Cost Flows in Process Costing

Cost Flows in Process Costing

Cost flows, or the flow of costs, refer to the way that costs move through an environment usually manufacturing. With the nature of manufacturing and all of the different inputs, such as raw materials, labor, and overhead, the flow of costs is pertinent in allocating costs. There are a number of systems that are used in defining the costs and different systems can be used to chart the cost flow.

The prices that are to be used when defining costs can be determined in a few different ways; such as First-In-First-Out (FIFO), Last-In-First-Out (LIFO), or the weighted average method. The method that is chosen can be selected for a number of reasons, but the most common is for tax purposes. There are no guidelines or regulations that dictate which system should be used, but changing from system to system can only be done if it is shown to be a financial pertinent undertaking. (Wild, Shaw, & Chiappetta, 2011)

First-In-First-Out process costing is when the first goods received are the first ones that are charged out. This way of doing things gives the goods that are being used the closest to their actual price. The LIFO process costing is when the price that you paid for the most recent goods in the price charged to the next ones to be on their way out. This practice can be very appealing if there has been a recent decrease in the cost of inventory, it gives you a larger profit margin. Then there is also the weight average method, this method combines the cost and number of units from the beginning inventory and from the current period and uses the average. This is thought to be the least sensitive to fluctuation in the market. The thought is that it will continue to go up and down and balance itself out. (Lanen, Anderson, & Maher, 2011)

The flow of cost can be broken down in two different ways. There is job-order costing and process costing. Job-Order costing is used when a company has many different products and often caters to the costumer's demands. Process costing is used when a company has one primary or a few main products that they produce. With a company that would be ideal for process costing they would have little or no use to break down cost by job, so they instead opt to break down cost by process or department. The costs are then tracked, or allocated to different parts of the process. The easiest and most definitive separation is by department. It is possible companies to use elements from both systems, but most often one of the other prevails. (Garrison, Noreen, & Brewer, 2012)

Cost flows are most frequently depicted with charts that show costs going from one department to another (as depicted in the exhibit below). With the nature of process costing

cost flows are followed from department to department. In this given example juice is used. It starts with the