Material Costing Material Losses
Syllabus ACCORDING TO UNIVERSITY OF KARACHI: Accounting for: o Waste and scrap materials. o Spoil and defective works. WHAT THE EXAMINER USUALLY ASK? Defective goods: o General Journal entries if the job is charged with the cost of defective goods. o General Journal entries if the job is not so charged directly for the defective goods. Spoiled goods: o General Journal entries if the loss is to be charged to the particular job. o General Journal entries if the loss is to be charged to all production. Page 126
MATERIAL LOSSES There are two types of material losses: a) Normal loss. b) Abnormal loss. Normal Loss: Abnormal Loss: The loss of input/output where the occurrence is inevitable i.e. which occur on account of normal reasons are normal losses. The magnitude of the loss is dependent on the production process in consideration. Normal losses may be expressed in absolute terms (like say 50 units) or in proportionate terms (like say 1/10the) or in percentage terms (like say 2%). Whether the calculation of loss should be based on the input or output is dependent on the method used to express the loss and to some extent on the process in consideration. The loss of input/output whose occurrence can be avoided i.e. which occur on account of abnormal reasons are abnormal losses. This can also be interpreted as the magnitude of actual loss that is incurred in excess of the normal loss. FORMS OF MATERIAL LOSSES There are four basic forms of material losses: i. Waste. ii. Scrap. iii. Spoilage. iv. Defectives. v. Obsolescence. vi. Rejects. a) WASTE The loss of raw materials in processing is waste. Waste has no receivable value. It is a quantity loss of material in the process of producing goods. Waste is brought into record by comparing the input quantity with the output quantity. Waste may occur due to shrinkage, smoke, weight loss and evaporation causing the material to become waste. They are material losses causing a quantity loss. Waste may occur in terms of a byproduct which does not produce any realizable value. For example, 20kg of potato does not give 20kg of potato chips. Thus, the fact that 15 kg of chips is produced out of 20kg potato means that 5 kg of potato is wasted in the course of making chips. 5kg of waste does not produce any sales value and so is treated as waste. Waste is divided into two types, normal and abnormal waste. Normal Waste: Abnormal Waste: Normal waste is estimated before production and is inherent in the nature of the raw material. Abnormal waste occurs because of a low quality/substandard of input material, bad process work, carelessness etc. b) SCRAP The leftover materials that are not used in the production of an item. If a product requires a component cut from a four-by-eight-foot sheet of plywood, the pieces of plywood that are cut off are the scrap. Page 127
c) SPOILAGE The term applied to products that are not acceptable quality and that are sold for reduced prices. Many outlet malls sell seconds at prices lower than retail. Those seconds, also called irregulars, are not the same quality as the regular product. Normal Spoilage: Abnormal Spoilage: The amount of defective or substandard parts that are produced even if the process is efficient. The process will not operate perfectly, and not all the materials will be perfect. Normal spoilage is calculated as the percentage of good units produced, and management determines the acceptable level of spoilage and calls it normal. The costs of normal spoilage are included in the cost of goods manufactured because the process is unable to produce good products without producing a few bad ones. Spoilage that results from errors, breakdowns, accidents, etc., in a manufacturing process. Abnormal spoilage is in excess of normal spoilage and the cost is a separate line item on the income statement. It is not included in the unit cost because it is avoidable. d) DEFECTIVE The faulty or substandard finished goods or spoilage are called defective units. Defective goods arise due to sub-standard materials, bad supervision, bad planning of production, poor workmanship, inadequate equipment, careless inspection etc. Defective units can be rectified and turned out as good unit by re-processing. Such re-processing work may need the use of additional material, labor and expenses. e) OBSOLESCENCE Items that are outdated hence obsolete. Reasons could be due to change in consumer demand, change in fashion, change in specification. f) REJECTS Materials that are not accepted on inspection. May be rejected when purchases are received or during the course of manufacturing. Where possible, rectification will be carried out or otherwise the rejected item will be disposed-off. ACCOUNTING TREATMENT FOR MATERIAL LOSSES 1) ACCOUNTING TREATMENT OF SCRAP There are following three options for accounting of scrap: Option # 1: Option # 2: Nominal sales price realized out of negligible scrap is treated as other income in cost account. A scrap account is opened with the full amount of the scrap of the process or job if such a scrap value is significant. Process account or job account is given credit by the value of scrap. The scrap account is closed by the balance either of profit or loss to the profit or loss account. Page 128
