Losses of materials may arise during handling, storage or during process of manufacture. Such losses may be classified into two categories, i.e. normal loss and abnormal loss. Normal loss is that loss which has necessarily incurred and thus is unavoidable. Examples:
- Loss by evaporation
- Loss due to loading and unloading
- Loss due to breaking the bulk, etc.
Normal losses of material cannot be completely avoided but may be controlled to a limited extent.
Abnormal loss is that loss which arises due to inefficiency in operations, mischief, carelessness, etc. Examples
- Theft or pilferage
- Breakage
- Fire, accident, flood, etc.
- Use of inaccurate instruments
- Improper storage, etc.
Accounting Treatment
As a principle, all normal losses which are necessarily incurred are treated as a part of the cost and abnormal losses should not be included in the cost. In order to absorb normal material losses in cost, the rates of usable units are inflated so that such losses are absorbed. Alternatively, normal material loss is transferred to factory overhead. However abnormal loss of material is charged to Costing Profit and Loss account.
Materials losses may arise in the form of waste, scrap, spoilage or defectives.
Waste: Waste comprises of invisible loss, visible loss that cannot be collected and also the unsalable portion of the collected loss. Waste is excluded from output quantity. Examples of waste are smoke, dust, gases, slag, etc.
In certain cases, the waste involves further costs of disposing it, e.g., cost incurred for disposal of effluent, obnoxious gases etc.
Accounting Treatment: Standards are established for waste. Actual wastage is recorded and variation from standards is reported.
- Normal Waste: This is unavoidable and uncontrollable and treated as part of the product cost. The wastage cost is borne by the good units.
- Abnormal Waste: It is valued as if the output is good. This cost is transferred to the Costing Profit and Loss Account.
Sometimes a demand may arise for the waste, e.g., it may be used as a substitute raw material. The selling price has to be suitably fixed on the basis of the market value of the raw material substituted.
Scrap
Scrap represents the unusable loss which can be sold. It is a residue which is measurable and has a minor value. It may result from the processing of materials, obsolete stock or defective parts. The sale value is credited to the concerned department which produced it. If the value is negligible, it is credited to the Costing Profit and Loss Account.
Scrap may arise in the form of turnings, boring’s, filings etc. from metal; sawdust in timber industry, off-cuts and cut pieces in leather industry.
A committee may be constituted which classifies the various types of scrap, calculates their value and quantity and also determine the method of use/disposal.
Accounting Treatment
- Where the scrap has negligible value, it is charged to good units. Income is credited to other income.
- The sale value can be reduced from the material cost.
- If the scrap has very little value, only a quantity record need be kept.
- The cost is calculated by reducing the sale price by the selling cost and this sum is taken as a credit to the production overhead account.
- Scrap arising in one job may be used in another. Such transfers should be properly recorded on material transfer notes.
The actual quantity of scrap is compared with the standard quantity. Excess scrap is investigated so that corrective action can be taken. At the designing stage, such a type, form and shape of material are chosen which will minimize the waste/scrap. Best equipments should be used and personnel should be properly trained.
Spoilage
Spoilage is those materials or components which are so damaged in the manufacturing process that they cannot be repaired or reconditioned. Some spoilage may be sold as seconds. If they are badly spoiled they can be sold as waste or scrap. Spoiled units do not attain the quality required and it is not economic to correct them.
Spoilage occurs due to some defect in operations or materials. Sometimes the entire production in a batch may have to be rejected or a part of it may be rejected.
Accounting Treatment
- Loss due to spoilage can be debited to the job/product/process in which it occurred.
- It may be charged to factory overheads so that the loss is borne by all products.
- Abnormal loss which is unexpected but controllable should be transferred to the Costing Profit and Loss Account.
If spoilage occurs on a specific job/special order, it is charged to that job itself. Sometimes loss is prorated on the basis of percentage of scrap anticipated from each job.
The method of apportionment of spoilage between normal and abnormal is explained below:
Total input 5,000 units
Normal spoilage 5% of units
Total spoiled unit’s 550 units
Total Cost 10,000
Sale value of spoilage 0.50 per units
Standard output input less 5% of spoilage
4,750 units
Cost of abnormal spoilage 10,000 – (250 x 0.5) x 300
4,750
10,000 – 125 x300 = 623.68
4,750
Net cost of abnormal spoilage 623.68 – (300 x 0.50) = 473.68
The cost of abnormal spoilage is charged to Costing Profit and Loss Account and sale value is credited to Costing Profit and Loss Account.
The cost of normal spoilage is charged as product cost
Unit cost of production = (Rs. 10,000 – 125 – 623.68) / 5,000 – 550
= (Rs. 9251.32) /4,450 = Rs. 2.0789
Defectives
Defectives are that portion of the process loss which can be converted into a finished product by incurring more material and labour expenses. The additional expenses are added to the cost of manufacture and the rectified units to total units. Imperfections may arise because of sub-standard materials, bad workmanship, inadequate inspection, lack of plans, etc. It should be ensured that the benefit resulting from rectification is more than the cost incurred on rectifications.
Rectification of defective units may be done by the department in which it was produced. In larger concerns a separate Department may be set up for this purpose.
Accounting Treatment
- Defectives inherent in the manufacturing process are classified as normal and treated in the following manner:
- The loss is charged to good products.
- The additional cost of rectification is charged to factory overheads and apportioned to various goods as part of the factory overhead.
- If a particular department is responsible for the additional cost of rectification, it can be charged to that department.
- If the defective units can be traced to a specific job/order, the additional costs can be charged to that job/order.
- If the defectives are abnormal and due to uncontrollable factors, the additional costs are charged to Costing Profit and Loss Account.
In many concerns, inefficient and bad workmanship results in defective units. To minimize defective work, suitable financial and non-financial incentives based on the quantity or percentage reduction in defective work should be provided.
