SPOILAGE, REWORK AND SCRAP
SPOILAGE,
REWORK AND SCRAP IN GENERAL
SPOILAGE
Spoilage is units of
production - whether fully or partially completed—that do not meet the
specifications required by customers for good units and that are discarded or sold
at reduced prices. Some examples of spoilage are defective shirts, jeans,
shoes, and carpeting sold as “seconds,” or defective aluminum cans sold to
aluminum manufacturers for remelting to produce other aluminum products.
REWORK
Rework is units of production
that do not meet the specifications required by customers but that are
subsequently repaired and sold as good finished units. For example, defective
units of products (such as pagers, computers, and telephones) detected during
or after the production process but before units are shipped to customers can
sometimes be reworked and sold as good products.
SCRAP
Scrap is residual
material that results from manufacturing a product. Examples are short lengths
from woodworking operations, edges from plastic molding operations, and frayed
cloth and end cuts from suit-making operations. Scrap can sometimes be sold for
relatively small amounts. In that sense, scrap is similar to by-products. The
difference is that scrap arises as a residual from the manufacturing process,
and is not a product targeted for manufacture or sale by the firm.
Some amounts of spoilage,
rework, or scrap are inherent in many production processes. For example,
semiconductor manufacturing is so complex and delicate that some spoiled units
are commonly produced; usually, the spoiled units cannot be reworked. In the
manufacture of high-precision machine tools, spoiled units can be reworked to
meet standards, but only at a considerable cost. And in the mining industry, companies
process ore that contains varying amounts of valuable metals and rock. Some amount
of rock, which is scrap, is inevitable, but its volume can often be decreased.
DIFFERENT
TYPES OF SPOILAGE
Accounting for spoilage aims to determine the extent of spoilage
costs and to distinguish between costs of normal and abnormal spoilage. To
manage, control, and reduce spoilage costs, companies need to highlight them,
not bury them as an unidentified part of the costs of good units manufactured.
To illustrate normal and abnormal spoilage, consider Mendoza
Plastics, which makes casings for the iMac computer using plastic injection
molding. In January 2012, Mendoza incurs costs of $615,000 to produce 20,500
units. Of these 20,500 units, 20,000 are good units and 500 are spoiled units.
Mendoza has no beginning inventory and no ending inventory that month. Of the
500 spoiled units, 400 units are spoiled because the injection molding machines
are unable to manufacture good casings 100% of the time. That is, these units
are spoiled even though the machines were run carefully and efficiently. The remaining
100 units are spoiled because of machine breakdowns and operator errors.
Normal Spoilage
Normal spoilage is
spoilage inherent in a particular production process. In particular, it arises
even when the process is operated in an efficient manner. The costs of normal spoilage
are typically included as a component of the costs of good units manufactured, because
good units cannot be made without also making some units that are spoiled. There
is a trade-off between the speed of production and the normal spoilage rate.
Management makes a conscious decision about how many units to
produce per hour with the understanding that, at the rate decided on, a certain
level of spoilage is almost unavoidable. For this reason, the cost of normal
spoilage is included in the cost of the good units completed. At Mendoza
Plastics, the 400 units spoiled because of the limitations of injection molding
machines and despite efficient operating conditions are considered normal
spoilage. The calculations are as follows:
Manufacturing
cost per unit, $615,000/20,500 units = $30
Manufacturing
costs of good units alone, $30 per unit*20,000 units $600,000
Add:
Normal spoilage costs, $30 per unit * 400 units 12,000
Manufacturing
costs of good units completed (includes normal spoilage) $612,000
Manufacturing
cost per good unit = $612,000 / 20000 units = $30.60
Because normal spoilage is the spoilage related to the good units
produced, normal spoilage rates are computed by dividing units of normal
spoilage by total good units completed, not total actual units
started in production. At Mendoza Plastics, the normal spoilage rate is therefore
computed as 400/20,000 = 2%.
Abnormal Spoilage
Abnormal spoilage is spoilage that is
not inherent in a particular production process and would not arise under
efficient operating conditions. If a firm has 100% good units as its goal, then
any spoilage would be considered abnormal. At Mendoza, the 100 units spoiled
due to machine breakdowns and operator errors are abnormal spoilage.