Option # 3: Net sales value of scrap after deduction of selling and distribution costs is deducted either from the overhead amount or from the material cost. Deduction out of overheads is made to adjust the overhead ratio if scrap is not possible to identify in relation to a process or a job. 2) ACCOUNTING TREATMENT OF SPOILAGE There are two methods of handling the cost of spoiled materials: (a) The loss due to spoilage may be charged to the job on which this spoilage occurred. (b) The loss due to spoilage may be charged to factory overhead thus spreading it over the cost of all the jobs. GENERAL JOURNAL ENTRIES If the loss due to spoilage may be charged to the job on which this spoilage occurred: Manufacturing Cost: DR. (with manufacturing cost) Raw material CR. (with direct material used) Accrued payroll CR. (with direct labour used) applied CR. (with factory overhead applied) Loss on Spoilage Goods Charged to Job: Spoiled goods DR. (with sales value) CR. (with sales value) Cost of Finished Gods: Finished goods DR. (with finished goods amount) CR. (with finished goods amount) If the loss due to spoilage may be charged to factory overhead thus spreading it over the cost of all the jobs: Manufacturing Cost: DR. (with manufacturing cost) Raw material CR. (with direct material used) Accrued payroll CR. (with direct labour used) applied CR. (with factory overhead applied) Loss on Spoilage Goods Charged to Job: Spoiled goods DR. (with sales value) DR. (with loss on spoiled goods) CR. (with original cost of spoiled goods) Cost of Finished Gods: Finished goods DR. (with finished goods amount) CR. (with finished goods amount) Page 129
3) ACCOUNTING TREATMENT OF DEFECTIVES The accounting treatment for defective work is similar to that relating to spoiled goods. The cost of defectives can be treated in the following manner: (1) Normal defectives i.e. those defectives which are inherent in the manufacturing process and are identified as normal, can be treated in the following manner: a. Charged to good products. b. Charged to general factory overheads. c. Charged to department overhead. (2) If the defectives units are clearly identifiable with a specific job or production order and defects are particular to the job, the cost to complete the defective units can be charged to that job. (3) If defectives are abnormal and due to reasons beyond the control of the business firm, the rework cost charged to the costing profit and loss account. GENERAL JOURNAL ENTRIES If the loss is charged to job: DR. (with total loss on waste) Raw material CR. (with direct material waste) Accrued payroll CR. (with direct labour waste) applied CR. (with factory overhead waste) If the loss is charged to factory overhead: DR. (with total loss on waste) Raw material CR. (with direct material waste) Accrued payroll CR. (with direct labour waste) applied CR. (with factory overhead waste) 4) ACCOUNTING TREATMENT OF WASTE Normal waste is treated as a part of the cost of the product i.e. the cost of normal waste unit is borne by the good remaining units. Abnormal waste cost is transferred to the costing profit and loss account. In case of normal waste, cost per unit of the finished output is relatively inflated, but in abnormal waste, cost per unit remains the same for abnormal units as well as good finished units. 5) ACCOUNTING TREATMENT OF OBSOLESCENCE When a business has inventory that it cannot sell, it must write off the obsolete inventory as an expense. The accounting method for this expense is for the business to determine if the inventory has any disposal value, subtract this value from the inventory's book value and set aside the difference in a reserve account. This step results in a debit to the cost of goods sold account and a credit to the reserve for obsolete inventory account. Cost of goods sold DR. (with obsolete inventory amount) Reserve for obsolete inventory CR. (with obsolete inventory amount) As the business gets rid of the obsolete inventory, the business debits the reserve for obsolete inventory account and credits the inventory account. If the business can get no payment for the inventory, the expense write-off becomes the same as the inventory's book value. However, Page 130
