ACCA F2 Management Accounting - 2010 - Study text

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Chapter 10: Process costing

no opening or closing WIP; or you might be given a question in which there is

opening or closing WIP but no losses in process.

Even so, process costing can be fairly complex, and you need to study this chapter

carefully.

1.2 Situations where process costing might be appropriate

Process costing is used when output is produced in a continuous process system,

and it is difficult to separate individual units of output. Examples of manufacturing

where process costing is used are:

 chemicals manufacture

 the manufacture of liquids

 the continuous manufacture of high volumes of low-cost food items such as tins

of peas or beans, or bottles of tomato ketchup.

In these types of production process, losses in process might occur and there are

often problems in measuring exactly the amount of unfinished work-in-process at

the end of a period.

The basic principle of costing is the same as for other types of costing. The cost of

output from a process is measured as:

Total costs of the process

Total units produced

However, in process costing there are special methods for costing loss in process

and for dealing with process costs when there is opening and closing WIP.

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Process costing: losses

 Process costing and normal loss

 Accounting for normal loss

 Process costing: accounting for normal loss when loss has a scrap value

 Introduction to abnormal loss

 Accounting for abnormal loss

 Process costing: abnormal loss and loss with a scrap value

2 Process costing: losses

2.1 Process costing and normal loss

A feature of process manufacturing is that there is often some loss or wastage in

production, and output quantities are less than input quantities of materials.

 Normal loss is the expected loss in processing. Normal loss is usually expressed

as a percentage of the input units of materials.

 Expected output = Input materials quantities – Normal loss

2.2 Accounting for normal loss

Normal loss is not given a value if it does not have a scrap value. This is logical,

because if there will always be some loss in a process, it makes no sense to give a

cost to the expected loss. It makes more sense to calculate the cost of the expected

output by making an allowance for the expected loss.

The cost per unit of output =

Total costs of the process

Expected units of output

For example, suppose that input to a process is 100 units and expected loss is 10% of

the input quantity. The process costs are $4,500. Expected output is 90 units.

 We could calculate the cost of production as $45 per unit of input, so that the

cost of output is $4,050 (= 90 units × $45) and the expected loss has a cost of $450

(= 10 units × $45). This is not appropriate, however, because the loss is expected

to happen and giving it a cost serves no useful purpose and certainly does not

provide useful management information.

 We could calculate the cost of output as $50 per unit, which is the cost of the

process divided by the expected output (= $4,500/90 units). This is the method

of costing used when there is normal loss. Output is costed in a way that

recognises the loss that should be expected to occur.

Chapter 10: Process costing

Example

The following information relates to a production process:

Input quantities of materials: 2,000 litres

Direct materials cost: $3,600

Direct labour cost: $300

Production overhead absorbed: $600

Normal loss as % of input: 10%

Actual output is 1,800 litres, and actual loss = expected loss (normal loss)

The cost per unit produced can be calculated as follows:

Direct materials 3,600

Direct labour 300

Production overheads 600

Total production cost 4,500

Expected output (90% of 2,000) 1,800 litres

Cost per litre (= production cost/expected output) $2.50

Accounting for normal loss: cost ledger

These costs could be set out in a process cost account. This is a work-in-progress

account for the process. The debit side of the account records direct materials and

direct labour costs, and production overheads absorbed. (= a work-in-progress

account for the process) as follows. The credit side of the WIP account records the

cost of the finished output.

The account also includes memorandum columns for the quantities of direct

materials input and the quantities of output and loss. Normal loss is shown so that

the quantities columns add up to the same amount on the debit or credit sides, but

the normal loss has no cost.

Process account

litres

litres $

Direct materials 2,000

3,600

Cost of sales 1,800 4,500

Direct labour -

300

(at $2.50 each)

Overhead -

600

Normal loss 200 -

2,000

4,500

2,000 4,500

2.3 Process costing: accounting for normal loss when loss has a scrap

value

In some cases, losses in a process have a scrap value. When loss has a scrap value,

the scrap value of the normal loss is deducted from the cost of the process. A cost

per unit of output is calculated as:

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Total costs of the process minus the scrap value of normal loss

Expected units of output

Example: scrap value of normal loss

The following information relates to a production process:

Input quantities of materials: 2,000 litres

Direct materials cost: $3,600

Direct labour cost: $300

Production overhead absorbed: $600

Normal loss as % of input: 10%

Actual output is 1,800 units, and actual loss = expected loss (normal loss)

Loss has a scrap value of $0.90 per litre.

