Process Costing – Normal and Abnormal Losses, Equivalent Production, Inter-process Profit | CMA Inter Syllabus

Table of Content

1. Preparation of Process Account
2. Important Aspects of Process Account
3. Inter Process Profits
4. Exercise

CMA Inter Blogs :

1. Material Costs
2. Operating Costing
3. Dividend Decisions and Dividend Theories
4. CMA Inter Syllabus (New Updates)

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Process costing is applied when output consists of a continuous stream of identical units. It is a costing method used where it is not possible to identify separate units of production, or jobs, usually because of the continuous nature of the production processes involved.

Process costing is used where there is a continuous flow of identical units and it is common to identify it with continuous production such as the following:

• Oil refining
• The manufacture of soap
• Paint manufacture
• Food and drink manufacture

The features of process costing which make it different from other methods of costing such as job or batch costing are as follows:

• The continuous nature of production in many processes means that there will usually be closing work in progress which must be valued. In process costing it is not possible to build up cost records of the cost of each individual unit of output because production in progress is an indistinguishable homogeneous mass.
• There is often a loss in process due to spoilage, wastage, evaporation and so on.
• The output of one process becomes the input to the next until the finished product is made in the final process.
• Output from production may be a single product, but there may also be a by-product (or by-products) and/ or joint products (Later discussed in detail.)

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1. Preparation of Process Account

A process account has two sides, and on each side there are two columns – one for quantities (of raw materials, work in progress and finished goods) and one for costs.

1. On the left-hand side of the process account i.e. Debit side, we record the inputs to the process and the cost of these inputs. So, we might show the quantity of material input to a process during the period and its cost, the cost of labour and the cost of overheads. 
2. On the right-hand side of the process account i.e. Credit side, we record what happens to the inputs by the end of the period.

1. 1. Some of the input might be converted into finished goods, so we show the units of finished goods and the cost of these units.
   2. Some of the material input might evaporate or get spilled or damaged, so there would be losses. So, we record the loss units and the cost of the loss.
   3. At the end of a period, some units of input might be in the process of being turned into finished units so would be work in progress (WIP). We record the units of WIP and the cost of these units

The objective of process costing is to work out the cost of each process, transfer the same to the subsequent process and finally ascertain the total cost of production. Therefore, it is necessary to charge various costs to each process. For this, the factory is divided into distinct processes or operations and an account is kept of each process to which all the costs are debited. The following are the various elements of cost, which are shown in the process accounts.

Materials: Raw materials required for each process is drawn from stores against material requisitions. Proper procedure like preparing and authorizing the requisition, pricing of the issues, return of materials to the stores, transfer of material from one process to another should be followed while issuing the materials. Cost of materials consumed should be computed as per the method employed for pricing of the issues and the cost should be debited to the process account.

Labour: Wages paid to workers and supervisory staff should be charged to the particular process if they can be identified with it. If workers work on two or more processes, proper allocation should be made according to some basis like time spent on each process.

Direct Expenses: If expenses are identifiable with a particular process, they should be charged to that process. For example, cost of electricity, depreciation may be charged directly to a process if they are identifiable with it.

Overheads: By nature, overheads are indirect expenses and hence cannot be identified with a particular process. These expenses can be apportioned on some suitable basis and charged to the process.

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2. Important Aspects of Process Account

While preparing process cost accounts, some important aspects are to be taken into consideration. These aspects are given below:

• Losses: During a production process, a loss may occur. If a certain level of loss is expected, this is known as normal loss. If losses are greater than expected, the extra loss is abnormal loss. If losses are less than expected, the difference is known as abnormal gain.
• Normal Process Loss: It is the loss which is unavoidable on account of inherent nature of production process. Such loss can be estimated in advance on the basis of past experience or available data. The normal process loss is recorded only in terms of quantity and the cost per unit of usable production is increased accordingly. Where scrap possesses some value as a waste product or as raw material for an earlier process, the value thereof is credited to the process account. This reduces the cost of normal output; process loss is shared by usable units.
• Abnormal Process Loss: Any loss caused by unexpected or abnormal conditions such as plants breakdown, sub-standard materials, carelessness, accident etc., or loss in excess of the margin anticipated for normal process loss should be regarded as abnormal process loss. Abnormal Loss Account is credited with realizable scrap value, if any. The balance is written off to Costing Profit and Loss Account.

