Learning Outcomes
After reading this article, you will be able to explain the principles and application of process costing in continuous production environments. You will be able to calculate and account for normal losses, abnormal losses and abnormal gains. You will understand the distinction between joint products and by-products, apply common joint cost allocation methods, and determine appropriate accounting treatments. You should also be able to evaluate further processing decisions and apply this knowledge to ACCA exam scenarios.
ACCA Management Accounting (MA) Syllabus
For ACCA Management Accounting (MA), you are required to understand process costing and its treatment of losses, gains, and multi-output processes. Revision should focus on:
- The characteristics and operation of process costing versus job or batch costing
- Calculation and accounting for normal and abnormal process losses and abnormal gains
- The difference between joint products and by-products, including accounting approaches
- Methods for allocating joint costs between products (physical units, sales value, net realisable value)
- Treatment of by-product revenue within the process account
- Use of incremental analysis for deciding on further processing of products
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- In a process where input is 2,000 units and the expected loss is 10%, actual output is 1,850 units. Is there an abnormal loss, abnormal gain, or neither?
- Which method best allocates joint costs if products have very different sales values?
a) Physical units
b) Sales value at split-off
c) Average cost
d) Time per process - How should minor by-product revenue normally be treated in process accounts?
- True or false? In decisions on whether to further process a joint product, the original joint costs are always relevant.
Introduction
Process costing is a method used where large quantities of identical products are manufactured through a continuous process. It is common in sectors such as chemicals, food, oils, and textiles, where output is homogeneous and tracing costs to individual units is impractical. Instead, costs are assigned to each process or department for a period and averaged across the output.
A distinctive feature of process costing is the occurrence of losses and gains throughout production. Some losses are expected and inevitable (normal loss), while others are the result of unusual events or inefficiency (abnormal loss or gain). Additionally, processes may generate more than one product—either joint products of significant value or by-products of minor value. Accurate cost assignment and reporting for all of these is a fundamental skill for ACCA exam success.
Key Term: process costing
A costing method used to calculate the average unit cost of identical items produced in a continuous process, by accumulating and sharing costs over all completed and partly completed units within a process.
Process Costing Principles
Process Costing Characteristics
Process costing is designed for operations where:
- Production is repetitive and output is uniform
- Costs are collected by process or department, not by individual units
- Costs are averaged over a large number of units
Materials, labour, and overhead are recorded for each process. Completed output from one process becomes input for the next, with all costs tracked along the production flow.
Allocating Costs to Output
At each process stage:
- Summarise all input costs (materials, labour, overheads)
- Deduct any value recovered from scrap or by-product sales
- Divide total net cost by total units of output (after adjusting for losses/gains)
- The resulting figure is the cost per unit
Accounting for Process Losses and Gains
Types of Losses
In continuous processes, some input is expected to be lost. Loss types must be distinguished:
Key Term: normal loss
The expected and unavoidable reduction in units during processing, often estimated as a percentage of input. Normal loss arises under efficient operating conditions.Key Term: abnormal loss
Units lost in excess of the normal loss, usually due to inefficiency, error, or unexpected events. Abnormal losses are unexpected and not part of standard process costs.Key Term: abnormal gain
Output greater than expected after allowing for normal loss, often resulting from better-than-expected process efficiency.
Calculating Losses and Gains
Use the following approach:
- Normal loss = Input units × normal loss %
- Expected output = Input units – normal loss
- If actual output < expected output: Abnormal loss = expected output – actual output
- If actual output > expected output: Abnormal gain = actual output – expected output
Normal loss units are valued at their scrap value, if any. Costs are not assigned to them—remaining costs are spread across the actual output and any abnormal losses/gains.
Worked Example 1.1
A company introduces 1,200 units to a process. Normal loss is 5%. Actual output is 1,130 units; normal loss units can be sold for $2 each. Calculate the normal loss, abnormal loss/gain, and assign costs.
Answer:
Normal loss: 1,200 × 5% = 60 units
Expected output: 1,200 – 60 = 1,140 units
Actual output is 1,130 units, so:
Abnormal loss = 1,140 – 1,130 = 10 units
Accounting Treatment
- Normal loss: Credited at scrap value per unit
- Abnormal loss: Debited at full process unit cost, with recovered scrap value deducted; expense written off to the income statement
- Abnormal gain: Credited at process unit cost (less scrap value); recognised as an unexpected benefit
Revision Tip
Always calculate normal loss first, then compare expected and actual output to find whether there is an abnormal loss or gain.
