Case 1: Normal Loss Charged to Manufacturing Overhead

Supplement B: Shrinkage Supplement and Lost B: Units Shrinkage and Lost Units The illustrations presented in Chapter 4 of the textbook assume units that are in process are either completed or still awaiting completion at the end of each period. In reality, units can disappear because of evaporation, losses, or rejection. Such missing units can be considered a normal part of the processing or may be deemed abnormal. Abnormal losses can be thought of as costs akin to unusual losses studied in financial accounting. Normal losses would be normal costs of operating the process department. Two accounting treatments are prevalent for normal losses. One, the amount of the loss can be charged to a specific loss account, which could be charged to manufacturing overhead. Two, the amount of the loss could be spread over all of the good units of work done during the period. If significant in amount and truly abnormal, abnormal losses should always be assigned to the unusual section of the income statement, where they can be offset by any recoveries from insurance or other means. The following illustrates the two alternative treatments of normal losses. The weighted-average method is used for illustration. LEARNING OBJECTIVE 1 Compute the cost of lost units or shrinkage. Case 1: Normal Loss Charged to Manufacturing Overhead Assume that Stabler Chemical had a machine breakdown causing a loss of 10,000 units that were 100% complete as to materials and 60% complete for labour and overhead. Exhibit SB 1 presents the cost of production report for Stabler Chemical after the assumption is included in the data for the problem. The lost units are included in the units accounted for, and the equivalent units lost become a separate line in the equivalent units calculation. When costs are accounted for, the lost units, whether normal (as they are in this case) or abnormal, are costed according to their equivalent units completed. The journal entry for normal losses would be: Manufacturing Overhead.............................. 11,272 Work in Process................................... 11,272 The total number of units lost, both normal and abnormal, can be determined from the quantity schedule. Units accounted for have to be transferred out, in Work in Process at the end of the period, or lost. Thus, even when lost units cannot be physically counted, they can be mathematically calculated by knowing the total units to account for. What is more difficult is to distinguish normal from abnormal losses. A common approach is to use a percentage to express what is normal. Usually this percentage is expressed in terms of the number of units that pass a prespecified inspection point. Thus, in Exhibit SB 1, the inspection point could be at 60% of the total production conversion process. If, for example, 5% of good output is considered to be normal losses, then 8,000 (0.05 160,000) units would be normal losses and 2,000 abnormal. Notice the ending Work in Process is only 40% complete so it has not reached the inspection point. Thus, the 5% figure would not be applied to the 30,000 units in the ending Work in Process. An assumption is needed here to avoid a significant complexity. The preceding entry assumes predetermined overhead is used so that $11,272 is an actual overhead cost that was previously estimated when the overhead rate was calculated. Because the $11,272 includes $4,632 for overhead, overhead is being charged to overhead, resulting in some cost duplication, but the amount of error introduced is assumed to be minor. If the losses were considered to be abnormal, the entry to record the loss would be: Unusual Loss Machine Breakdown...................... 11,272 Work in Process................................... 11,272

SB 2 Supplement B Shrinkage and Lost Units Exhibit SB 1 Production Report Weighted-Average Method Quantity Schedule and Equivalent Units Quantity Schedule Units to be accounted for: Work in process, beginning (all materials, 30% labour and overhead added last month)..................................... 20,000 Started into production.................................. 180,000 Total units to be accounted for............................. 200,000 Materials Labour Overhead Units accounted for as follows: Transferred out........................................ 160,000 160,000 160,000 160,000 Units lost, normal (100% of materials, 60% labour and overhead).... 10,000 10,000 6,000 6,000 Work in process, ending (all materials, 40% labour and overhead added this month)..................................... 30,000 30,000 12,000* 12,000* Total units accounted for................................... 200,000 200,000 178,000 178,000 Unit Costs Total Materials Labour Overhead Work in process, beginning................................. $ 17,000 $ 8,000 $ 3,600 $ 5,400 Cost added by the department............................... 283,000 63,000 88,000 132,000 Total cost (a)............................................ $300,000 $ 71,000 $ 91,600 $137,400 Equivalent units (b)....................................... 200,000 178,000 $178,000 Unit cost, (a) (b)....................................... $1,642 $0.355 $0.515 $0.772 Cost Reconciliation Costs Cost to be accounted for: Work in process, beginning................................ $ 17,000 Cost added by the department.............................. 283,000 Total cost to be accounted for................................ $300,000 Cost accounted for as follows: Transferred to cooking: 160,000 $1.642..................... $262,720 160,000 160,000 160,000 Normal losses Materials (at $0.355 10,000)............................. 3,550 10,000 Labour (at $0.515 6,000)................................ 3,090 6,000 Overhead (at $0.772 6,000).............................. 4,632 6,000 Total normal losses...................................... 11,272 Work in process, ending: Materials (at $0.355 30,000)............................. 10,650 30,000 Labour (at $0.515 12,000)............................... 6,180 12,000 Overhead (at $0.772 12,000)............................. 9,264 12,000 Total work in process, ending.............................. 26,094 Total cost accounted for.................................. 300,086 Less: Rounding........................................ 86 Total cost accounted for.................................... $300,000 *40% 30,000 units 12,000 equivalent units. EU Equivalent unit.

