Cost Accounting Procedure for Spoiled Goods:

Cost accounting should provide product costs and cost control information. In the case of spoilage, the first requirement is to know the nature and cause of the spoiled units.

The second requirement, the accounting problem is to record the cost of spoiled units and to accumulate spoilage costs and report them to responsible personnel for corrective actions.

Attaining the degree of materials and machine precision and the perfection of labor performance necessary to eliminate spoiled units entirely would involve costs far in excess of a normal or tolerable level of spoilage. If spoilage is normal and happens at any time and at any stage of the productive process, its cost should be treated as factory overhead, included in the predetermined factory overhead rate, and prorated overall production of a period. If, on the other hand, normal spoilage is caused by exacting specifications, difficult processing, or other unusual and unexpected factors, the spoilage cost should be charged to that order. In either cause, the cost of abnormal spoilage should be charged to factory overhead.

Example:

Spoiled materials charged to total production: The Nevada Products company has a monthly capacity to manufacture 125,000 three inch coil springs for use in mechanical brakes. Production is scheduled in response to orders received. Spoilage is caused by a variety of unpredictable factors and averages $0.05 per spring. During November, 100,000 springs were produced with a materials cost of $40 per unit, a labor cost of $50 per unit, and factory overhead charged to production at a rate of 150% of the direct labor cost. This rate is based an estimate that includes $0.05 per spring for spoilage. The entry to record work put into production during the month is:

On the last working day of the month, the entry days production of 4000 units are spoiled due to improper heat treatment; however, theses units can be sold for $50 each in the second hand market. To record this normal loss on spoiled goods and the possible resale value, the entry that charges all production during the period with proportionate share of the spoilage is:

The materials, labor, and factory overhead in the spoiled units reduced by the recovery or sales value of these units ($1,600 materials+ $2000 labor + $3,000 factory overhead – $2000 cost recovery = $4,600 spoilage loss) is relocated or transferred from work in process to factory overhead control. Each of the 96,000 good units produced during the month has a charged in cost of $0.05 for spoilage (96,000 × $0.05 = $4,800); the actual spoilage during the period is $4,600.

The good units produced during the week are on the order where spoilage did occur carry a cost of $0.40 for materials, $0.5 for labor, and $0.75 for overhead because spoilage is charged to all production–not to the lot or order which happens to be in process at the time of spoilage. In other words, the $165,000 monthly production cost less the $6,600 credit resulting from spoiled units levels $158,400 to be divide by the 996,000 good units manufactured during the month at a cost of $1.65 per good unit. The entry transferring the good units to finished goods is:

During the month, the amounts charged to factory overhead control represent the depreciation, insurance, taxes, indirect materialsand indirect labor actually experienced, along with the $4,600 spoilage cost. All production during the month is charged with overhead of $0.75 per unit. Over head analysis reveals a $200 favorable variance ($4,600 actual minus $4,800 applied) attributable to the spoilage units. Any difference between the price when the inventory was recorded and the price realized at the time of sale would be a plus or minus adjustment to factory overhead control (loss on spoiled goods).

For effective cost control normal spoilage rates and amounts should be established for each department and for each type of class of materials. Weakly or monthly spoilage reports similar to the scrap report illustrated on scrap and waste page.

Spoiled materials charged to a particular job: The Nevada Products Company has contract to manufacture 10,000 heavy duty coil springs for the Tri-state Supply Company. This order requires a steel wire that is harder and slightly heavier than stock normally used, but the production process, as well as labor time and overhead factors, is identical with the standard product. Materials cost for each of these springs is $0.60 this special order requires exacting specifications, and normal spoilage is to be charged to the order. The $0.050 per unit spoilage factor is now eliminated from the overhead rate, and 140% of direct labor cost, and $0.70 per unit, is the rate used on this job. The order is put into production the first day of December, and sampling during the first hour of production indicates that eleven units of production are required to secure ten good springs. Entries to record costs placed into production for 11,000 units are:

One thousand units did not meet specifications and are spoiled but can be sold as seconds for $0.45 per unit. The entry to record the spoilage is:

The net result of this treatment is to charge the spoilage loss of $1,350 ($1,800 less $450 cost recovery) to 10,000 good units that are delivered at the original contract price. The unit cost of completed springs is $1,935 ($19,350 / 10000 units).

Any difference between the price when the inventory was recorded and the price realized at the time of sale should be an adjustment to work in process, finished goods, or cost of goods sold, depending on the completion status of the particular job order. as an expedient, the difference might be closed to factory overhead control.

You may also be interested in other useful articles from “controlling and costing materials” chapter:

1. Purchases of productive material
2. Purchases of supplies, services, and repairs
3. Materials purchasing forms
4. Receiving materials
5. Invoice approval and data processing
6. Correcting invoices
7. Electronic data processing (EDP)  for materials received and issued
8. Cost of acquiring materials
9. Storage and use of materials
10. Issuing and costing materials into production
11. Materials ledger card – perpetual inventory
12. First-in-First-Out (FIFO) Costing Method
13. Average Costing Method
14. Last-in-First-Out (LIFO) Costing Method
15. Other Methods-Month end average cost, last purchase price or market price at date of issue, and standard cost
16. Inventory valuation at cost or market whichever is lower
17. American Institute of Certified Public Accountant (AICPA) cost or market rules
18. Adjustments for departures from the costing method used
19. Inventory pricing and interim financial reporting
20. Transfer of materials cost to finished production
21. Physical inventory
22. Adjusting Materials Ledger Cards and Accounts to Conform to Inventory Accounts
23. Scrap and waste
24. Spoiled goods
25. Defective work
26. Discussion Questions and Answers about Controlling and Costing Materials

Other Related Accounting Articles:

• Transfer of Materials Cost to Finished Production–Inventory Valuation
• First In First Out (FIFO) – Materials and Inventory Costing Method
• Cost Accounting Procedure for Scrap and Waste
• Physical Inventory – Inventory Valuation
• Product Cost or Manufacturing Cost
• Invoice Approval and Data Processing
• Issuing and Costing Materials into Production
• Receiving Materials
• Other Materials Costing Methods – Month End Average Cost | Market Price at Date of Issue | Standard Cost
• Cost or Market Whichever is Lower–Inventory Valuation