Exam Warning
Do not assign a share of input costs to normal loss units—only deduct any scrap proceeds from total process costs.
Joint Products and By-products
Where a process yields more than one output, correct classification and costing are essential.
Key Term: joint product
Two or more main products resulting from a single process, each with significant sales value and importance to the business.Key Term: by-product
Secondary output from a process, produced incidentally and having low value relative to main products. By-products are often further processed or sold as scrap.Key Term: split-off point
The stage in production where joint products and by-products become separately identifiable and can be physically separated.
Joint Costs
- Joint costs are all process costs incurred up to the split-off point.
- These costs must be apportioned between joint products, typically for inventory valuation and performance reporting.
Common Joint Cost Allocation Methods
- Physical output method: Allocate joint costs based on physical quantity (litres, kg, units) of each product at split-off point.
- Simple, but ignores product value.
- Sales value at split-off method: Allocate based on each product's share of the total sales value at split-off.
- Reflects relative economic value.
- Net realisable value (NRV) method: Allocate joint costs in proportion to the final sales value after subtracting further processing and selling costs.
- Used when joint products need further processing before sale.
By-product Revenue
By-products rarely receive an allocated share of joint costs unless material. Normal approaches:
- Deduct net proceeds from by-product sales (sales revenue less any further processing costs) from joint process costs, reducing the cost attributed to main products
- Alternatively, treat by-product sales as 'other income' in the income statement
Worked Example 1.2
A process yields 2,500 kg of Product X and 3,500 kg of Product Y at split-off. Total joint process cost is $90,000. Product X sells for $8/kg at split-off; Product Y sells for $4/kg. Allocate joint costs using the sales value at split-off method.
Answer:
Product X: 2,500 kg × $8 = $20,000
Product Y: 3,500 kg × $4 = $14,000
Total sales value = $20,000 + $14,000 = $34,000
X's share: ($20,000 / $34,000) × $90,000 = $52,941
Y's share: ($14,000 / $34,000) × $90,000 = $37,059
Accounting for By-products
By-products are usually of minor value and do not warrant allocation of joint process costs. Instead:
- If by-products require further processing, deduct any further costs from sales to arrive at net value
- Deduct net by-product revenue from joint process costs before apportioning costs to main products, or record as 'other income'
Worked Example 1.3
A timber company makes 12,000 kg of planks and 600 kg of sawdust (a by-product) from a process. Sawdust sells for $0.20/kg after $30 further processing. Total process cost is $38,000. What cost is assigned to planks?
Answer:
By-product proceeds: 600 × $0.20 = $120
Net revenue: $120 – $30 = $90
Net process cost for planks: $38,000 – $90 = $37,910
Exam Warning (By-products)
Only allocate joint costs to by-products if specifically required by the scenario. Otherwise, offset their revenue against main process costs.
Further Processing Decisions
Deciding whether to further process joint products should consider only incremental revenues and costs. Joint costs up to split-off are already incurred and irrelevant to this decision.
Incremental Analysis Steps
- Calculate additional revenue from further processing
- Subtract further processing costs
- If incremental profit > 0, further processing is financially beneficial
Worked Example 1.4
At split-off, Product Q can be sold for $7/unit (400 units). Further processing costs $1/unit and enables selling at $9/unit. Should Q be processed further?
Answer:
Additional revenue: ($9 – $7) × 400 = $800
Additional cost: $1 × 400 = $400
Incremental profit: $800 – $400 = $400
Further processing is profitable.
Revision Tip (Further Processing)
In further processing decisions, ignore joint costs—the key is whether extra revenue exceeds extra costs.
Summary
Process costing is used for high-volume, uniform production, with costs averaged across many identical units. Losses are expected (normal) and unexpected (abnormal); only abnormal losses or gains affect profit. Processes may generate joint products, which share in joint costs, or by-products, where revenue is set against main process cost. When considering further processing, focus on incremental benefits only.
Key Point Checklist
This article has covered the following key knowledge points:
- Characteristics and operation of process costing in continuous production
- Calculation and accounting for normal and abnormal process losses and gains
- Distinction between joint products and by-products
- Main methods of joint cost allocation: physical quantity, sales value, NRV
- Typical treatments of by-product revenue in process accounts
- Use of incremental analysis for further processing decisions
Key Terms and Concepts
- process costing
- normal loss
- abnormal loss
- abnormal gain
- joint product
- by-product
- split-off point