Supplement B Shrinkage and Lost Units SB 3 Exhibit SB 2 Production Report Weighted-Average Method Quantity Schedule Quantity Schedule Units to be accounted for: Work in process, beginning (all materials, 30% labour and overhead added last month)..................................... 20,000 Started into production.................................. 180,000 Total units to be accounted for............................. 200,000 Materials Labour Overhead Units accounted for as follows: Transferred out........................................ 160,000 160,000 160,000 160,000 Units lost normal...................................... 10,000* 0 0 0 Work in process, ending (all materials, 40% labour and overhead added this month)..................................... 30,000 30,000 12,000 12,000 Total units accounted for................................... 200,000 190,000 172,000 172,000 Unit Costs Total Materials Labour Overhead Work in process, beginning................................. $ 17,000 $ 8,000 $ 3,600 $ 5,400 Cost added by the department............................... 283,000 63,000 88,000 132,000 Total cost (a)............................................ $300,000 $ 71,000 $ 91,600 $137,400 Equivalent units (b)....................................... 190,000 172,000 172,000 Unit cost, (a) (b)....................................... $1.706 $0.374 $0.533 $0.799 Cost Reconciliation Costs Cost to be accounted for: Work in process, beginning................................ $ 17,000 Cost added by the department.............................. 283,000 Total cost to be accounted for.............................. $300,000 Cost accounted for as follows: Transferred to cooking: (160,000 $1.706).................... $272,960 160,000 160,000 160,000 Work in process, ending: Materials (at $0.374 30,000)............................ 11,220 30,000 Labour (at $0.533 12,000)............................. 6,396 12,000 Overhead (at $0.799 12,000)........................... 9,588 12,000 Total work in process, ending........................... 27,204 Total cost accounted for.................................. 300,164 Less: Rounding........................................ 164 Total cost accounted for.................................... $300,000 *Total units to be accounted for 200,000 units transferred 160,000 units in process, ending 30,000 10,000 units lost. 40% 30,000 units 12,000 EU. EU Equivalent unit.

SB 4 Supplement B Shrinkage and Lost Units Case 2: Normal Loss Charged to All Good Output Assume Stabler Chemical had normal evaporation of liquid evenly through the process. The illustrated solution is presented in Exhibit SB 2. Notice first that the amount of loss is not given in units. The units lost have to be determined from the quantity schedule by computing the difference between the total units to be accounted for and what is known to have been completed or is still in process. The number of units lost is assigned a 0 equivalent units amount. The resulting smaller number of units is used to determine the unit costs. When costs are accounted for, the unit costs are greater because they include the costs of the evaporation or normal losses. Thus, no entry is required to record the normal loss. Careful thinking about these two cases presents a number of theoretical issues as to where to charge losses and whether or not it is fair to charge Work in Process with losses if the units in this ending inventory have not been inspected at their stage of completion. Exhibit SB 1 provides an opportunity to look at one type of complication. Normal losses have to be calculated and separated from abnormal losses where both types of losses are present. In Exhibit SB 1, 10,000 units of normal losses represent all of the units lost. In addition, these units were lost at the 60% stage of production. If, however, the ending work in process had reached or passed the 60% stage, then normal losses could be separated from the known total losses by applying the normal loss percentage to both the completed units and the ending work in process. For example, if the lost units totalled 10,000 and the ending work in process was 70% complete instead of the assumed 40%, then a normal loss percentage of, say, 5% would be applied as follows to separate normal and abnormal: 5% 160,000 8,000 (from completed items) 5% 30,000 1,500 (from ending work in process) Total normal losses 9,500 Abnormal 500 (balance of losses) Total losses 10,000 Questions Questions SB 1 SB 2 Describe two methods of dealing with normal losses in a process. Which of the two methods of dealing with normal losses would you prefer from a management control perspective? Why? Problems Problems PROBLEM SB 1 Processing Cost and Spoilage Milliners Flour Ltd. operates under a processing cost system for one of its products. During June 2003, 5,676 units were put into production and 5,000 units were completed and transferred out. Inspection occurs when the process is 50% complete, and normal spoilage amounts to 10% of the good units passed. The ending work in process is 75% complete. There were no beginning inventories, and during June, $56,760 of direct materials were applied at the beginning of the process; conversion costs of $52,820 were applied evenly during the process. No abnormal spoilage was incurred during June. Compute the cost of goods completed and the cost of the ending inventory of work in process. Charge the costs of all normal spoilage to all good output.