 The units of abnormal loss or gain are calculated as under: 

Abnormal loss (or gain) = Total Loss – Normal Loss

The valuation of abnormal loss should be done with the help of the formula below: 

 Value of Abnormal Loss =Total Cost incurred in the process - Scrap value of Normal loss units / Input units - Normal loss units 

• Abnormal Gain: Normal loss is an estimate which is based on expectation in process industries in normal condition but slight differences are bound to occur between the actual and the anticipated losses of a process. These differences will not always represent increased loss, on occasions the actual loss will be less than that expected. Thus, when actual loss in a process is less than the expected, it results in an abnormal gain. The value of the gain will be calculated in similar manner to an abnormal loss. The Abnormal Gain Account is to be debited for the loss of income on account of less quantity of sale of scrap available as a result of Abnormal gain and Normal Process Loss Account credited accordingly. The balance is transferred to Costing Profit and Loss Account as abnormal gain.

The valuation of abnormal gain should be done with the help of the formula below: 

Value of Abnormal Gain =Total Cost incurred in the process - Scrap value of Normal loss units / Input units - Normal loss units 

Example: Abnormal Losses and Gains

Suppose the input to a process is 1,000 units at a cost of ₹4,500. Normal loss is 10% and there is no opening or closing inventories. Determine the accounting entries for the cost of output and the cost of the loss if actual output was

1. 860 units (so that actual loss is 140 units)
2. 920 units (so that actual loss is 80 units)

Solution :

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3. Inter Process Profits

The output of one process is transferred to the subsequent process at cost price. However sometimes, the transfer is made at cost plus certain percentage of profit. This is done when each process is treated as a profit center. In such case, the difference between the debit and credit side of the process account represents profit or loss and is transferred to the Profit and Loss Account. The stocks at the end and at the beginning contain an element of unrealized profits, which have to be written back in this method. If the profit element contained in the closing inventory is more than the profit element in the opening inventory, profit will be overstated and vice versa. Profit is realized only on the goods sold, thus to obtain the actual profit the main task would be to calculate the profit element contained in the inventories. In order to compute the profit element, in closing inventory and to obtain the net realized profit for a period, three columns have to be shown in the ledger for showing the cost, unrealized profit and the transfer price.

Illustration 24

In a manufacturing unit, raw material passes through four processes, I, II, III, and IV and the output of each process is the input for the subsequent process. The losses in the four processes are 5%, 20%, 20% and 16 2/3 % respectively. If the product at the end of the IV process is 40,000 kg, what is the quantity of raw material required at the beginning of Process I and the cost of the same is at ₹5 per kg?

Solution: 

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Equivalent Production: 

This represents the production of a process in terms of completed units. In other words, it means converting the incomplete production units into its equivalent of complete units. In each process an estimate is made of the percentage completion of any work-in-progress. A production schedule and a cost schedule will then be prepared. The work-in-progress is inspected and an estimate is made of the degree of completion, usually on a percentage basis. It is most important that this estimate is as accurate as possible because a mistake at this stage would affects the stock valuation used in the preparation of final accounts.

The formula for equivalent production is:

Equivalent Production = Actual no. of units in process of manufacture × Percentage of work completed

For example, if 20% work has been done on the average of 1,000 units still in process, then 1,000 such units will be equal to 200 completed units. The cost of work-in-progress will be equal to 200 completed units.

Calculation of Equivalent Production

The following steps are adopted to calculate statement of equivalent production:

1. State the opening work-in-progress in equivalent completed units by applying the percentage of work needed to complete the unfinished work of the previous period. If the opening work-in-progress is 100 units is which 40% is completed, then the equivalent units of the current period will be 100 x 60% i.e., 60 units.
2. Add to (i), the number of units introduced and completed during the period. This can be found out by deducting the units in the closing work-in-progress from the number of units put into the process.
3. Add to the above, the equivalent completed units of closing work-in-progress. This can be found out by applying the percentage of work done on the finished units at the end of the period.

