Wednesday, July 18, 2018

Spoilage, Rework and Scrap in Job costing



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.

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