Supplement B Shrinkage and Lost Units SB 5 PROBLEM SB 2 Processing Cost, Second Department: Spoilage The Morin Company uses a processing cost system to account for the costs of three production departments (Departments A, B, and C). Department B receives units from Department A and applies conversion costs evenly throughout the process. When the units are 90% complete, they are inspected and all materials are then added to the good units. The following is additional information related to Department B for the month of August 2003: a. The company put 2,800 units in process at the beginning of August 2003. They were estimated to be 40% complete. Costs associated with these units were as follows: Department A costs................... $14,000 Department B costs................... 2,520 b. During August 2003, 49,000 units were received from Department A at a cost of $287,000. c. Actual costs incurred by Department B during August 2003 were: Materials........................... $ 17,500 Conversion costs..................... 147,000 d. During August 2003, 44,800 units were completed and transferred to Department C. e. At the end of August 2003, there were 5,600 units in process, which were estimated to be 70% complete. 1. Prepare a cost of production report for Department B for August 2003 using the weightedaverage method. (Note: Calculations of unit costs should be rounded to five decimal places.) 2. Explain briefly one major difference between the weighted-average method and the FIFO method. No calculations are required. 3. How much money could Morin save if it was able to reduce its spoilage to zero? Would society benefit from such an action? PROBLEM SB 3 Processing Cost, Second Department: Spoilage Randall Company has two production departments Assembly and Finishing. The Finishing Department received 10,000 units from the Assembly Department during the month of December. The cost of these units was $98,800. Inspection takes place in the Finishing Department when the units are 80% complete. Normal spoilage is 3%. Materials are added immediately to the good units that pass inspection. On December 1, the Finishing Department had 2,000 units in process. These units were 60% complete. These units contained $20,000 of Assembly Department costs and $10,000 of conversion costs. The Finishing Department used $14,175 of materials and $158,000 of conversion costs during December. At the end of December, the Finishing Department had 1,000 units on hand that were 60% complete. During December, 10,500 units were transferred to finished goods. Randall company accounts for its inventory using the weighted-average method. 1. Prepare a December cost of production report for Randall Company. 2. Calculate the equivalent units for December if Randall had used the FIFO method of process costing. PROBLEM SB 4 Processing Cost, Second Department: Spoilage The Mosley Co. Ltd. has two departments and uses a weighted-average processing cost system. The following information pertains to Department 2 for the month of April 2003. a. At March 31, 2003, the work in process inventory in Department 2 consisted of 6,000 units that were 50% complete and had been charged $56,000 for Department 1 costs, and $24,000 for conversion costs in Department 2. b. During April, 22,000 units were received from Department 1 at a cost of $224,000. c. Department 2 costs during April were $24,000 for materials and $156,000 for conversion costs. d. 16,000 units were completed and transferred to finished goods. e. At the end of April, 10,000 units were still in process in Department 2. They were estimated to be 60% complete. In Department 2, it is expected that 5% of good output will be spoiled. Inspection takes place at the end of the process. Materials are added after inspection in Department 2.

SB 6 Supplement B Shrinkage and Lost Units 1. Prepare the cost of production report for the month of April 2003 for Department 2. 2. Was the spoilage in Department 2 greater or less than normal? What was its cost to Mosley? 3. How much could Mosley save if it could cut its normal spoilage to 2%? PROBLEM SB 5 Processing Cost, Second Department: Spoilage The Larado Company uses a processing cost system to account for the costs of three production departments (Departments I, II, and III). Department II receives units from Department I and applies conversion costs evenly throughout the process. When the units are 90% complete, they are inspected and all materials are then added to the good units. The following is additional information related to Department II for the month of November 2003: a. Two thousand units were in process at the beginning of November 2003. They were estimated to be 40% complete. Costs associated with these units were as follows: Department I costs............................ $10,000 Department II costs........................... $ 1,800 b. During November 2003, 35,000 units were received from Department I at a cost of $205,000. c. Actual costs incurred by Department II during November 2003 were: Materials................................... $ 12,500 Conversion costs.............................. 105,000 d. During November 2003, 32,000 units were completed and transferred to Department III. e. At the end of November 2003, there were 4,000 units in process, which were estimated to be 70% complete. 1. Prepare a cost of production report for Department II for November 2003 using the weighted-average method. (Note: Calculations of unit costs should be rounded to five decimal places.) 2. Explain briefly one major difference between the weighted-average method and the FIFO method. No calculations are required. 3. How much could Larado save if it was able to reduce its spoilage to zero? Would society benefit from such an action? PROBLEM SB 6 Processing Cost, Second Department: Spoilage The Nieforth Co. Ltd. operates under a weighted-average processing cost system. It has two departments, 1 and 2. In Department 2, materials are added at the end of the process, following inspection. Normal spoilage is considered to be 9% of good output. Labour and overhead costs are assumed to apply evenly throughout the process. Inventory at the beginning of the period was one-half complete; ending inventory is two-thirds complete. Following are the costs and unit production statistics for November 2003: Beginning inventory.......................... 2,000 units Received from Department 1.................... 8,000 units Completed and transferred to finished goods storeroom..................... 7,000 units Ending inventory............................ 1,500 units Transferred from Costs Department 1 Materials Labour Overhead Beginning inventory............ $ 6,100 $ 1,400 $ 550 Current costs................. 23,900 $7,000 12,000 5,050 1. Prepare a cost of production report for Department 2, including the amount to be charged to finished goods, the value of the ending inventory, and the disposition of the cost of spoiled units. 2. If Nieforth could improve processing in Department 2 and cut spoilage by 50%, what could it save?