Illustration 25 : 

From the following particulars, prepare the following in the books of X Ltd.

1. Statement of equivalent production
2. Statement of apportionment of cost
3. Process Account

1. 1. Opening stock as on 1st August: 200 units @ ₹4 per unit
   2. Degree of completion: Materials 100%, Labour and Overheads: 40%
   3. Units introduced during August: 1,050 units & Output transferred to the next process: 1,100 units
   4. Closing stock: 150 units
   5. Degree of completion: Materials 100%, Labour and Overheads: 70%
   6. Other relevant information regarding the process,

1. 1. 1. Materials: ₹3,150
      2. Labour: ₹4,500
      3. Overheads: ₹2,250

Solution: 

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Transfer to next process is calculated as shown under

• Cost incurred on opening stock already: ₹ 800
• Cost incurred to complete the opening work in progress [stock]: ₹ 720
• Cost of completion of units introduced in this process: ₹8,100. Total ₹ 9,620 (800 + 720 + 8100)

There are mainly three methods of calculating cost per unit, out of which FIFO method and Weighted Average Methods are frequently used in equivalent production.

First In First Out (FIFO)

In this method, the assumption is that the incomplete units from the opening stock are completed first and then the units introduced in the process are completed. The costs added in each process during the current period is prorated to the production necessary to complete the opening work-in-progress, to complete the units added in the process and units in the work-in-progress. The objective of the first in first out method is to value the inventory at the current costs and as such the main problem is to calculate the equivalent production under this method.

Average Method

Process costs are sometimes computed on the basis of average costs. Where degree of completion of opening work-in-progress is not given, average method is used. The average process cost is obtained by adding the cost of opening work-in-progress and the cost of units introduced in the process during the current period and dividing this total cost by total equivalent units obtained by adding the number of units completed and equivalent units of the closing work-in-progress of each element, material, labour and overheads. The main objective of average method is 
to even out the fluctuations in prices and hence is used when the prices fluctuate widely during a particular period.

Weighted Average Method

In a manufacturing unit where two or more products are manufactured and the products are quite dissimilar to each other, weighted average method is used. Under this method, weighted average is computed and used in valuation of the incomplete units.

Illustration 26

The following particulars for process II are given:

Particulars	UNITS	Amount (₹)
Transfer to process II at cost	4,000	9,000
Direct wages		2,000
Direct material		3,000
Transfer to Finished stock	3,240

Factory overheads in process are absorbed at a rate of 400% of direct material. Allowance for Normal loss is 20% of Units worked. Scrap value is ₹ 5 per unit.

Evaluate the cost of transfer to finished stock. Using the information supplied above, show the amount of gain or loss in the process to be taken to Cost Profit and Loss A/c.

Solution: 

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Illustration 27

Product X is obtained after it passes through three distinct processes. You are required to prepare Process Account from the following information:

		Processes
	Total	I	II	III
	Amount (₹)	Amount (₹)	Amount (₹)	Amount (₹)
Material	15,084	5,200	3,960	5,924
Direct Wages	18,000	4,000	6,000	8,000
Production Overheads	18,000	-	-	-

1,000 units @ ₹ 6 per unit was introduced in Process I. Production overheads to be distributed at 100% on direct wages.

Actual Output	Units	Normal Loss	Value of Scrap (₹ per unit)
Process I	950	5%	4
Process II	840	10%	8
Process III	750	15%	10

Prepare Process Account for I, II and III, Normal Loss Account, Abnormal Loss Account and Abnormal Gain Account .

Solution: 

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Illustration 28

A product passes through three Processes – A, B and C. 10,000 units at a cost of ₹ 1.10 were issued to Process A. The other direct expenses were as follows:

	Process – A Amount (₹)	Process – B Amount (₹)	Process – C Amount (₹)
Sundry materials	1,500	1,500	1,500
Direct Labour	4,500	8,000	6,500
Direct Expenses	1,000	1,000	1,503

The wastage of Process A was sold at ₹ 0.25 per unit and that of Process B at ₹ 0.50 per unit and that of Process C at ₹ 1.00.

