Process costing

Process costing is used where identical units flow continuously through one or more production stages. Instead of costing each job, you total the cost of each process for the period and divide it by the expected output, adjusting for normal losses and for part finished units by converting them into equivalent whole units. Losses above the normal level are valued at full cost and written off, so they do not inflate the cost of good output.

When is process costing the right method?

ACCA’s article on process costing describes it as a method used mainly in manufacturing where units are continuously mass produced through one or more processes, giving erasers, chemicals and processed food as examples. The process is costed, not the individual unit or order. That is the key contrast with job costing, where each job is unique and collects its own costs.

Typical users include food and drink producers, paint and chemical makers, brewers, paper mills, bottling plants and plastics moulders. Many businesses use a mix: process costing for the standard product line and job costing for one off orders.

How is the cost per unit worked out?

The basic formula is the cost of inputs to the process divided by the expected output in units. Inputs are materials, direct labour and production overheads, usually charged using overhead absorption rates. Where there are several processes, the output of one is transferred at cost into the next, so the cost of the final product builds up stage by stage.

The complications come from two sources: inputs that do not all emerge as good output (losses), and units still in progress at the period end (work in progress). Each needs its own adjustment.

How do normal losses, abnormal losses and abnormal gains work?

Normal loss

The expected wastage under usual operating conditions, for example through evaporation, testing or rejects. It is part of the cost of making good units, so it carries no cost of its own. If it can be sold as scrap, the scrap proceeds reduce the process cost.

Abnormal loss

Loss above the normal level, for example from faulty machinery or operator error. It is valued at the same cost per unit as good output and taken out of the process account to a separate abnormal loss account, then charged to profit and loss.

Abnormal gain

Arises when actual loss is lower than the normal loss, perhaps because new machinery is more efficient. It is valued at the full cost per unit and credited, less the scrap income that was expected on those units but not received.

ACCA’s chocolate bar example shows the mechanics. Process 1 costs $11,000 for 4,000kg of input, and staff are allowed to eat 5%, so normal loss is 200kg and expected output is 3,800kg. The cost per kg is $11,000 divided by 3,800kg, about $2.89. When a heatwave means 3,810kg are transferred instead, the extra 10kg is an abnormal gain worth about $29, credited to an abnormal gain account rather than reducing the cost of every kg.

What does a process account look like with scrap and an abnormal loss?

Illustration only. A process takes in 10,000 litres. Materials cost £50,000 and conversion costs (labour and overheads) are £26,250. Normal loss is 5% (500 litres), and waste sells for £0.50 a litre. Actual good output is 9,300 litres.

1. Normal loss scrap value: 500 litres at £0.50 = £250.
2. Expected output: 10,000 less 500 = 9,500 litres.
3. Cost per litre: (£76,250 less £250) divided by 9,500 = £8.00.
4. Abnormal loss: 9,500 expected less 9,300 actual = 200 litres, valued at £8.00 = £1,600.
5. Good output transferred: 9,300 litres at £8.00 = £74,400.

Process account	Litres	£
Debit: materials and conversion	10,000	76,250
Credit: normal loss (scrap)	500	250
Credit: good output to finished goods	9,300	74,400
Credit: abnormal loss	200	1,600

The abnormal loss account then receives £100 of scrap income for the extra 200 litres, so the net charge to profit and loss is £1,500. The good output carries only the cost of normal production, and the £1,500 shows management exactly what the inefficiency cost.

What are equivalent units?

At the end of a period some units are part finished. Equivalent units convert them into the number of whole units that the work done represents. ACCA’s example: 1,000 cars that are 40% complete equal 400 equivalent cars. If those cars are 60% complete for painting but 40% complete for testing, separate equivalent unit figures are needed for each type of cost.

In most processes materials go in at the start, so closing work in progress is 100% complete for materials but only partly complete for labour and overheads. The method is to prepare a statement of equivalent units for each cost element, calculate a cost per equivalent unit for each, and then value completed output and closing work in progress using those rates.

Should opening work in progress be valued on FIFO or weighted average?

Under the weighted average method, opening work in progress is merged with the period’s new input and everything is costed at one average rate. Under first in, first out (FIFO), opening units are completed first, so the period’s costs are spread only over the work actually done this period. In ACCA’s worked example, the same process gives a cost of $4.50 per kg under weighted average and $4.375 under FIFO, and slightly different closing work in progress values ($1,410 and $1,398), although total costs of $15,360 are fully accounted for either way.

For the statutory accounts, FRS 102 paragraph 13.18 allows the FIFO or weighted average cost formula and does not permit LIFO, and the same formula must be used for inventories of a similar nature and use. See inventory cost formulas for the wider rules.

How do process costs feed into stock values in the accounts?

The management figures need adjusting in a few places before they become a year end stock valuation:

• Abnormal waste is excluded. FRS 102 paragraph 13.13(a) requires abnormal amounts of wasted materials, labour or other production costs to be expensed, which matches the abnormal loss treatment above.
• Fixed overheads use normal capacity. Paragraph 13.9 says fixed production overheads are allocated on the basis of normal capacity, and the amount per unit is not increased because of low production or idle plant. A slow month should not push up the stock value.
• Joint products and by products. Paragraph 13.10 requires joint costs that cannot be separately identified to be allocated on a rational and consistent basis, for example relative sales value at the split off point or at completion. Immaterial by products are measured at selling price less costs to complete and sell, and that amount is deducted from the cost of the main product.

For tax, HMRC’s Business Income Manual (BIM33115) says a stock valuation in accounts prepared under generally accepted accounting practice should be accepted, provided it reflects GAAP correctly, pays sufficient regard to the facts and does not breach the taxing statutes. A process costing system that follows these rules gives a valuation that is defensible in an HMRC enquiry.

What mistakes are common in process costing?

• dividing costs by actual output instead of expected output, which loads abnormal losses onto good units;
• forgetting to deduct scrap value of the normal loss before calculating cost per unit;
• crediting the full scrap value of normal loss when there is an abnormal gain, instead of adjusting it through the abnormal gain account;
• using a single equivalent unit figure when materials and conversion are at different stages of completion;
• setting the normal loss rate once and never reviewing it, so genuine waste problems are hidden inside the standard.

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Related Accountapedia entries

• Absorption vs marginal costing
• Standard costing
• Budget variance analysis
• What goes in cost of sales
• Relevant costs for decisions
• Simplified customs declarations and EIDR

Sources

• ACCA: Sa june11
• ACCA: Process costing
• Financial Reporting Council: FRS 102 September 2024 tmKYWO6
• GOV.UK: Manual page BIM33115
• ACCA: MA.FMA%20S25 A26%20syllabus%20and%20study%20guide%20 %20final

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 19 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.