sometimes a business can dispose of inventory at a greatly reduced price and only has to write off part of value as an expense. Reserve for obsolete inventory DR. (with obsolete inventory amount) Inventory CR. (with obsolete inventory amount) ILLUSTRATION # 1: (DEFECTIVE GOODS) The ABC Company produces many varieties of shirts. The cost upon the completion of the order were: Material Rs.6,000 Rs.4,200 Rs.1,800 Inspection reveals that a certain part of the work is defective. The defectiveness has removed at the following cost: Material Rs.800 Rs.300 Rs.200 Entries in the books of accounts under each of the following conditions: (a) When the job is charged with the cost of defective work. (b) When the job is not so charged directly for the defective work. SOLUTION # 1: When the job is charged with the cost of defective work: ABC COMPANY GENERAL JOURNAL Date Particulars P/R Debit Credit (1) Work in process 12,000 Raw material 6,000 Accrued payroll 4,200 applied 1,800 (To record the manufacturing cost applied to production) (2) Work in process 1,300 Raw material 800 Accrued payroll 300 applied 200 (To record the additional cost applied to defective goods) (3) Finished goods (12,000 + 1,300) 13,300 Work in process 13,300 (To record the cost of goods manufactured) Page 131
When the job is not so charged directly for the defective work: ABC COMPANY GENERAL JOURNAL Date Particulars P/R Debit Credit (1) Work in process 12,000 Raw material 6,000 Accrued payroll 4,200 applied 1,800 (To record the manufacturing cost applied to production) (2) 1,300 Raw material 800 Accrued payroll 300 applied 200 (To record the additional cost applied to defective goods) (3) Finished goods 12,000 Work in process 12,000 (To record the cost of goods manufactured) ILLUSTRATION # 2: (SPOILAGE) 1991 Regular & Private Lahore University Fabrication is producing lot No. 657, which called for 2,500 dresses style No. 34 incurred costs as follows: Material Rs.2.00 per dress Rs.1.20 per dress Rs.1.60 per dress When the lot was completed, inspection rejected 200 spoiled dresses, which were sold Rs.3 each. (a) Journal entries if the loss is to be charged to the lot No. 657. (b) Journal entries if the loss is to be charged to all production of the fiscal year. SOLUTION # 2: Computation of Actual Cost of Spoiled Goods: Material (200 x 2.00) 400 (200 x 1.20) 240 (200 x 1.60) 320 Total cost of soiled goods 960 Computation of Sales Recovery of Spoiled Goods: Sales recovery rate = Sales recovery of spoiled goods Cost of spoiled goods Sales recovery rate = 3.00 4.80 x 100 Sales recovery rate = 62.5% x 100 Material (400 x 62.5%) 250 (240 x 62.5%) 150 (320 x 62.5%) 200 Total sales recovery of soiled goods 600 Page 132
Computation of Loss on Spoiled Goods: Total sales recovery of spoiled goods 600 Less: Total cost of spoiled goods (960) Loss on spoiled goods 360 Material Costing Material Losses If the loss is to be charged to the lot No. 657: UNIVERSITY FABRICATION GENERAL JOURNAL Date Particulars P/R Debit Credit (1) Work in process 12,000 Raw material (2,500 x 2.00) 5,000 Accrued payroll (2,500 x 1.20) 3,000 applied (2,500 x 1.60) 4,000 (To record the manufacturing cost applied to production) (2) Spoiled goods (200 x 3) 600 Work in process 600 (To record the cost of spoiled goods) (3) Finished goods 11,400 Work in process (12,000 600) 11,400 (To record the cost of goods manufactured) If the loss is to be charged to all production of the fiscal year: UNIVERSITY FABRICATION GENERAL JOURNAL Date Particulars P/R Debit Credit (1) Work in process 12,000 Raw material (2,500 x 2.00) 5,000 Accrued payroll (2,500 x 1.20) 3,000 applied (2,500 x 1.60) 4,000 (To record the manufacturing cost applied to production) (2) Spoiled goods (200 x 3) 600 360 Work in process 960 (To record the cost of spoiled goods) (3) Finished goods 11,040 Work in process (12,000 960) 11,040 (To record the cost of goods manufactured) Page 133
PRACTICE QUESTIONS Question # 1: 2004 Regular (Cost Accounting) UOK The Sana Company produces many varieties of frocks. One of which was for Tooba Manufacturing Company. The cost upon the completion of the order were: Material Rs.3,000 Rs.2,100 Manufacturing expenses Rs.900 Inspection reveals that a certain part of the work is defective. The defectiveness has removed at the following cost: Material Rs.400 Rs.200 Manufacturing expenses Rs.100 Entries in the books of accounts under each of the following conditions: (a) When the job is charged with the cost of defective work. (b) When the job is not so charged directly for the defective work. Question # 2: 2007 Regular & Private (Cost Accounting) Bahawalpur Prince Investment Company manufactures for stock a number of precision instruments, which must meet strict specifications. During the last month an order for 20,000 instruments was received and executed costs incurred were: Direct materials Rs.65,000 Direct labours Rs.45,000 Manufacturing overhead was applied @ 50% of material cost. An examination of the finished instruments indicated that 1,000 instruments were defective and had to be reworked, the additional costs for this rework were: Direct materials