PRODUCTION LOSSES IN JOB ORDER COSTING

Overview of Production Losses

It is normal for a manufacturing company to experience production losses. The incidence of

employee errors, technical failures, machine and human inefficiencies, low quality materials and
unusual occurrences can disrupt the flow of the production process and causes damages and
material cost within the company. But no matter how common and ordinary these losses are,
management should not tolerate it and continuous quality improvement must be maintained.

Improving and implementing different quality concepts that could enhance the efficiency of every
production will help the management to control the costs associated with these production losses.
Many of the manufacturing companies already aspire for the accreditation of international
standards as it proves to be beneficial and could help lower down any wastage that will affect the
product or period cost. However discussion of these costs of quality and improvements will be
taken up in your study of cost accounting part II.

This chapter will focus on how these production losses are treated if it happens during the
manufacture of goods under Job Order Costing system. Losses could be within normal or
abnormal limits.

Normal production losses are those acceptable levels of losses as defined by management.
Every manufacturing concern delineates its control limits. Every company may have different
definition of what is normal as it is dependent on their production process, quality consciousness,
any statistical process control methodology or just simply what is agreeable to the management.
It is important to note that any normal production losses are generally considered as part of the
cost of producing a product.

Abnormal production losses on the other hand, are those beyond the acceptable lee and is
considered and interpreted by management as an out of bound condition. The management
seeing this event must correct the circumstance immediately and must keep the production within
control limits. Any losses beyond the limit are charged to a loss account.

There are three (3) common types of production losses that may occur under job or costing (may
it be within normal or abnormal condition), namely: 1) scrap, 2) spoiled goods and 3) reworking
defective goods. The accounting treatment varies according to the type of losses involved.

ACCOUNTING FOR SCRAP

A scrap is a small piece of material, usually with a lesser value, that is left over after the rest has
been used. These are the residue or leftover from a manufacturing process resulting from fillings
or trimmings, defective materials that cannot be used or broken parts from a production process.
In many manufacturing processes, waste and scrap resulted from the processing of materials,
defective and broken parts, revision or abandonment of experimental projects, or from the use of
worn out machinery of equipment.

This scrap should be collected and placed in storage awaiting sale to scrap dealers, or other
industries that may find it useful. The amount realized from the sale of scrap and waste may be
credited to Scrap Sales account on the date of sale and generally individuals reported on the
income statement under Other Income if it is considered as an additional Terre of income for the

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company If such sale is considered as a primary Source of Income then it may be reported under
the Sales section of the income statement. Another alternative is to credit it to FOC account on
the date of sale, thus reducing the total factory overhead costs and cost of goods manufactured.
When scrap is collected from a job or department, the sales value of Scrap Materials is often
treated as a reduction in the Material cost charged to the individual jab, so you Credit Work in
Process account.

When the quantity and value of Scrap Materials is relatively high, it should be stored in a
designated place under the supervision of a storekeeper. A scrap report is generally prepared in
duplicate to authorize transfer and receipt of the scrap. Timely scrap reports for producing
department call attention to unexpected items and unusual amounts and could induce prompt
corrective actions.

WEEKLY SCRAP REPORT

Department: Fabricating For week ending: November 20, 2019

Part No. Description Units Used Scrapped % Scrap Cost Reason

218 d Braces 7,200 108 1.5 P 7.00

218 e Fine 9,400 305 3.23 30.50

218 s Guides 15,600 520 3.33 41.40

218 k Supports 8,500 42 0.05 25.30 Defective

Parts

Total for the Week P 104.20

Scrap Cost – Year to date 4,533.75

Predetermined Scrap Allowance for the Year 5,000

The original copy is forwarded to the material ledger clerk and a copy remains on file in the
department in which the scrap originated. The said clerk may either:

1. open material ledger card, filling in the quantity only. The peso value would not be needed;
or
2. record both the quantity and peso value of the scrap delivered to the storekeeper. Such
value would be based on scrap prices quoted on the market. So the entry will be:

Scrap Materials ----------------------------- xxx

Scrap Sales / WIP / FOC -------------------- xxx

Any difference between the price at the time the scrap Inventory was recorded and the price
realized on the date of sale would be a + or - adjustment to the account previously credited at the
time of storage.