Abnormal
spoilage is usually regarded as avoidable and controllable. Line operators and other
plant personnel generally can decrease or eliminate abnormal spoilage by identifying
the reasons for machine breakdowns, operator errors, etc., and by taking steps
to prevent their recurrence. To highlight the effect of abnormal spoilage
costs, companies calculate the units of abnormal spoilage and record the cost
in the Loss from Abnormal Spoilage account, which appears as a separate line
item in the income statement. At Mendoza, the loss from abnormal spoilage is
$3,000 ($30 per unit*100 units).
JOB COSTING AND SPOILAGE
The concepts of normal and abnormal spoilage also apply to job-costing
systems. Abnormal spoilage is separately identified so companies can work to
eliminate it altogether. Costs of abnormal spoilage are not considered to be
inventoriable costs and are written off as costs of the accounting period in
which the abnormal spoilage is detected. Normal spoilage costs in job-costing
systems—as in process-costing systems—are inventoriable costs, although
increasingly companies are tolerating only small amounts of spoilage as normal.
When assigning costs, job-costing systems generally distinguish normal spoilage
attributable to a specific job from normal spoilage common to all jobs.
Example 1: In the Hull Machine Shop, 5
aircraft parts out of a job lot of 50 air- craft parts are spoiled. Costs
assigned prior to the inspection point are $2,000 per part. When the spoilage
is detected, the spoiled goods are inventoried at $600 per part, the net
disposal value. Our presentation here and in subsequent sections focuses on how
the $2,000 cost per part is accounted for.
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. The journal entry to recognize disposal value (items in
parentheses indicate subsidiary ledger postings) is as follows:
Materials Control
(spoiled goods at current net disposal value): 5 units* $600 per unit 3,000
Work-in-Process Control (specific job): 5 units *$600 per unit 3,000
Note,
the Work-in-Process Control (specific job) has already been debited (charged) $10,000
for the spoiled parts (5 spoiled parts*$2,000 per part). The net cost of normal
spoilage $7,000 ($10,000-$3,000), which is an additional cost of the 45 (50-5)
good units produced. Therefore, total cost of the 45 good units is $97,000,
comprising $90,000 (45 units*$2,000 per unit) incurred to produce the good
units plus the $7,000 net cost of normal spoilage. Cost per good unit is
$2,155.56 ($97,000/45 good units).
Normal Spoilage Common to All Jobs
In some cases, spoilage may be considered a normal
characteristic of the production process. The spoilage inherent in production
will, of course, occur when a specific job is being worked on. But the spoilage
is not attributable to, and hence is not charged directly to, the specific job.
Instead, the spoilage is allocated indirectly to the job as manufacturing
overhead because the spoilage is common to all jobs. The journal entry is as
follows:
Materials
Control (spoiled goods at current disposal value): 5 units * $600 per unit 3,000
Manufacturing
Overhead Control (normal spoilage): ($10,000 - $3,000) 7,000
Work-in-Process Control (specific job): 5 units * $2,000 per
unit 10,000
When normal spoilage is common to all jobs, the budgeted
manufacturing overhead rate includes a provision for normal spoilage cost.
Normal spoilage cost is spread, through overhead allocation, over all jobs
rather than allocated to a specific job. For example,
if Hull produced 140 good units from all jobs in a given month, the $7,000 of
normal spoilage overhead costs would be allocated at the rate of $50 per good
unit ($7,000/140 good units). Normal spoilage overhead costs allocated to the
45 good units in the job would be $2,250 ($50*45 good units). Total cost of the
45 good units is $92,250, comprising $90,000 (45 units*$2,000 per unit)
incurred to produce the good units plus $2,250 of normal spoilage overhead
costs. Cost per good unit is $2,050 ($92,250/45 good units).
Abnormal Spoilage
If the spoilage is abnormal, the net loss is charged to the Loss
from Abnormal Spoilage account. Unlike normal spoilage costs, abnormal spoilage
costs are not included as a part of the cost of good units produced. Total cost
of the 45 good units is $90,000 (45 units*$2,000 per unit). Cost per good unit
is $2,000 ($90,000/45 good units).
Materials
Control (spoiled goods at current disposal value): 5 units * $600 per unit 3,000
Loss
from Abnormal Spoilage ($10,000 - $3,000) 7,000
Work-in-Process Control (specific job): 5 units * $2,000 per
unit 10,000
Even
though, for external reporting purposes, abnormal spoilage costs are written
off in the accounting period and are not linked to specific jobs or units,
companies often identify the particular reasons for abnormal spoilage, and,
when appropriate, link abnormal spoilage with specific jobs or units for cost
management purposes.