Rs.1,400 Direct labours Rs.900 Manufacturing overhead at applied rate. Entries that would appear in the books under each of the following conditions: (1) When reworking costs are charged directly to the job on which incurred. (2) When additional costs incurred in reworking are charged to factory overhead account. Question # 3: 2010 Regular & Private (Cost Accounting) Punjab Faizan & Co. manufactures appliances to be sold to an automobile industry. An order of 1,200 appliances was received at sales price of Rs.200 per unit. The cost per unit was as follows: Material cost Rs.32 cost Rs.42 cost Rs.22 On completion of the order, it was found that 100 units were imperfect and spoiled and could only be sold at a price of Rs.48 per unit to a small manufacturing company which would repair and sell them under their own name. Faian & Co. decided to sell 100 spoiled units to this company at a price of Rs.48 per unit. Prepare all necessary journal entries to record the following: (a) Putting the 1,200 units into process. (b) Placing the spoiled units in the inventory. (c) Completion and sale for cash 1,100 good units. (d) Sale for cash of the 100 spoiled units. Page 134
Question # 4: 2002 Regular & Private (Cost Accounting) UOK Stylo Fabricators is producing lot No. 55 which called for 500 dresses style No. 2002 incurred costs as follows: Materials Rs.240 per dress. Rs.165 per dress. Rs.135 per dress. When the lot was completed inspection rejected 20 spoiled dresses which were sold for Rs.324 each. (1) Journal entries if the loss is to be charged to lot No. 55. (2) Journal entries if the loss is to be charged to all production of the fiscal period. Question # 5: 2004 Private (Cost Accounting) UOK XYZ Company is producing lot No. CJQ which called for 2,500 dresses style No. 3B20 incurred costs as follows: Materials Rs.40 per dress. Rs.24 per dress. Rs.32 per dress. When the lot was completed, inspection rejected 20% spoiled dresses which were sold for Rs.60 each. (1) Journal entries if the loss is to be charged to lot No. CJQ. (2) Journal entries if the loss is to be charged to all production of the year. Question # 6: 2006 & 2007 Regular & Private (Cost Accounting) Sargodha A company has received an order for 2,500 shirts. It incurred the costs as follows: Material cost Rs.48 per unit. cost Rs.33 per unit. cost Rs.17 per unit. When the lot was completed, inspection rejected 200 spoiled shirts which were sold for Rs.65 each. (1) Journal entries if the loss is to be charged to the same job. (2) Journal entries if the loss is to be charged to all production of the year. Question # 7: 2005 Regular & Private (Cost Accounting) Bahawalpur ABC Company had a production run of 4,500 pairs of jeans during the last week of December with the following unit cost: Direct materials Rs.15.00 Direct labour Rs.14.00 Rs.13.50 Final inspection showed that 320 pairs were not up to standard. They were sold for Rs.7 each. (1) Journal entries if the loss is to be charged to the same job. (2) Journal entries if the loss is to be charged to all production of the year. Question # 8: 2013 Regular & Private (Cost Accounting) Punjab Production of an order consisting 800 units requires direct material of Rs.350,000 and direct labour of Rs.250,000. is applied at the rate of 80% of direct labour cost. After completion of the order, 16 units are classified as spoiled which can be sold for Rs.4,000. Customer takes delivery of remaining 784 good units and paid in cash the contracted prices at the rate of Rs.1,250 per unit. Spoiled units are sold and Rs.4,000 received in cash. Page 135
(1) Journal entries if the loss is charged to the order. (2) Journal entries if the loss is charged to factory overhead. Question # 9: 2005 Regular (Cost Accounting) UOK 20 units costing Rs.8,000 were rejected as spoiled units with salvage value of Rs.95 each, and 50 defective units were reworked at the following costs: Direct materials Rs.2,500; Direct labour Rs.1,500; 75% of prime cost. Entries in General Journal to allocate the losses to: (i) All jobs. (ii) Specific job. Question # 10: 2006 Regular & Private (Cost Accounting) Bahawalpur Kiran Crockery received an order for 50 units of a product. In anticipation of spoilage, production of 52 units was started. The following costs were incurred: Direct materials Rs.80 per unit. Direct labour Rs.50 per unit. 100% of direct labour. During inspection, 10 units were found defective and required the following additional cost: Direct materials Rs.10 per unit. Direct labour Rs.20 per unit. 100% of direct labour. On final inspection, 2 units were classified as spoiled and sold Rs.90 each. The good units were dispatched to the customer at a price of Rs.240 per unit. Pass journal entries to record completion of order, and sales of good and spoiled units under both of the assumptions as to charge of the additional cost. Page 136