Chapter Summary

This chapter covers the accounting treatment for shrinkage, defective and spoiled units, and accretion of units in a process costing system. Management typically specifies a certain level of shrinkage/defects/spoilage that will be tolerated as normal if a loss of units is commonly anticipated. If lost units exceed that expectation, the excess is considered an abnormal loss. Normal losses are product costs, and abnormal losses are period costs.

To account for the cost of lost units, the location of the loss within the process must be known in addition to knowing whether the quantity of lost units is normal or abnormal. If the loss point is continuous, the period's good production absorbs the cost of the lost units. This treatment is handled in the cost of production report by not extending the lost units to the equivalent units columns. If the loss point is discrete, lost units are included in the EUP schedule at their unit equivalency at the quality control point. If ending inventory has reached the inspection point, the cost of the lost units is allocated both to units transferred from the department and units in ending inventory. If ending inventory has not yet reached the quality control inspection point, the lost unit cost attaches only to the units transferred.

In a job order costing system, the cost of anticipated defects/spoilage is estimated and included in setting the predetermined overhead rate. This approach allows expected cost of lost units to be assigned to all jobs. When lost units occur, any disposal value of those units is carried in a separate inventory account; the net cost of defects/spoilage is debited to Manufacturing Overhead. If lost units do not generally occur in a job order system, any normal defects/spoilage associated with a specific job is carried as part of that job's cost; the disposal value of such units reduces the cost of the specific job.

Treatment of the rework cost for defective units depends on whether the rework is normal or abnormal. If rework is normal, the cost is considered to be a product cost and either (1) increases actual costs in the cost schedule or (2) is considered in setting an overhead application rate and charged to overhead when incurred. If rework is abnormal, the cost is assigned to the period as a loss.

Adding material to partially completed units may increase the number of units. If the material addition occurs in a successor department, a new transferred-in cost per unit must be calculated using the increased number of units. If units of measure change between the start and end of production, a consistent measuring unit must be used in the cost of production report to properly reflect production of the period.

Accounting for spoiled and defective units is essential when total quality does not exist. The traditional methods of accounting for spoilage often "bury" the cost of poor quality by spreading that cost over good output. Managers should attempt to compute the costs of spoiled or defective units and search for ways to improve product quality, reduce product cost, and increase the company's competitive market position.

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