1. Spoilage, Rework, and Scrap 1

2. Learning Objective 1 Distinguish among spoilage, rework, and scrap. 2

3. Basic Terminology Spoilage — units of production, either fully or partially completed, that do not meet the specifications required by customers for good units and that are discarded or sold for reduced prices. 3

4. Basic Terminology Rework—units of production that do not meet the specifications required by customers but which are subsequently repaired and sold as good finished goods. Scrap—residual material that results from manufacturing a product. Scrap has low total sales value compared with the total sales value of the product. 4

5. Learning Objective 2 Describe the accounting procedures for normal and abnormal spoilage. 5

6. Accounting for Spoilage Accounting for spoilage aims to determine the magnitude of spoilage costs and to distinguish between costs of normal and abnormal spoilage. To manage, control, and reduce spoilage costs, they should be highlighted, not simply folded into production costs. 6

7. Normal Spoilage Normal spoilage is spoilage that is an inherent result of the particular production process and arises even under efficient operating conditions. Normal spoilage rates should be computed using total good units completed as the base, not total actual units started in production. 7

8. Abnormal Spoilage Abnormal spoilage is spoilage that should not arise under efficient operating conditions. Companies record the units of abnormal spoilage and keep a separate Loss from Abnormal Spoilage account. 8

9. Process Costing and Spoilage Units of normal spoilage can be counted or not counted when computing output units (physical or equivalent) in a process costing system. Counting all spoilage is considered preferable. 9

10. Inspection Points and Spoilage Inspection point — the stage of the production process at which products are examined to determine whether they are acceptable or unacceptable units. Spoilage is typically assumed to occur at the stage of completion where inspection takes place. 10

11. The Five-Step Procedure for Process Costing with Spoilage Step 1: Summarize the flow of physical units of output—identify both normal and abnormal spoilage. Step 2: Compute output in terms of equivalent units. Spoiled units are included in the computation of output units. 11

12. The Five-Step Procedure for Process Costing with Spoilage Step 3: Summarize total costs to account for. Step 4: Compute cost per equivalent unit. Step 5: Assign total costs to: 1. Units completed 2. Spoiled units 3. Units in ending work-in-process 12

13. Process Costing and Spoilage Example Big Mountain, Inc., manufactures skiing accessories. All direct materials are added at the beginning of the production process. In October, $95,200 in direct materials were introduced into production. Assume that 35,000 units were started, 30,000 good units were completed, and 1,000 units were spoiled (all normal spoilage). 13

14. Process Costing and Spoilage Example Ending work in process was 4,000 units (each 100% complete as to direct material costs). Spoilage is detected upon completion of the process. Spoilage is typically assumed to occur at the stage of completion where inspection takes place. 14

15. Process Costing and Spoilage Example Approach A recognizes spoiled units when computing output in equivalent units. Approach B does not count spoiled units when computing output in equivalent units. 15

16. Approach A Example Costs to account for$95,200 Divide by equivalent units 35,000 Cost per equivalent unit$ 2.72 Good units completed: 30,000 × $2.72$81,600 Add normal spoilage: 1,000 × $2.72 2,720 Costs of good units transferred out$84,320 Work in process: 4,000 × $2.72 10,880 Costs accounted for$95,200 16

17. Approach B Example Costs to account for$95,200 Divide by equivalent units 34,000 Cost per equivalent unit$ 2.80 Good units completed: 30,000 × $2.80$84,000 Costs of good units transferred out$84,000 Work in process, ending: 4,000 × $2.80 11,200 Costs accounted for$95,200 17

18. Learning Objective 3 Account for spoilage in process costing using the weighted-average method. 18

19. Weighted-Average: Spoilage The following example is for the month of November and relates to Big Mountain, Inc. Direct materials are introduced at the beginning of the production cycle. Conversion costs are added evenly during the cycle. 19

20. Weighted-Average: Spoilage Normally the spoiled units are 2% of the output. Assume that Big Mountain, Inc., had 1,000 units in the beginning work in process inventory, 100% complete for materials ($9,700), and 60% complete for conversion ($10,000). 20

21. Weighted-Average: Spoilage Ending work in process inventory was 4,000 units (100% materials and 20% conversion). Costs added during the month were $87,500 for materials and $72,000 for conversion. What are the costs assigned to the units completed, spoiled, and in ending work in process inventory? 21

22. Physical Units (Step 1) Work in process, beginning (November 1) 100% material, 60% conversion costs 1,000 Started during November:35,000 36,000 Good units completed and transferred out:31,000 Work in process, ending inventory: 100% material 20% conversion costs 4,000 35,000 22

23. Physical Units (Step 1) What is the number of spoiled units? 36,000 – 35,000 = 1,000 What is the normal spoilage? 31,000 × 2% = 620 What is the abnormal spoilage? 1,000 – 620 = 380 23

24. Compute Equivalent Units (Step 2) Materials Conversion Completed and transferred31,00031,000 Normal spoilage 620 620 Abnormal spoilage 380 380 Ending inventory 4,000 800 Equivalent units36,00032,800 100%20% 24

25. Compute Equivalent Unit Costs (Step 3) Materials Conversion Beginning inventory$ 9,700$10,000 Current costs 87,500 72,000 Total$97,200$82,000 Equivalent units 36,000 32,800 Cost per unit $2.70 $2.50 25

26. Summarize Total Costs (Step 4) Work in process beginning inventory: Materials$ 9,700 Conversion 10,000 Total beginning inventory$ 19,700 + Current costs: Materials $87,500 Conversion 72,000 = Costs to account for$179,200 26

27. Assign Total Costs (Step 5) Good units completed and transferred out (31,000 units): Costs before adding normal spoilage: 31,000 × ($2.70 + $2.50) $161,200 Normal spoilage: 620 × ($2.70 + $2.50) 3,224 Total$164,424 27