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To reduce accounting for scrap to a minimum, often no entry is made until the scrap is actually
sold. This method is expedient and is justified when a more accurate account becomes expensive
and burdensome, the sales value is relatively small or the is uncertain.

To account for the sale of scrap, different accounting treatment is available. To illustrate, will use
the previous manufacturing company - the Raiborn Envelope International. Assume that there
were scrap materials arising from the current month's production due trimmings valued at P2,400.

(a) Recognizing Scrap as part of Scrap Sales or Other Income

At the time of sale, one of the simplest accounting treatments is recognizing the value
scrap as part of the revenue; hence the journal entry is:

Cash or Accounts Receivable ---------------------------- 2,400

Scrap Sales or Other Income ---------------------------- 2,400

(b) As Deduction to Cost of Goods Sold

The value from the sale of scrap can also be treated to reduce the cost of sale for the
period. The reduction to the product cost can result in an increase of the income having
the same effect as to the first method mentioned earlier. If such will be the case the
accounting entry would be as follows:

Cash or Accounts Receivable ------------------------------ 2,400

Cost of Goods Sold ------------------------------------------- 2,400

(c) Scrap Directly Attributable to a Specific Job

If a particular scrap can be directly traced to a particular job, the sale of such scrap wil be
used to reduce the cost of the material of that specific job, crediting the work in Process
account. The entry would have been:

Cash or Accounts Receivable------------------------------------ 2,400

Work In Process---------------------------------------------------- 2,400

If this entry was made, the amount credited to Work in Process must be reflected in the
Job Order Cost Sheet as a reduction in the Material cost of such job.

Furthermore, if the scrap is material and has a significant value, most of the manufacturing
companies do not immediately sell these items. It will be returned to the storeroom and be
held until such time that the market price for the scrap is high. In this case, Scrap Inventory
account will be debited and Work in Process account will be credited.

(d) Scrap Cannot be Traced to a Specific Job

If the P2,400 scrap cannot be identified to a particular job, such proceeds can be treated
as a deduction to Factory Overhead Control account. The scrap will be treated as
common to all jobs and this reduction must also appear in the Factory overhead

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analysis sheet (a subsidiary record) to make the proper adjustment. The entry would
have been as follows.

Cash or Accounts Receivable ----------------------------------- 2,400

Factory Overhead Control ------------------------------------- 2,400

The same with (c) if the scrap will have a significant value and are not sold immediately
after the production process, a debit to Scrap Inventory must be recorded and credit to
Factory Overhead Control account. When these items will be sold in the future, the Scrap
Inventory will be closed by crediting it and recognize Cash or Accounts Receivable for
the same amount.

However, since the scrap had been stored for a period of time, the value of the recorded
amount will be different when it will be sold in the future. If there are any differences, the
adjustment will depend if the scrap is directly attributable to specific job or not.

If the scrap will be traceable to a particular job, the value of the discrepancies will be
adjusted to Work in Process account but if it cannot be traced and is common to all jobs,
Factory Overhead Control (FOC) account shall be used.

Based on the previous example, if the scrap items have been stored and was sold for
P2,000 only, the journal entry would be:

Cash Accounts Receivable --------------------------- 2,000

Work in Process or Factory Overhead Control---- 400
Inventory------------------------------------------------ 2,400

Furthermore, there are also instances when the manufacturing companies will not sell
the scrap items but rather reuse it. When the item is returned to the storeroom and have
an intention to reuse it, Materials account is debited at its estimated net realizable value
rather than the Scrap Inventory Account.