REWORK
Rework is units of production that are inspected, determined to
be unacceptable, repaired, and sold as acceptable finished goods. It distinguish
(1) normal rework attributable to a specific job, (2) normal rework common to
all jobs, and (3) abnormal rework.
Consider the Hull Machine Shop data in Example 2. Assume the
five spoiled parts are reworked. The journal entry for the $10,000 of total
costs (the details of these costs are assumed) assigned to the five spoiled
units before considering rework costs is as follows:
Work-in-Process
Control (specific job) 10,000
Materials Control 4,000
Wages Payable Control 4,000
Manufacturing Overhead Allocated 2,000
Assume
the rework costs equal $3,800 (comprising $800 direct materials, $2,000 direct manufacturing
labor, and $1,000 manufacturing overhead).
Normal Rework Attributable to a Specific
Job
If
the rework is normal but occurs because of the requirements of a specific job,
the rework costs are charged to that job. The journal entry is as follows:
Work-in-Process
Control (specific job) 3,800
Materials Control 800
Wages Payable Control 2,000
Manufacturing Overhead Allocated 1,000
Normal Rework Common to All Jobs
When
rework is normal and not attributable to a specific job, the costs of rework
are charged to manufacturing overhead and are spread, through overhead allocation,
over all jobs.
Manufacturing
Overhead Control (rework costs) 3,800
Materials Control 800
Wages Payable Control 2,000
Manufacturing Overhead Allocated 1,000
Abnormal Rework
If
the rework is abnormal, it is recorded by charging abnormal rework to a loss
account.
Loss
from Abnormal Rework 3,800
Materials Control 800
Wages Payable Control 2,000
Manufacturing Overhead Allocated 1,000
ACCOUNTING FOR SCRAP
Scrap is residual material that results from manufacturing a product;
it has low total sales value compared with the total sales value of the
product. 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.
There
are two aspects of accounting for scrap:
1.
Planning and control, including physical tracking
2.
Inventory costing, including when and how scrap affects operating income
Initial entries to scrap records are commonly expressed in
physical terms. In various industries, companies quantify items such as
stamped-out metal sheets or edges of molded plastic parts by weighing,
counting, or some other measure. Scrap records not only help measure
efficiency, but also help keep track of scrap, and so reduce the chances of
theft. Companies use scrap records to prepare periodic summaries of the amounts
of actual scrap compared with budgeted or standard amounts. Scrap is either
sold or disposed of quickly or it is stored for later sale, disposal, or reuse.
To
illustrate, we extend our hull example. Assume the manufacture of aircraft
parts generates scrap and that the scrap from a job has a net sales value of
$900.
Recognizing Scrap at the Time of Its Sale
When the dollar amount of scrap is immaterial, the simplest
accounting is to record the physical quantity of Scrap returned to the
storeroom and to regard scrap sales as a separate line item in the income
statement. The journal entry is
Sale
of scrap:
Cash
or accounts receivable 900
Scrap revenues 900
When the dollar amount of scrap is material and the scrap is
sold quickly after it is produced, the accounting depends on whether the scrap
is attributable to a specific job or common to all jobs.
1. Scrap Attributable to a Specific Job
Job-costing systems sometimes trace the
scrap revenues to the jobs that yielded the scrap. This method is used only when
the tracing can be done in an economically feasible way. For example, the hull
machine shop and particular customers, such as the US. Department of defense,
may reach an agreement that provides for charging specific jobs with all rework
or spoilage costs and for crediting these jobs with scrap revenues that arise
from the jobs. The journal entry is
Scrap returned to storeroom: No entry.
[Notation
of quantity received and related job is entered in the inventory record]
Sale of scrap: Cash or accounts receivable 900
Work-in-process
control 900
Unlike spoilage and rework, there is no
cost assigned to scrap and hence no distinction is made between normal and
abnormal scrap. All scrap revenues, whatever the amount, are credited to the
specific job. Scrap revenues reduce the costs of the job.
2. Scrap common to all jobs
The journal entry is
Scrap returned to storeroom: No entry.
[Notation of
quantity received and related job is entered in the inventory record]
Sale of scrap: Cash or accounts receivable 900
Manufacturing
overhead control 900
All products bear production costs
without any credit for scrap revenues except in an indirect manner. Expected
scrap revenues are considered when setting the budgeted manufacturing overhead
rate, thus it is lower than it would be if the overhead budget had not been
reduced by expected scrap revenues. This accounting for scrap is used in both
job costing and process costing systems.
Reference:
Horngren, Datar & Rajan - Cost
Accounting: A Managerial Emphasis.