Introduction to Cost Accounting

Chapter Four
4. Accounting for spoilage, Defective units and scrap
Definitions
Spoilages:- is unacceptable unit of production that will be discarded or sold for
reduced price. Both partially and fully completed units of output may
be spoil.
Rework: is unacceptable unit of production that is subsequently repaired and
sold as acceptable finished goods.
Scrap: is material, left over when making a product (s). It has low sales value
compared with its original sales value.
Spoilage always happens in an operating process. Some of this spoilages are
avoidable a manageable while the others are not. In general, they are of two
types.
Types of Spoilage
Normal Spoilage: is an inherent result of a production process. It occurs even
under a very efficient operation condition. Because of this, most managers
set a rate of spoilage that he/she will accept as normal.
- The rate is computed using total good units completed as the base not total
units started; because, normal spoilage is related to good units produced.
- Cost of Normal spoilage is treated as component of cost of good units
manufactured; because, with out it, goods units cannot be produced.
Abnormal Spoilage: is a spoilage that should not arise under efficient
operation condition.
- Unlike that of normal spoilage, Abnormal spoilage is not an inherent
result of operation.
- It is avoidable and contrastable by line personnel, plant personal.
- It is written-off as loss of the accounting period in which it is
detected.

4.1. Process Costing and Spoilage

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In process costing, to treat the cost of spoilage (Normal and Abnormal), there are
two approaches.
Approach A: Counting the abnormally spoiled unit leads to more accurate
product cost determination, because it makes visible the costs associated
with normal spoilage and spreads it over good units produced.

Approach B: If abnormal spoilage is not counted, the cost determination and

allocation become less accurate.

Example
ABC factory manufactures products in its Forming department. Direct
Materials are entered at the beginning of the process. Conversation costs are
added evenly during the etc process. Some units of products are spoiled and
detected only at the end of the production process. Normally, spoiled units are
10% of the good units of output.

Summary of date for July

Physical D.M C.C
units
Beginning WIP 1,500 100 60%
%
Started in July 8,500 100 100
% %
Completed and transferred
out
Good unit 7,000 100 100
% %
End WIP 2,000 100 50%
%

Total cost for July 2004

Total D.M C.C
Cost
Beginning WIP 21,000 12,0 9,00
00 0
Cost added in July 166,600 76,5 89,1

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00 00
Total cost to account 186.600
for

Spoiled units= (Beg. Units + units stored) - (Goods unit

transferred + End units)
= (1,500 + 8,500) - (7,000 + 2,000)
= 1,000 units
Normal spoilage = 0.1 x 7,000 units
= 700 units
Abnormal spoilage = 1,000 - 700
= 300 units
To determine the number of equivalent units that is completed and transferred
out; normal spoilage; abnormal spoilage and ending WIP, previously discussed
five steps are used.

A. Weighted Average
Step 1 & 2, computation of Equivalent units and physical units
Equivalent
Physical Units
Flow of production units D.M C.C
Beg. WIP 1.500
Started in July 8.500
Units To account for 10,000
Good units comp. tran. Out in 7.000 7.000 7.000
July
Normal spoilage 700 700 700
Abnormal spoilage 300 300 300
End WIP 2,000 2,000 1,000
Units Accounted for 10,000
Work done in current period 10,000 9,000

Step 3, 4 and 5 Production cost worksheet

Total D.M. C.C.
Production
cost
Beg. WIP Br. 21,000 12.0 9.00
00 0
Cost incurred in July Br. 165,000 76.5 89.1
00 00
Cost incurred to date 88.5 98.1
00 00
Equivalent units 10.0 9.00

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00 0
Cost per equivalent unit 8.85 10.9
0
Total cost to account for Br. 186,600
Assignment of cost to
Good units comp. and 138,250 61,9 76,3
transferred out 50 00
Normal spoilage 13,825 6,19 7,63
5 0
Total cost of goods comp. 152.075
and tran
Abnormal spoilage 5,925 2,65 3,27
5 0
End WIP 28,600 17,7 10,9
00 00
Total cost accounted for 186.600

B. FIFO Method
Step 1 & 2, Computation of Equivalent Unit and physical units
Equivalent
Physical Units
Flow of production units D.M C.C
Beg. WIP 1.500
Started in July 8.500
Units To account for 10,000
Good units comp. tran. Out in
July
From Beginning WIP 1,500 600
From Started and Comp. in 5,500 5,500 5,500
July
Normal spoilage 700 700 700
Abnormal spoilage 300 300 300
End WIP 2,000 2,000 1,000
Units Accounted for 10,000
Work done in current period 8,500 8,100

