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There are two methods of costing cost flows under process costing. The two methods of accounting for cost flows in process costing are
(1) weighted average method and
(2) First In First Out (FIFO) Method.
These methods relate to the manner in which cost flows are assumed to occur in the production process. In a very general way, these process costing approaches could be related to the cost flow methods used in financial accounting.
In a small and retail business firm, the weighted average method is followed to find out an average cost per unit of an inventory. This cost is calculated by dividing the total cost of goods available by total units available sale. Total cost and total units are found by adding purchases to beginning inventory. Costs and units of the current period are not distinguished in any way from those on hand at the end of the prior period.
In contrast, in the FIFO method of accounting for merchandise inventory which separates goods by when they were purchased and at what cost. The costs of beginning inventory are the first costs sent to Cost of Goods Sold; units remaining in the ending inventory are assigned costs based on the most recent purchase prices.
Use of these methods of costing the production of a manufacturing company is similar to their use by a retailer. The weighted average method calculates a single average cost per unit of the combined beginning inventory and current period production. The FIFO method separates beginning inventory and current period production and their costs so that a current period cost per unit can be calculated. The denominator used in the cost formula to determine unit cost differs depending on which of the two methods is used.
