Process costing is a method of tracking the value of work in process in manufacturing systems that involve a flow of materials rather than the construction of individual products. These environments are not disposed to the traditional accounting methods which place a value on work in process according the raw material content of each and the cost of the processing up to its current, unfinished state.
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Process costing applies values to a quantity of a product and then allocates the costs to units by dividing the total costs of the batch by the batch size. This situation occurs mostly in process manufacturing implementation. The process flow involves a continuous stream of materials. The terms “flow” and “stream” are particularly apt, because these types of industries deal with liquids or gases.
Water companies and sewage treatment plants are two examples of industries that use the process costing method. In the case of sewage treatment, waste water is processed through a series of filtration tanks. It is possible to place a cost for each stage in the process, but there is no specific item to allocate that cost to. Instead, the costs are worked out for the tank’s entire contents and then expressed per unit of measure. Water companies also deal with a flow rate of water and so the cost of processing a day’s water supply and applying the costs to the flow rate of water exiting through the mains.
Oil and gas
The oil and gas industry is another example where costs can only be applied to a flow rate rather than to discrete items. Thus the oil and gas industry including extraction and then refining use process costing.
Chemicals and cosmetics
The processing of liquid chemicals are also impossible to allocate to a specific item. The chemicals industry therefore has to use process costing. Cosmetics such as sunscreen and shampoo are other fluids that can only be accounted for once they are bottled. In their batch state as work in process, they can only be valued through process costing.
Although paper is ultimately packed into discrete items, like a pack or ream of writing paper or a roll of kitchen towel, in its unfinished state it is impossible to allocate costs to a specific unit. A batch of wood pulp being processed into paper has no accounting unit until it results in the finished product. Many paper products, like kitchen towel are manufactured on mass and so cannot be identified as units even once the paper is in a finished state and is being processed into a specific product.
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