The overhead charges were 160% of direct labour. The final product was sold at ₹ 10 per unit fetching a profit of 20% on sales. Find out the percentage of wastage in Process C.

Solution: 

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Illustration 29

	Degree of completion
Opening stock	1,600 units	Material 70%
		Labour 60%
		Overhead 60%
Transfer from Process I	10,200 units
Transfer to next process	9,200 units
Units scrapped	800 units
Normal Loss 10% of Input	1,800 units	Material 60%
Closing stock		Labour 40%
		Overhead 40%

Prepare a Statement of Equivalent Production.

Solution: 

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Illustration 30

From the following information compute (i) Equivalent Production (ii) Statement of apportionment of cost, (iii) Prepare Process Account.

	Stage of completion
Work in progress (opening)
200 units @ ₹ 4 per unit	100% Material
	40% Labour and Overheads
Units introduced 1,050
Transfer to next process 1,100 units
Closing stock 150 units	100% Material
	70% Labour and Overheads

 

Other information	Amount (₹)
Material Cost	1,050
Labour	2,250
Production Overhead	1,125
	4,425

Solution: 

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Illustration 31

From the following information prepare Process Account.

Opening Stock		Degree of Completion
800 units @ ₹ 6 per unit	₹ 4,800	Material I – 100%
		Material II – 60%
		Labour and Overheads – 40%
Transfer from Process – I
12,000 units costing	₹ 16,350
Transfer to next Process	9,700 units
Normal Process Loss	10%
Closing stock	1,800 units

Degree of completion: For units scrapped: Material - 100%, Labour and Overheads – 50%.

For closing stock: Material I – 100%, Material II - 60%, Labour and Overheads – 50%

Scrap realized ₹ 1.00 per unit.

Other information: Material ₹ 10,500, Labour ₹ 20,760, Overheads ₹ 16,670.

Solution: 

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Illustration 32

SM Ltd., furnished you the following information relating to Process B for the month of October, 2021.

1. Opening work in progress – Nil
2. Units introduced – 10,000 units @ ₹ 3 per unit
3. Expenses debited to the process: Direct Materials - ₹ 14,650; Labour - ₹ 21,148; Overheads - ₹ 42,000
4. Finished output – 9,500 units
5. Closing work in progress – 350 units; Degree of completion: Material – 100%, Labour and Overheads – 50%
6. Normal Loss in process – One percent of input
7. Degree of completion of Abnormal Loss: Material – 100%, Labour and Overhead – 80%
8. Units scrapped as normal loss were sold at ₹ 1 per unit
9. All the units of abnormal loss were sold at ₹ 2.50 per unit

Prepare:

1. Statement of Equivalent Production
2. Statement of Cost
3. Process B Account
4. Abnormal Loss Account

Solution: 

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Illustration 33

AB Ltd is engaged in process Engineering Industry. During the month of April, 2022, 2,000 units were introduced in Process X. The normal loss was estimated at 5% of input. At the end of the month 1,400 units had been produced and transferred to Process Y. 460 incomplete units and 140 units after passing through fully the entire process, had to be scrapped. The incomplete units had reached the following stage of completion.

Material	75% completed
Labour	50% completed
Overheads	50% completed

Following are the further information on the Process X

	Amount (₹)
Cost of the 2,000 units	58,000
Additional Direct Material	14,400
Direct Labour	33,400
Overheads	16,700

Units scrapped realized ₹ 10 each. Prepare Statement of Equivalent Production, Statement of Cost, Statement of Evaluation and the Process X Account.

Solution: 

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Illustration 34

The product of a manufacturing unit passes through two distinct processes. From the past experience the incidence of wastage is ascertained as under:

Process A 2%

Process B 10%

In each case the percentage of wastage is computed on the number of units entering the process concerned. The sales realisation of wastage in Process A and Process B are ₹ 25 per 100 units and ₹ 50 per 100 units respectively.