Step 3, 4 and 5 Production cost worksheet

Total D.M. C.C.
Production
cost
Beg. WIP Br. 21,000
Cost incurred in July Br. 165,000 76.5 89.1
00 00
Equivalent units 8.50 8.10
0 0
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Cost per equivalent unit 9 11
Total cost to account for Br. 186,600
Assignment of cost to
Good units comp. and 138,250 61,9 76,3
transferred out 50 00
1. From the Beg. WIP 6,600 0 6,60
0
Cost incurred last period 21,00
Total cost of Beginning 27,600
WIP
2. From started in July 110,000 49,5 60,5
00 00
3. Normal spoilage 14,000 6,30 7,70
0 0
Total cost of goods comp. 151,600
and tran
Abnormal spoilage 6,000 2,70 3,30
0 0
End WIP 29,000 18,0 11,0
00 00
Total cost accounted for 186.600

Journal Entries Weighted Average FIFO

Finished goods 152,075 151,600
WIP- Forming 152,075 151,600
To transfer good units completed in July

Loss from Abnormal spoilage 5,925 6,000

Work in process- Forming 5,925 6,000
To recognize abnormal detected in July.

Inspection points and allocating cost of Normal spoilage

Spoilage might occur at any time in the production process. However, it can be
detected on one or more specific inspection points.
Inspection point is a stage of predication cycle where products are checked to
determine whether they are produced being in acceptable or
unacceptable standard.

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When spoiled units have a disposal value, to assign the cost of spoilage to the
good units produced, its net cost is computed by deducting the disposal value
from the cost of spoiled goods.

1.2. Job-Order Costing and spoilage

The concept of normal and abnormal spoilage also apply to Job-Order costing
system. Like that of process costing, in job order costing system, Abnormal
spoilage is controllable and is considered as avoidable cost. Thus, it is written-off
as loss of the period in which it is detected.

Similarly, the management up to some level tolerates Normal spoilages. When

these spoilages are assigned cost to the good units completed and transferred
out, job-order costing system distinguished between (1) normal spoilage
attributable to specific job and (2)normal spoilage attributable to all jobs.

1. Normal spoilage attributable to a specific job

Eg. Total units to be completed 50
Good unit completed 45
Spoiled units 5
Note that:
Spoiled units have a disposal value of br. 600.
Each units produced absorbs manufacturing costs of br. 2,000
When normal spoilage occurs, the Job from which the spoilage arise will absolve
the uncovered cost of the spoiled units br. 1,400 (2,000 - 600)
Considering the above given data, the following entry must be recorded when the
spoiled units are disposed and br. 600 is secured from each spoiled units.
Material control (5x600) 3,000
WIP control (specific job 3.000

- WIP had already been debited for 10,000 (2,000 x 5) thus it has to reduce
to 7,000 (10,000 – 3,000) by the amount recovered.

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- The br. 7,000 an additional cost of the good units produced 45units (50 -
5). Actually, the cost of the good units was br. 90,000 (2,000 x 45), but
when we add the cost of spoiled units, it become 97,000 (90,00 + 7,000)

2. Normal spoilage, Common to all Jobs

In some case, spoilage many be considered as a normal characteristics of a given
production cycle. Thus, spoilage is not attributable to a specific job. Rather, it is
considered as a MOH cost of all jobs performed in a period. Therefore, the
budgeted MOH rate includes a provision (Estimation) for normal spoilage cost.
This indicates that normal spoilage cost is spread through overhead allocation
rather than overloading it only on a particular job.

The entry to record the MOH cost is

Material control (spoiled good at disposal value) 3.000

MOH control (normal spoilage 10,000 - 3,000) 7.000
WIP control (specific Job 5 x 2,000) 10.000

Therefore the total cost of the 45 good units is 90,000 (45 x 2,000) plus a
prorated share of br. 7,000 normal spoilage overhead cost.

Abnormal Spoilage
If spoilage is proved to be abnormal, the net of disposal valued is reported as
abnormal loss and it is not included as part of the cost of good units produced.
Eg. Assume that the above 5 units spoiled are abnormal. Thus, the entry to
record these abnormal units is an follow.

Material control (spoiled good at

current price) 3,000
Loss from Abnormal spoilage
7,000

Rework In Job order Costing

Rework is unacceptable units of production that is subsequently repaired and
sold as acceptable finished goods.
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Eg. Assume that the 5 spoiled part are reworked. Assume also that the Journal
entry of the 10.000 assigned cost of the spoiled unit was as follows.