When these scraps will be reused and issued to production, the entry to record the
issuance of direct material is debit to Work in Process account and credit to the Materials
account. Using the same example, if the scrap cannot be traced to a particular job and
reused, the journal entries will be:

Materials-------------------------------------------------- 2,400
Factory Overhead Control -------------------------- 2,400
To return the scrap to storeroom

Work in Process --------------------------------------- 2,400

Materials ------------------------------------------------ 2,400
To reuse the scrap

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 Attributable to a specific job: sales traced to
specific jobs that yielded scrap
MATERIAL
(sold quickly) Common to all jobs: sales reduce
manufacturing overhead – indirectly affect
At the time of the manufacturing overhead rate

sale of scrap

Memo of quantity and separate

IMMATERIAL line item of other revenues

Attributable to a job: Dr. Scrap

Inventory; Cr. WIP
At the time of the MATERIAL
production of scrap But not sold
Cannot be attributed to a job: Dr.
Scrap Inventory; Cr. FOH

Exhibit 3.1 Accounting for Scrap: Simplified

ACCOUNTING FOR SPOILED GOODS

Scrap and Spoilage differs because Scrap is usually cannot be avoided and normally incurred in
a specific manufacturing process. Spoilage, on the other hand, is avoidable unusual and do not
occur in every production run. If an item either partially or fully finished have some mutation that
is irreparable or if it can be repaired it will be costly and expensive, then the unit is classified as
Spoiled Goods.

There are two possible causes of spoilage (1) caused by the customer and (2) due to Internal
failure. Accounting treatment of the spoiled units under these two causes differs.

(1) Spoilage Caused by the Customer or Attributable to a Specific Job

If the spoilage occurs because the customer changes the specification or design particular order,
the cost of production loss will be charged fully to that specific job. However if the spoiled items
has a disposal value and can be resold, such amount will be deducted from the cost of that of that
job.

To illustrate, let us assume that Job #103 of Raiborn Envelope International calls for a production
of 25,000 pieces of A4 size white envelopes. After the first 10,000 pieces of envelopes, the
customer called up to change the envelope size from A4 to AS. The A4 size envelopes cannot be
used by the customer and uncorrectable to an acceptable condition. However, Raiborn can sell
these envelopes for P0.10 each, or total amount of P1,000. The company manufactured an
additional 10,000 pieces to meet the customer's order resulting to a total production of 35,000
pieces of envelopes (including the 10,000 A4 size). Total cost incurred for Job#103 is as follows:

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 Materials -------------------------------------------------P 45,000
Direct Labor ----------------------------------------------- 12,000
Factory Overhead --------------------------------------- 6,400
Total Job Cost P 64,000

To record the cost of the completed made to order job upon shipment to the customer:

Spoiled Goods Inventory------------------------------- 1,000

Cost of Goods Sold------------------------------------- 63,000
Work in Process------------------------------------------ 64,000

If Raiborn Envelope International provides a selling price of 120% of cost, Job# 103 will be billed
for (P63,000 x120%) P75,600. The journal entry to record the sale of Job #103 will be:

Cash or Accounts Receivable------------------------ 75,600

Sales--------------------------------------------------------- 75,600

(2) Spoilage Caused by Internal Failure or Common to All Jobs

If the spoilage is due to internal failure, like machinery or employee errors, the cost of the
production loss will be charged fully to Factory Overhead Control. However, if the spoiled goods
will have a disposal value it must be deducted first to the Factory Overhead Control Account so
that the value reflected will only be the unrecovered cost from the spoiled units. Furthermore if
the cost of the production loss is material and can distort the financial report, the amount should
be reported separately and accounted as a loss on the income statement

Using the same example above but instead of a change in customer's specification, an
employee's error took place. The employee's miscommunication to the production about the
Proper size of the envelopes resulted to spoilage. To account for this, compute first the unit of the
job by dividing the Total Cost of the Job by the total number of units produced (including the
spoiled goods). The cost per envelope will be P1.83 (P64,000/35,000 envelopes).