The following information is obtained for the month of April, 2022; 40,000 units of crude material were introduced in Process A at a cost of ₹ 16,000.

Particulars	Process A	Process B
	Amount (₹)	Amount (₹)
Other Materials	16,000	5,000
Direct Labour	9,000	8,000
Direct Expenses	8,200	1,500
	Units	Units
Output	39,000	36,500
Finished Product Stock:
April 1	6,000	5,000
April 30	5,000	8,000
Value of stock per unit on April 1st	₹ 1.20	₹ 1.60

Stocks are valued and transferred to subsequent process at weighted average costs. Prepare respective Process Accounts and Stock Accounts.

Solution: 

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Illustration 35

The following information is obtained in respect of Process III of the month of August:

Opening Stock	1,000 units
Value	Direct Material I - ₹ 390; Direct Material II - ₹ 75;
	Direct Labour - ₹ 112; Production Overhead - ₹ 118
Process II transfer	6,000 units at ₹ 2,360
Process IV transfer	4,700 units
Direct Material added in process	₹ 520
Direct Labour employed	₹ 1,036
Production Overheads	₹ 1,541
Units scrapped	300 units
Degree of completion	Direct Material - 100%
	Direct Labour – 80%
	Production Overhead – 60%
Closing Stock	2,000 units
Degree of completion	Direct Material – I 100%
	Direct Material - II 60%
	Direct Labour - 50%
	Production Overhead - 40%

Normal Loss: 5% of Production; units scrap realized ₹ 0.20 each

Prepare Process Account on Weighted Average Method.

Solution: 

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4 Exercise

1. The type of process loss that should not be allowed to affect the cost of good units is:

1. Abnormal loss
2. Normal loss
3. Seasonal loss
4. Standard loss

Answer : a

The type of process loss that should not affect the cost of inventory value is abnormal loss. Generally, an abnormal loss occurs because of negligence, carelessness, theft, mischief, fraud of employees, or inefficiency.

2. Spoilage that occurs under inefficient operating conditions and is ordinarily controllable is called:

1. Normal spoilage
2. Abnormal spoilage
3. Normal defectives
4. None of the above

Answer : b

Abnormal spoilage refers to spoilage that occurs under inefficient or abnormal operating conditions, which are typically controllable with better management and maintenance practices. It is not part of the expected or normal production process and is considered avoidable through proper control measures.

3. In which of the following situations an abnormal gain in a process occurs:

1. When normal loss is equal to actual loss
2. When the actual output is greater than the planned output
3. When actual loss is more than the expected
4. When actual loss is less than the expected loss

Answer : d

An abnormal gain in a process occurs when the actual loss is less than the expected loss. This means that the process or operation has performed better than anticipated, resulting in a positive outcome. An abnormal gain can occur in various contexts, such as manufacturing, project management, or financial analysis, and it is typically seen as a favorable deviation from the expected or budgeted performance. It indicates that resources were used more efficiently or that the process was more effective than initially planned.

4. The value of abnormal loss is equal to:

1. Total cost of materials
2. Total process cost less realizable value of normal loss
3. Total process cost less cost of scrap
4. Total process cost less realizable value of normal loss less value of transferred out goods

Answer : d

Abnormal loss refers to the loss of materials beyond the normal expected level. The value of abnormal loss is calculated by subtracting the realizable value of the normal loss (which can often be sold as scrap) and the value of transferred out goods from the total process cost. This calculation takes into account the costs incurred, the expected losses, and the actual output to determine the value of abnormal loss.

5. A process account is debited by abnormal gain, the value is determined as:

1. Equal to the value of normal loss
2. Cost of good units less realizable value of normal loss
3. Cost of good units less realizable value of actual loss
4. Equal to the value of good units less closing stock

Answer : b

When an abnormal gain occurs in a process, it means that more units have been produced or received than expected due to factors like lower scrap or defect rates. In this case, the process account is debited by the value of abnormal gain. The value of the abnormal gain is calculated by subtracting the realizable value of normal loss from the cost of good units. This helps in determining the value of the unexpected gain that occurred beyond the normal loss that was anticipated in the process.