Process Costing DefinitionActivity-based costing also known as Process Costing. Activity-based costing is a term that has significantly influenced the cost-accounting discussion and design in the recent past.  With the same content, the terms “activity-based costing” and “cost driver accounting” are used in the USA.

Basic characterization

Activity-Based Costing focuses on practice deficiencies of traditional cost accounting systems, especially deficiencies in the treatment of overhead costs.

The criticism concerns, on the one hand, the wage surcharge calculation of the full cost accounting. It is argued that in view of the rapid progress of production automation (CIM), manufacturing wages are only a poor indicator of product-related cost causation in the finished cost centers. This criticism is particularly found in the USA, where even today calculations are often based on direct labor.

Related: What is Product? Math, Definition, Variation and its types & reasons

On the other hand, the criticism relates to the treatment of upstream and downstream service sectors, such as Order disposition, production preparation, and control, storage and transport. For them, full cost accounting is dominated by very rough, flat-rate clearing methods (for example, in the form of apportionment), and they are also insufficiently penetrated in the budget costing (for example, general abandonment of analytical cost planning in such cost centers). Improved permeation of Overhead Cost Areas (CCRs) allows process costing to provide better control of these areas as well as more accurate product pricing.

Process analysis

For each overhead area (cost center, such as manufacturing control), should determine the services that the area serves to fulfill. This methodology can be based on methods of overhead cost analysis, zero-based budgeting or similar techniques. In addition, some areas have relevant experience (especially for logistics). For the example of production control, the service types can be, for example, the processes “schedule assembly orders, retrieve parts, and monitor production process assembly”.

Assignment of costs to processes

Each process has its own costs. The more cost associations exist with greater difficulties.

Determination of Cost Drivers (Cost Driver)

  • For the types of process costing:

The respective cost drivers must be determined in the next step, ie the factors that determine the utilization of the corresponding services.

  • For the example that has been started:

The number of production orders processed for the first two processes and if necessary subdivide into standard and special orders.

  • For the monitoring task

Such a cost driver is difficult. Such processes are also called “activity-neutral” in activity-based costing.

Process Costing Definition

For the cost drivers, should determine the respective quantity characteristics. This does not mean additional acquisition and/or planning effort. As in normal reference quantity calculations, costs determine per process unit of measure (for example: per production order). Within process cost accounting, there are differences of opinion as to whether or not these process costs should include the costs of process-neutral processes per process unit.

Process cost calculation

In the last step, the process costs debit to the products within the framework of cost object accounting. In terms of cost terms, the activity-based costing process converts the character of previously proposed sites into final cost centers. Production cost will charge to the products in process cost accounting if not include before. For this purpose, one must also record how many process units each product has claimed. This also involves considerable acquisitions and/or planning costs.

Related: What is Product Pricing? Definition and Calculation

Evaluation

Schmalenbach already expressed the basic idea of process cost accounting in 1899. You can find many thoughts of process cost accounting in a more precise and differentiated way at Kilger. The activity-based costing also strongly postulates the way to higher detail without the evidence of the cost-effectiveness of this approach. Activity-based costing as an element of ongoing cost accounting is often too time-consuming so it usually operates as a case by case basis in companies. On the other hand, the discussion about activity-based costing has led to a greater (and much-needed) cost-centered attention to overheads.

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