Multiply the cost per envelope by the number of spoiled envelopes to get the total cost of spoilage
which is P18,300 (10,000 spoiled goods x P1.83). However, the spoiled envelopes have a resale
value totaling P1,000 and this will be deducted from the total spoilage cost of P18,300 to get the
unrecovered cost of spoilage amounting to P17,300 and this amount will be charged to the Factory
Overhead Control (FOC) account.

To summarize, here is the compound entry of recording both the cost and the loss spoilage
(charged to FOC account) caused by internal failure and the transfer of completed Job#103
directly to CGS account:

Spoiled Goods Inventory---------------------------------------- 1,000

Factory Overhead Control -------------------------------------- 17,300
Cost of Goods Sold------------------------------------------------- 45,700
Work in Process-------------------------------------------------- 64,000

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So if Raiborn Envelope International sets a price of 120% of cost, Job#103 will be billed P54,840
(P45,700 cost x 120%). The journal entry will be:

Cash or Accounts Receivable----------------------------------- 54,840

Sales----------------------------------------------------------------- 54,840

ABNORMAL SPOILAGE

Spoilage beyond the acceptable level should be charged to a loss account and be part of the
period cost. This occurrence happens because of many reasons other than customers unusual
specification. Like for example poor adjustment of production line equirin resulting to substandard
finished products, inferior raw materials, production fire or explosion and other unusual events.
To record any abnormal spoilage, the applicable jouma entry would be

Loss from Abnormal Spoilage--------------------------------------------- xxx

Spoilage Inventory or Spoiled Goods ---------------------------------- xxx
Work in Process Inventory--------------------------------------------- xxx

POINTS TO PONDER!
 Normal spoilage attributable to a specific job job bears the cost of the spoilage
reduced by current disposal value of that spoilage.
 Normal spoilage common to all jobs: cost of spollage costed as manufacturing
overhead
 Abnormal spoilage: charged to an abnormal loss account
o Spoilage might occur at various stages of the production cycle, although
typically detected only at one or more inspection points
o Costs of spoiled units assumed to be all costs incurred by spoiled units prior
to inspection point
o Net cost of spoilage is difference between disposal value of spoiled units and
costs of the spoiled goods accumulated to inspection point
o Unit costs of normal and abnormal spoilage are same when two are detected
at same inspection point
o Costs of abnormal spoilage are separately accounted for as losses of the
accounting period in which they are detected Common approach: presume
normal spoilage occurs at inspection point and allocate cost over all units
that have passed that point

ACCOUNTING FOR REWORK COSTS

In the manufacturing processes, imperfections may arise because of faults in materials, labor or
machines. If the unit can be reprocessed on one or more stages and made into a standard
saleable product, it is often advantageous to rework the defective units.

A defective unit is a unit that does not originally meet product specifications, although it can be
reworked into a good unit of product. Unlike spoilage, defective units can be economically and

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technically corrected. Rework is the process of correcting defective units, The accounting
treatment for rework cost depends on the cause of rework:

1. If caused by the customer, then rework cost is charged to WIP.

2. If caused by an internal failure, then rework cost is charged to FOC.

If the defective work was a consequence of demanding nature of this particular job, then rework
cost is assigned to the job. If the defective work was a consequence of assigning how, untrained
labor to the job, the rework cost is charged to FOC account. The cost of Head units that cannot
be reworked are similarly charged to the job if caused by the demands of the job, and to FOC if
not.

