Accounting For Losses

In process costing, we can often found the output from a process is less than the input. Where the output from a process is less than the input, there is therefore a loss.

Basically there are two types of losses in Process Costing: 1. 2. Normal loss Abnormal Loss Normal Loss Normal loss is unavoidable losses arising due to the nature of the material or the process

The reasons for such loss in output can be due to the following:

Evaporation; Breakage;

Scrap due to high quality needed; Rejection on inspection;

Defective Units;

Loss inherent in large scale manufacturing; Chemical change Residue Material

Examples of normal losses are metal turnings, off-cuts, metal borings, edges, shreddage and ends.

The quantity of normal loss anticipated is determined from past experience and from the material specification. The cost of normal loss is absorbed by the completed output. The value of scrap of normal loss units is deducted from the direct

material cost. Normal loss never receives a share of the process cost.

Treatment of Normal Loss are as follows: 1. Where the loss has NO scrap value:-

The quantity of loss is credited to the process account. The good output bears the cost of the expected/normal loss

2.

Where the loss has SCRAP value:-

Deduct the scrap value from the process cost;

Open a Normal Loss account and debit the quantity and value of the loss and credit the process account with the scrap value when it is sold 3. Scrap that needs to be REWORKED in that process or in an earlier process:-

Credit the process account and debit stock account with the value of the raw material/input entering the process or with the market price of such scrap. 4. Scrap value is small:-

Credit Scrap Sales account and regard the sale as a profit. ILLUSTRATION ofNormal LossFor Company A which manufactured

drink, the production manager usually experiences a 10% loss of direct materials in the production process. In August 07 the details/data are as follows: Inputs: $

Direct materials(2,000 litre)

18,000

Direct labor

17,000

Overheads Required: (a) compute the number of litre lost in the process; (b) compute the cost per litre of drink produced; (c) write up the process cost account

12,000

Solution: (a) The number of litres lost in the process:

=Total direct materials x % loss=2,000 x 10%=200 (b) The cost per litre of drink is computed as follows: =Total Cost/Total output =$47,000/1,800 litres =$26.11 per litre Notes: Total Cost=(Sum of direct costs plus overheads) Total Output=2,000litre x (100-10%) =1,800 litres Process Cost Account as follows:

Dr

Cr

Litres

Litres

Direct materials

2,000

18,000

Normal loss

200

Labor

17,000

Output

1,800

47,000

Overheads

12,000

2,000

47,000

2,000

47,000

1. (a) Normal spoilage arises under normal, efficient operating conditions; i.e., it is

inherent in the production process and is uncontrollable in the short run. Abnormal spoilage is not expected under the normal, efficient operating conditions; i.e., it is not inherent in the production process and management usually considers it avoidable or controllable. Thus, by definition, the critical factor in distinguishing between normal and abnormal spoilage is the degree of controllability of units spoiled. Any spoilage that occurs during a production process functioning within the expected usual range of performance is considered normal. Any spoilage occurring in amounts in excess of the defined usual range is considered abnormal (controllable). (b) Conceptually the cost of normal loss should be included in the cost of good units produced because of its association with normal production. Likewise, the cost of abnormal loss should be accounted for as a loss because of its abnormal unusual nature and should be separately identified as a loss on reports for management. For practical reasons, there may be no distinction between normal and abnormal loss in reports for management, since it is sometimes very difficult (or impossible) to do so. The production process may be relatively new or the process may be altered often enough to make such a distinction impractical or too costly. Whenever possible, however should be made and accounted for as discussed in the preceding paragraphs.