The cost per unit produced can be calculated as follows:

Direct materials 3,600

Direct labour 300

Production overheads 600

4,500

Less: scrap value of normal loss (200 x $0.90) 180

4,320

Expected output (90% of 2,000) 1,800 litres

Cost per litre $2.40

These costs could be set out in a process cost account as follows.

Process account

litres

litres $

Direct materials 2,000

3,600

Cost of sales 1,800 4,320

Direct labour -

300

(at $2.40 each)

Overhead -

600

Normal loss (at

$0.90): scrap account

200 180

2,000

4,500

2,000 4,500

This is exactly the same as the previous process account showing normal loss, with

the exception that the scrap value of the normal loss is shown as a value for the

normal loss in the credit side of the account.

2.4 Introduction to abnormal loss

Normal loss is the expected amount of loss in a process. Actual loss might be more

than the expected or normal loss. When actual loss exceeds normal loss, there is

Chapter 10: Process costing

abnormal loss. The difference between total actual loss and normal loss is abnormal

loss.

Abnormal loss = Actual loss – Expected (normal) loss, when actual loss is higher

than expected loss.

Alternatively:

Total loss = Normal loss + Abnormal loss.

Abnormal loss is not expected and should not happen. It therefore makes sense to

give it a cost. By giving a cost to abnormal loss, management information about the

loss can be provided, and management can be made aware of the extent of any

problem that might exist with excessive losses in process.

2.5 Accounting for abnormal loss

Units of abnormal loss are given a cost. If it is assumed that all losses in process

occur at the end of the process, units of abnormal loss are costed in exactly the same

way in the as units of finished output.

The cost of actual output units and the cost of abnormal loss units = the cost of an

expected unit of output. The cost per unit of abnormal loss is therefore:

Total costs of the process

Expected units of output

The cost of units of abnormal loss is treated as an expense for the period, and

charged as an expense in the income statement for the period.

Example: abnormal loss

The following information relates to a production process:

Input quantities of materials: 2,000 litres

Direct materials cost: $3,600

Direct labour cost: $300

Production overhead absorbed: $600

Normal loss as % of input: 10%

Actual output is 1,700 units.

Actual loss is 300 units in total (= 2,000 – 1,700). Normal loss = 200 litres (= 10% of

2,000); therefore abnormal loss = 100 litres.

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The cost per unit produced can be calculated as follows:

Direct materials 3,600

Direct labour 300

Production overheads 600

4,500

Expected output (90% of 2,000 = actual output + abnormal loss) 1,800 litres

Cost per litre $2.50

Cost of finished output = 1,700 units

× $2.50 = $4,250.

Cost of abnormal loss = 100 units

× $2.50 = $250.

Accounting for abnormal loss: ledger entries

These costs could be set out in a process cost account as follows.

Process account

litres

litres $

Direct materials 2,000

3,600

Cost of sales (at $2.50) 1,700 4,250

Direct labour -

300

Normal loss 200 0

Overhead -

600

Abnormal loss (at $2.50) 100 250

2,000

4,500

2,000 4,500

Notice that abnormal loss is included in the credit side of the account, in the same

way that normal loss is shown on the credit side. However whereas normal loss has

no value/cost, abnormal loss has a cost. The appropriate double entry in the cost

ledger is:

Debit: Abnormal loss account

Credit: Work-in-process account

Abnormal loss account

litres

WIP account 100

250

At the end of the financial period, the balance on the abnormal loss account is

written off as a cost in the costin gincome statement.

2.5 Process costing: abnormal loss and loss with a scrap value

When loss has a scrap value, the scrap value of normal loss is deducted from the

process cost, as explained earlier.

Any abnormal loss will also have a scrap value. However, the scrap value of

abnormal loss is treated differently from the scrap value of normal loss.

 The cost of expected units of output is calculated in the usual way.

Chapter 10: Process costing

 In the WIP account the cost of abnormal loss = units of abnormal loss × cost per

expected unit of output.

 The scrap value of abnormal loss is set off against the cost of abnormal loss in

the abnormal loss account, not the process account (WIP).

- Debit: Cash (= scrap value: money from sale of the scrapped units)

- Credit: Abnormal loss account (abnormal loss units

× scrap value per unit)

 The net cost of abnormal loss (= cost of abnormal loss minus its scrap value) is

then transferred as a cost to the cost accounting income statement at the end of

the accounting period.