28. Assign Total Costs (Step 5) Abnormal spoilage: 380 × ($2.70 + $2.50)$ 1,976 Work in process, ending (4,000 units): Direct materials (4,000 × $2.70)$10,800 Conversion (800 × $2.50) 2,000 Total$12,800 28

29. Assign Total Costs (Step 5) Costs of units completed and transferred out (including normal spoilage)$164,424 Cost of abnormal spoilage 1,976 Costs in ending inventory 12,800 Total costs accounted for$179,200 The $1,976 cost of abnormal spoilage is assigned to the Loss from Abnormal Spoilage account. 29

30. Learning Objective 4 Account for spoilage in process costing using the first-in, first-out (FIFO) method. 30

31. Physical Units (Step 1) Work in process, beginning (November 1): 100% material, 60% conversion costs 1,000 Started during November35,000 36,000 Good units completed and transferred out: From beginning inventory 1,000 Started and completed30,000 31,000 31

32. Physical Units (Step 1) Work in process, ending inventory: 100% material, 20% conversion costs4,000 Normal spoilage 620 Abnormal spoilage 380 32

33. Compute Equivalent Units (Step 2) Materials Conversion Good units completed and transferred out: From beginning inventory 0 400 Started and completed30,00030,000 Normal spoilage 620 620 Abnormal spoilage 380 380 Ending inventory 4,000 800 Equivalent units35,00032,200 33

34. Compute Equivalent Unit Costs (Step 3) Materials Conversion Current costs$87,500$72,000 Divided by equivalent units 35,000 32,200 Cost per unit $2.50 $2.236* *$2.236 (rounded) 34

35. Summarize Total Costs (Step 4) Work in process beginning inventory: Materials$ 9,700 Conversion 10,000 Total beginning inventory$ 19,700 + Current costs: Materials$ 87,500 Conversion 72,000 = Costs to account for:$179,200 35

36. Assign Total Costs (Step 5) Good units completed and transferred out: From beginning inventory: Work in process$ 19,700.00 Conversion costs added in current period (400 × $2.236) 894.40 Total$ 20,594.40 Started and completed: 30,000 × ($2.50 + $2.236)$142,080.00 36

37. Assign Total Costs (Step 5) Costs before adding normal spoilage: ($20,594.40 + $142,080.00)$162,674.40 Normal spoilage: 620 × ($2.50 + $2.236) 2,936.32 Total$165,610.72 37

38. Assign Total Costs (Step 5) Abnormal spoilage: 380 × ($2.50 + $2.236)$1,799.68 Work in process, ending (4,000 units): Direct materials (4,000 × $2.50)$10,000 Conversion (800 × $2.236) 1,789 Total$11,789 38

39. Assign Total Costs (Step 5) Costs of units completed and transferred out (including normal spoilage)$165,610.72 Cost of abnormal spoilage 1,799.68 Costs in ending inventory 11,789.00 Total costs accounted for$179,200.00 The $1,799.68 costs of abnormal spoilage are assigned to the Loss from Abnormal Spoilage account. 39

40. Learning Objective 5 Account for spoilage in job costing. 40

41. Job Costing and Spoilage Job costing systems generally distinguish between normal spoilage attributable to a specific job from normal spoilage common to all jobs 41

42. Job Costing and Accounting for Spoilage Normal Spoilage Attributable to a Specific Job: When normal spoilage occurs because of the specifications of a particular job, that job bears the cost of the spoilage minus the disposal value of the spoilage 42

43. Job Costing and Accounting for Spoilage Normal Spoilage Common to all Jobs: In some cases, spoilage may be considered a normal characteristic of the production process. The spoilage is costed as manufacturing overhead because it is common to all jobs The Budgeted Manufacturing Overhead Rate includes a provision for normal spoilage 43

44. Job Costing and Accounting for Spoilage Abnormal Spoilage: If the spoilage is abnormal, the net loss is charged to the Loss From Abnormal Spoilage account Abnormal spoilage costs are not included as a part of the cost of good units produced 44

45. Learning Objective 6 Account for rework in job costing. 45

46. Job Costing and Rework Three types of rework: 1. Normal rework attributable to a specific job – the rework costs are charged to that job 2. Normal rework common to all jobs – the costs are charged to manufacturing overhead and spread, through overhead allocation, over all jobs 3. Abnormal rework – is charged to the Loss from Abnormal Rework account that appears on the income statement 46

47. Learning Objective 7 Account for scrap. 47

48. Accounting for Scrap No distinction is made between normal and abnormal scrap because no cost is assigned to scrap The only distinction made is between scrap attributable to a specific job and scrap common to all jobs 48

49. Aspects of Accounting for Scrap 1. Planning & Control, including physical tracking 2. Inventory costing, including when and how it affects operating income NOTE: Many firms maintain a distinct account for scrap costs 49

50. Accounting for Scrap Scrap Attributable to a Specific Job – job costing systems sometime trace the scrap revenues to the jobs that yielded the scrap. Done only when the tracing can be done in an economic feasible way No cost assigned to scrap 50

51. Accounting for Scrap Scrap Common to all Jobs – all products bear production costs without any credit for scrap revenues except in an indirect manner Expected scrap revenues are considered when setting is lower than it would be if the overhead budget cost had not been reduced by expected scrap revenues 51

52. Accounting for Scrap Recognizing Scrap at the Time of its Production – sometimes the value of the scrap is material, and the time between storing and selling it can be long The firm assigns an inventory cost to scrap at a conservative estimate of its net realizable value so that production costs and related scrap revenues are recognized in the same accounting period 52

53. 53

54. Questions Week 7 (18-16, 18-17, 18-18, 18-25) HW 54

55. End 55