value. Joint costs before split-off must be apportioned between them for inventory valuation.
By-product
A product with insignificant sales value relative to joint products, produced incidentally from the main process. Its net revenue is typically deducted from joint costs; no joint costs are allocated to it.
Split-off point
The point in a joint process where individual products become separately identifiable. Before this point: joint costs (shared). After: separable costs (traceable to individual products).
Joint cost apportionment
Allocating joint process costs to individual joint products for inventory valuation. Methods: sales value at split-off, NRV, physical measure. Does NOT affect decision-making (joint costs are sunk at split-off).
Key Formulas
Worked Examples
Related Topics
Key Takeaways
- ✓Process costing is for continuous, mass-production environments where identical units are produced. Costs are accumulated per process and averaged over units.
- ✓Process account: inputs (materials, labour, OH) on debit side; outputs (finished goods, losses, closing WIP) on credit side. Must balance in units and value.
- ✓Normal loss: expected, unavoidable loss (e.g., 5% evaporation). Its cost is absorbed by good output. Scrap value (if any) reduces the net process cost. Cost per unit = (Total cost − Scrap of normal loss) ÷ Expected good output.
- ✓Abnormal loss = Actual loss − Normal loss. Valued at cost per unit of good output. Charged to income statement as a separate visible expense. Abnormal gain is the reverse (actual loss < normal).
- ✓Equivalent units convert partially complete WIP into fully complete equivalents. EU = Physical units × Degree of completion. Calculate separately for materials and conversion costs.
- ✓Weighted average: merges opening WIP with current period (one pool). Cost per EU = Total cost ÷ Total EU. Simpler but blends periods.
- ✓FIFO: keeps opening WIP separate. EU = only current period work. Cost per EU uses current period costs only. More accurate for cost control.
- ✓Joint products have significant sales value; by-products have insignificant value. By-products: net revenue deducted from joint costs (not allocated joint costs).
- ✓Joint cost apportionment methods: sales value at split-off, NRV, physical measure. For REPORTING only — NOT for decision-making (joint costs are sunk at split-off).
Practice Questions
Question 1 of 8
Input to a process is 5,000 kg. Normal loss is 10%. Actual output is 4,300 kg. The abnormal loss is:
Question 2 of 8
Total process cost is £80,000. Normal loss is 400 kg (scrap value £2/kg). Input is 4,000 kg. The cost per kg of good output is:
Question 3 of 8
An abnormal loss is valued at:
Question 4 of 8
Closing WIP of 300 units is 100% complete for materials and 60% complete for conversion. The equivalent units for conversion are:
Question 5 of 8
Under the weighted average method, the cost per equivalent unit is calculated using:
Question 6 of 8
Joint costs should be apportioned to joint products for the purpose of:
Question 7 of 8
A by-product differs from a joint product because a by-product has:
Question 8 of 8
In the FIFO method for process costing, the equivalent units calculation for opening WIP includes:
Source and Version
Syllabus: ICAEW ACA Certificate Level 2026 · Reviewed: 2026-05-04