Describes a Cost Accounting System designed to determine the cost of products/services that follow a fixed/constant path to be produced.

It is the cost system appropriate for mass produced, batch type production, where the concern is not to obtain the exact cost of unique product (i.e. Job Order) but an average cost.   Say the standard cost for a Hershey Bar is 10 cents, then the average production cost a day's production of 1,000,000 bars should be 10 cents.  If 11 cents, then the cause has to be found and corrective action taken, so the next day the average cost will be 10 cents.

The production engineers use the process cost system to find the reason.  It defines the cost at each step of the process employed to produce the bar which enables tracking what part of the production process caused the one cent cost overrun.

Basically, the cost starts with the raw material which is worked on during the manufacturing process in individual departments following a sequencing process.  Each department adds its cost so that at the end, you have the total cost which you divide by the number of units produced to give you the average cost. 

Our interest is to be able to understand the cost reports prepared.  Managers analyze this information and take corrective action should it be required. 

A major difficulty is to determine what was produced and what these cost (i.e. finished items) because at the end of the day you have both finished items and work in process still to be finished.  So the next day, you spent resources to finish the items that were partially completed (i.e. lower cost) and others that were started from the beginning.

The way this is handled is via the use of "Equivalent Units".

Calculating Equivalent Units and Product Cost - A Simple Example 

A furniture company produces chairs.  On February 15^th the following outputs and costs were recorded:

Units started and completed 12,000.