Process costing is a method of assigning a cost to the products a manufacturer produces. Process costing is one of the main types of costing for a manufacturing firm, and its main alternative is job order costing. According to North Seattle Community College, process costing is most useful when a manufacturer produces items that are very similar to one another, such as batches of chocolate or barrels of gasoline. Disadvantages of process costing apply when a company produces different products or works on dissimilar jobs.
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Process costs are easier to calculate when the manufacturer completes all products that it starts work on during an accounting period. If all products are not complete, the cost accountant must calculate equivalent units of production. Products are assigned a partial value after each step they go through in the manufacturing process, and the company adds up these partial values to estimate the total units produced during the period. For complicated items, it may be difficult to assign a partial value.
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The costs of materials and labour may change during the period in which the manufacturer creates the product. Process costing requires the cost accountant to use additional methods to calculate the expenses of manufacturing the product. According to the Peralta Colleges, two methods that assign costs to a process are First in First Out, or FIFO, and average cost. Both of these methods are estimates and are inexact.
Methods a cost accountant uses to assign process costs assume that all of the products a manufacturer produces are interchangeable. This not only requires each product to use the same materials; it also means that each department must perform the exact same work on each product. According to the College of San Mateo, units produced during an earlier period are blended with units produced during the current period when using the weighted average method to calculate process cost.
A company that uses job order costing can compete more easily when selling a product. Process costing averages many types of costs together, instead of recording the exact expenses necessary to manufacture a product. If a company produces different types of items and uses process costing, it may assign an average cost that is higher than some products actually cost to manufacture. Competitors who know what the cheaper products cost to manufacture can sell these items for less and capture additional market share.
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