Example: abnormal loss when loss has a scrap value

The following information relates to a production process:

Input quantities of materials: 2,000 litres

Direct materials cost: $3,600

Direct labour cost: $300

Production overhead absorbed: $600

Normal loss as % of input: 10%

Loss has a scrap value of $0.90 per litre.

Actual output is 1,700 litres. and actual loss is 300 litres. Normal loss = 200 litres;

therefore abnormal loss = 100 litres.

Actual loss is 300 units. Normal loss is 200 units; therefore abnormal loss is 100

units.

Direct materials 3,600

Direct labour 300

Production overheads 600

4,500

Scrap value of normal loss (200 × $0.90)

180

4,320

Expected output (1,700 litres + 100 litres) 1,800 litres

Cost per litre $2.40

These costs would be set out in a process cost account as follows:

Process account

litres $

Direct

materials

2,000 3,600

Cost of sales (at $2.40) 1,700 4,080

Direct labour - 300

Normal loss (at $0.90) 200 180

Overhead - 600

Abnormal loss (at $2.40) 100 240

2,000 4,500

Paper F2: Management Accounting

Abnormal loss account

litres

litres $

WIP 100

240

Scrap (at $0.90) 100 90

At the end of the financial period, the balance on this account should be written off

in the costing income statement as a cost for the period.

Scrap account

litres

litres $

WIP: normal loss 200

180

Bank (or financial

ledger control

account)

300 270

Abnormal loss 100

270

Chapter 10: Process costing

Process costing: abnormal gain

 Definition of abnormal gain

 Accounting for abnormal gain: no scrap value for loss

 Accounting for abnormal gain: where loss has a scrap value

3 Process costing: abnormal gain

3.1 Definition of abnormal gain

Abnormal loss occurs when actual loss is more than the expected (normal) loss.

Abnormal gain occurs when the actual loss is less than normal loss. Abnormal gain

is the difference between the normal loss (expected loss) and the actual loss.

Abnormal gain = Expected (normal) loss – Actual loss, when actual loss is less than

expected loss.

Alternatively:

Actual loss = Normal loss – Abnormal gain

3.2 Accounting for abnormal gain: no scrap value for loss

The method of costing for abnormal gain is the same in principle as for abnormal

loss. If it is assumed that all losses occur at the end of the process, the cost per unit

of finished output and the value/cost of abnormal gain are calculated as the cost per

expected unit of output.

When loss has no scrap value, the cost/value per unit of abnormal loss is therefore:

Total costs of the process

Expected units of output

The differences between costing for abnormal loss and costing for abnormal gain are

that:

 Abnormal gain is a benefit rather than a cost: whereas abnormal loss is written

off as a cost at the end of the financial period, abnormal gain is an adjustment

that increases the profit for the period.

 Abnormal gain is recorded as a debit entry in the process account, because it is a

benefit.

 The other half of the double entry is recorded in an abnormal gain account. At

the end of the period, the balance on the abnormal gain account is then

transferred to the income statement as a benefit for the period, adding to profit.

Paper F2: Management Accounting

Example: abnormal gain

The following information relates to a production process:

Input quantities of materials: 2,000 litres

Direct materials cost: $3,600

Conversion costs (= direct labour + production overheads): $900

Normal loss as % of input: 10%

Actual output is 1,850 litres, and actual loss is 150 litres.

Normal loss = 200 litres (= 10% of 2,000) and actual loss is 150 units. There is

abnormal gain of 50 litres.

The cost per unit produced can be calculated as follows:

Direct materials 3,600

Conversion costs 900

4,500

Expected output 1,800 litres

Cost per litre $2.50

Cost of actual finished output = 1,850 units

× $2.50 = $4,625

Value of abnormal gain = 50 units

× $2.50 = $125.

Accounting for abnormal gain: ledger entries

These costs could be set out in a process cost account as follows:

Process account

litres

litres $

Direct

materials

2,000

3,600

Cost of sales (at

$2.50)

1,850 4,625

Conversion

costs

900

Normal loss 200 0

Abnormal gain

(at $2.50)

125

2,050

4,625

2,050 4,625

Notice that the abnormal gain is shown on the debit side of the account, and the

total number of units in the memorandum column for quantities (2,050) is larger

than the actual quantity of units input to the process (2,000).

Abnormal gain account

litres

litres $

WIP 50 125

ACCA F2 Management Accounting - 2010 - Study text - Emile Woolf Publishing

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