(1) Rework Caused by the Customer or Attributable to Specific Job

If the defective item is caused by the customer, its cost will be charged to that particular job
resulting to the increase in the billing price. To illustrate, Raiborn Envelope International received
an order from the customer labeled as Job#110 for 25,000 pieces of A4 size white envelopes.
The total cost of the said production is as follows:

Materials ---------------------------------------------- P 45,000

Direct Labor ----------------------------------------------- 12,000
Factory Overhead --------------------------------------- 6,400
Total Job Cost P 64,000

However before the shipment, the customer decided to provide a security mark on every envelope
that can help every receiver of the mail to determine if the envelope has been previously opened
or not. As a result, a total additional cost is added equal to P 6,400 (comprising of P4,600 for
direct labor and P1,800 for factory overhead, no material has been added). The journal entry to
record the rework cost will be as follows:

Work in Process----------------------------------------- 6,400

Payroll --------------------------------------------------- 4,600
Applied Factory Overhead -------------------------- 1,800

The total cost for Job#110 will now be P70,400, consisting of P64,000, the original cost and
P6,400 rework cost. If Raiborn will sell the said items with the mark up of 20% of cost, the journal
entries to record the cost and the sales are as follows:

Cost of Goods Sold----------------------------------------- 70,400

Work in Process---------------------------------------------- 70,400

Cash or Accounts Receivable--------------------------- 84,480

Sales------------------------------------------------------------ 84,4804
P70,400 x 120%

(2) Rework Caused by an Internal Failure or Charged to All Jobs

If the defective units are caused by an internal failure, the cost of the rework will be charged to
manufacturing overhead and it will be spread throughout the job. The same example as above,
however instead of customer change of specification and error was made by the employees, in

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such case the journal entry to record the additional cost will not be charged to Work in Process
but through Factory Overhead Control as summarized below:

Factory Overhead Control -------------------------------------- 6,400

Payroll--------------------------------------------------------------- 4,600
Applied Factory Overhead ------------------------------------ 1,800

However, when Job#110 will be sold to customer the original cost of the job will be reflected as
the total production cost ignoring the rework cost. The effect of the additional rework cost will only
be in the computation of the predetermined factory overhead rate. To record the cost of goods
sold and the sale of the items with 20% markup based on cost will be:

Cost of Goods Sold ------------------------------------------------ 64,000

Work in Process --------------------------------------------------- 64,000

Cash or Accounts Receivable ------------------------------------ 76,600

Sales ---------------------------------------------------------------- 76,600
P 64,000 x 120%

Abnormal Rework

Rework costs that exceed the control limits are charged to a loss account called Loss from
Abnormal Rework, which is a period cost. Conceptually, the approach is the same as that used
for abnormal spoilage.

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COMPARISON OF ENTRIES

PROCESS COSTING JOB ORDER COSTING

(Common to all production) Specific Job Common to All
Spoilage
Loss from Abnormal
Abnormal Loss from Abn. Sp. Loss from Abn. Sp.
Spoilage
Work in Process WIP WIP

Normal Finished Good --No Entry-- Factory OH Control

Work in Process (stays in WIP) WIP

Rework
Abnormal Loss from Abnormal Rework Loss from Abn. Rework Loss from Abn. Rework
Materials Materials Materials
Payroll Payroll Payroll
Applied Factory OH Applied Factory OH Applied FOH

Normal Factory Overhead Control WIP Factory OH Control

Materials Materials Materials
Payroll Payroll Payroll
Applied Factory OH Applied Factory OH Applied FOH

Scrap
At Sale Cash (Accounts Receivable) Cash (A/R) Cash (A/R)
Factory OH Control WIP Factory OH Control

Materials Materials Materials

Factory OH Control WIP Factory OH Control

(Source: Cost Accounting by Horngren, 2009 ed.)

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TERMINOLOGIES

Abnormal loss: A loss of units in excess of expected levels (normal loss) during production;
normal losses are part of the cost of the job, while abnormal losses are written off as a period
cost.

Normal loss: A loss of units that falls within a tolerance level that is expected during production;
normal losses are part of the cost of the job, while abnormal losses are written off as a period
cost.

Rework units: Defective goods which can still be reprocessed to meet the production standards
by using additional materials, labor or overhead.

Scrap: A small piece of material, usually with a lesser value, that is left over after the rest has
been used

Spoilage: Production process errors that cause a loss of units through rejection at inspection for
failure to meet appropriate quality standards or designated product specifications that cannot be
economically reworked

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