WIP control (Specific Job)………………….. 10.000

Material control ………………….………..……
7.000
Direct Labor control ………………..
………….4.000
MOH Allocated (applied). …………….….
…...2.000

i. Normal Rework, common to all Jobs

When a rework is normal and not attributable to any specific job, the
cost of rework is charged to MH and spread through overhead allocation,
over all jobs as follows. Assume that the cost of rework is br. 3.800
(800 for Mat, 2.00 for labor and 1.00 for MOH)
ii. Abnormal Rework
If a rework is abnormal, it is recorded by debiting the abnormal rework
cost to a separate loss account as follow.

Less from Abnormal Rework…………….. 3.800

Material control ………………….………..……
800
Wage payable control ………………..…….
….2.000
Most Allocated (applied). …………….….
…...1.000

Rework in Process costing

Here, also we need to distinguish Abnormal rework with the normal one

Normal Rework: Assuming the same example in allocating normal

rework cost we use the method of process costing are identical.

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Thus, the entry is

MOH Control ..........………………….. 3.800
Material control ………………….………..…… 800
Wage payable control ………………..
……….2.000
Most allocated (applied). …………….….…..1.000

Abnormal Rework: The some procedure is used as in job order costing

system.
Less from Abnormal Rework…………….. 3.800
Material Control ……………….………..…… 800
Wage payable control ………………..…….
….2.000
MOH Allocated (applied). …………….….
…...1.000

Scrap in Job order costing

- It is a material left over when making a product(s).
- There is no distinction of normal or abnormal scrap but there are
scraps attributable of specific job and scrap common to all jobs.
- There are two major aspect of accounting for scrap
1. Planning and controlling (including physical tracking)
2. Inventory costing (including when and How to affect operating
income)
- The two most important question here by,
i. When should the value of scrap be recognized?
A. At the time, scrap is produced
B. At the time, scrap is sold.
ii. How should revenue from scrap be accounted for?
Eg. Assume that the scrap from a job has a total sales value of br. 900

A. Recognizing scrap at the time of its sales

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When a dollar amount scrap is immaterial (insignificant), we will make a
memo for the quantity of scrap returned to the store room and regard scrap
sales as a separate line of other revenue.

Thus, the only entry is

Cash /A/R 900
Sales of scrap 900

However, when the dollar amount of scrap is material (significant), and it is

sold quickly, the accounting department on the following condition
i. Is it attributable to a specific job? or
ii. Is it common to all jobs?

1. Scrap attributable to a specific Job

When we can simply identifies a job that credit a scrap, we may trace
the sales of the scrap with it.

The Journal entry is

For scrap returned to storeroom No Entry
For sale of scrap
Cash A/R……………….. 900
WIP control (specific job) 900

By making the above entry, we can easily reduce the cost of a specific job by the
value of scrap.

2. Scrap common to all jobs

Here also the sales value of a scrap is used to reduce the MOH century and
the prorated sales of scrap will reduce the cost a job. To do so, the Journal
entry is
Cash /A/R ………… 900
MOH control 900

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NB. The Budgeted MOH needs to include the expected sales of scrap. Thus the
entry is
Cash /A/R
MOH control 9,000

B. Recognizing scrap at the time of it’s production

Sometimes, scrap may not be immaterial and the time between it’s storage
and sales may be long. For instance, some company as tend to delay sales
of scrap until the market price become most attractive.

Under the above conditions, the company is expected to make an estimate

of net realizable value of scraps occurred in some given period. This is used
to report the appropriate production cost and the related scrap.

Assuming similar example above (the value of scrap is br. 900) here also we
need to classify scrap as originated from specific job or common to all jobs.

i. Scrap, attributable of specific Job

- When it is returned to store rooms.
Material control 900
WIP control 900

- When it is sold
Cash /A/R 900
Material control 900

- When it6 is revised

WIP control – Job x 900
Most control 900

ii. Scrap, common to all Jobs

- When it is returned to storeroom
Material control 900
Most control 900

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- When it is sold or revised, the journal entry is similar with that of the
entry in attributable to specific job condition.

Process costing and scrap

The accounting for scrap in process costing is similar with the accounting under
job order costing when scrap is common to all jobs, because process costing
applies to the manufacture of mass of identical units.

Thus, the entries are

When scrap is returned to storeroom
Material control 900
MOH control 900

When scraps are sold

Cost 900
Material control 900

When scraps Reused

WIP control 900
Material control 900

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