What Is procedure Costing? How To compute procedure Costs

Your artisanal baking corporation is doing great and growing rapidly, selling gourmet crackers online as quick as it can make them. But to recognize exactly how great you’re doing, you require to recognize your production costs. Doing this for each cracker, or even each box, can be tricky. After all, you’re buying and mixing ingredients in bulk, and the ovens and mixers are running continuously. So after a gossip with your accountant, you adopt a expense-tracking way categorizing costs by their stage of production. This is a technique known as procedure costing, and it can assist you accurately track your production costs.

What is procedure costing?

procedure costing is a way of tracking product costs in mass-production industries where output is continuous, the units are uniform, and it would be challenging to monitor costs for each person item. Industries like oil refining, chemical manufacturing, and food processing tend to use procedure costing. This monetary reporting way is called procedure costing because you track all direct costs for labor, raw materials, and overhead through the various stages of manufacturing. Continuing with the bakery example, you’d track all the costs of the mixing, baking, and packaging stages of cracker production.

Although many tiny businesses are retailers and distributors, not manufacturers, they can adopt a procedure-costing way by tracking costs through the stages of customer purchase and order fulfillment. Various monetary reporting software providers propose procedure-costing tools to assist you organize this procedure. procedure costing helps businesses control inventory, track earnings margins, identify inefficiencies, and set competitive prices. The data generated by procedure costing is also used to prepare financial statements.

procedure costing vs. job costing

procedure costing and job costing are two different methods for tracking production costs. procedure costing is suitable for the continual production of homogeneous products—bags of snacks, rolls of document towels, or yards of textiles, for instance. Job costing, on the other hand, tracks costs for person and distinctive products, such as custom furniture, or one-off projects such as office building construction or shipbuilding. Plumbing, electrical, and other contracting businesses also use the job costing structure, because each job is different.

How to compute procedure costing

The first step is adding up the costs of all the procedure stages at the complete of an monetary reporting period, such as a quarter or year, and then dividing the total expense by the number of units produced. This determines the per-unit expense.

Let’s declare the artisanal baking corporation has $200,000 in total production costs in a quarter and produced 50,000 boxes of crackers. With procedure costing, it calculates the expense to produce a box of crackers as follows:

$200,000 / 50,000 = $4 per box

But procedure costing also accounts for unfinished goods. To account for this in-procedure inventory, include the partial expense of the unfinished production units, based on the percentage of completion.

For example, let’s declare your cracker business has another 10,000 boxes in the pipeline, estimated to be half completed at the complete of the quarter. This means you’d include 10,000 units as 50% completed, or equivalent to 5,000 boxes of finished crackers. You then add this to the 50,000 finished boxes, calculating per-unit production expense as:

$200,000 / (50,000 + 5,000) = $3.64 per box

This calculation gives you a more accurate look at where your production costs are netting out at any point in the procedure.

Types of procedure costing

• Weighted average costs
• Standard costs
• First in, first out (FIFO)

You can use one of three methods to compute procedure costs:

Weighted average costs

The weighted average way is the simplest and most frequently used. Companies add all actual production costs for the period and divide by the number of units completed, plus the equivalent units of work in advancement based on their percentage of completion.

Standard costs

This way uses an estimated standard expense for each procedure stage instead of the actual costs used in weighted average costing. Companies typically use this way when it’s too challenging or period-consuming to collect all real-period expense information.

For example, a large soda bottler would set a standard expense for manufacturing a one-liter bottle, based on the expected amount of labor and ingredients needed. The standard expense totals are then compared to actual costs for a production period. The difference is recorded and charged to another account, usually called a variance account. You can then analyze the variance account to either discover ways to lower costs or adjust the standard costs for upcoming production periods.

First in, first out (FIFO)

First in, first out (FIFO) is the most complicated procedure costing way because it creates different costs. One expense is for units started in the previous period but not completed, and another for any production started in the current period. FIFO costing assumes the first units in—work in advancement at the beginning of the current period—are completed and shipped out first. When calculating costs for the current period, you exclude costs incurred during the previous period for partly completed equivalents.

Companies such as oil refiners tend to use FIFO when costs can fluctuate significantly from one period to the next. FIFO costing is also often used in industries selling perishables or products with expiration dates, such as food processors, grocery chains, and pharmaceutical makers.

How to do procedure costing step-by-step

1. Analyze inventory
2. compute equivalent units
3. Tally total applicable costs
4. compute per-unit expense
5. Allocate costs to finished and unfinished goods

Businesses using the procedure costing structure typically receive the following five steps to arrive at a per-unit expense:

1. Analyze inventory

Analyze the flow of products during the period. The first step is determining the amount of starting inventory—incomplete items. Then assess how many were finished and moved out, and how many remain incomplete. This reflects the ending inventory.

2. compute equivalent units

Next, convert any ending inventory that is a work in advancement to an equivalent number of finished units. Equivalent units account for the work done so far on the incomplete items and assist you accurately allocate costs.

3. Tally total applicable costs

Add up the costs of the various production stages that accumulate during the manufacturing procedure. Companies often shatter down production costs into direct material costs and conversion costs. Conversion costs include the direct labor and manufacturing overhead for each production procedure. The total is known as the expense of goods manufactured (COGM). This amount is proportionately applied, or weighted, between the inventory that is completed and the work in advancement.

4. compute per-unit expense

The per-unit calculation includes the costs for completed units and partly finished equivalents at the complete of the period. Costs for unfinished goods are usually expressed as a percentage of the total expense, reflecting processing costs incurred so far.

5. Allocate total costs to finished and unfinished goods

Finally, split up the total costs by allocating the appropriate amounts to the number of products completed, as well as to the inventory that was considered in-procedure at the complete of the period. For example:

This leaves you with a total of $200,000 in production costs. This can assist a business recognize how much money is committed to work-in-procedure inventory.