Chapter 6 – Accounting for Production Losses

LEARNING OBJECTIVES
After completing this module, you should be able to
know the following:
1. What are the types of production losses?
2. How to account production losses under job-order
costing system?
3. How to account production losses under process
costing system?
On the production set-up, it is a usual incident that units being produced do not meet
production standards and specifications. Thus, a need for either repair, reprocess or
just be thrown out since such production loss does not have another remedy option.

Types of Production Spoilage/Losses

1. Normal Spoilage
These are type of production spoilage that are inherent and inevitable,
thus, expected in the production process even if the production
process is operating efficiently.
Amount incurred in normal spoilage are treated as part of product
costs.

2. Abnormal Spoilage
These are type of production spoilage that are not expected on a
production process that is operating efficiently.
Amount incurred in abnormal spoilage are treated as an outright
expense, thus, it is considered as period costs.

Accounting for Production Losses under Job-Order Costing System

In a job order costing, normal losses are accounted depending on whether
such losses are anticipated on all jobs or specifically identified on a
particular job.
It should be noted further, that abnormal losses are expensed outright.

Normal Loss as Anticipated on All Jobs

Since normal losses are part of a product cost, the predetermined overhead
rate should include the amount of such losses because this methodology
assumes that losses are inherent, thus, cannot be avoided in any production
set-up. With this, predetermined overhead rate is calculated as follows:
Normal Loss as Specifically Identified on a Particular Job
If normal losses are accounted for as specifically identified on a particular job, estimated
amount of losses should be accounted depending on whether lost units has disposal value or
without disposal value.
Accordingly, if lost units has disposal value, cost of the jobs are reduced by the cost of lost
units. On the other hand, if there is no disposal value, cost of lost units are treated as already
attached and assigned to the jobs.
However, regardless whether such losses has or without disposal value, the estimated amount
of such losses are not included in the computation of predetermined overhead rate. Thus,
predetermined overhead rate is calculated as is: (Predetermined OH rate = Overhead costs /
Activity Volume).

Illustrative Problem:
Case 1: Normal Loss as Anticipated on All Jobs
ABC Corporation assumes that regardless of the job, spoilage always occur in the mixing
process. Shown below are the estimates made:
Overhead costs before losses are accounted P 364,500
Estimated spoilage cost 30,900
Disposal value of spoiled units 12,900
Estimated production. 150,000 units
During the period, the company is manufacturing 100 units of Job#700. In the mixing
process, the factory worker accidentally added a wrong component to the job.
Actual cost of the spoiled unit amounted to P60 per unit and it can still be sold at the market
for P20 per unit.

On the actual incurrence of costs of the spoiled units, overhead control account is debited for
the net amount of the actual cost of lost unit and its associated disposal value, such difference
reflects the net cost of the normal lost units.

Case 2: Normal Loss as Specifically Identified on a Particular Job

Using the same given information on Case 1, the calculation for the accounting of normal
losses as specifically identified on a particular job are as follows:

Case 3: Abnormal Loss

Using the same given information on Case 1 and assume further that the defective units of
Job #700 costs P70, the additional P10 per unit is attributable to the abnormal defects,
accounting of abnormal losses as are as follows:

The debit to loss from abnormal spoilage will be directly reported as period costs, thus, will
not form of the cost of goods sold.

Accounting for Production Losses under Process Costing System

Before production losses under the process cost system are accounted, production type must
first be determined, which is either produced on a continuous basis or discrete production type.
Under the continuous production type, components of finished goods placed to production
cannot be counted on a per piece basis since its production process involves mixing of
chemicals, liquids and other ingredients and are thus measured only in terms of liters, grams
and the like. The end product has therefore undergone a substantive mixing of quantities of
materials before it was generated as a final output. Take for an instance the mass production of
biscuits, before it can be readily sold to the market, ingredients such as wheat flour, sugar,
skimmed milk, oil, artificial flavoring are being mixed together on different stages of
production. Thus, manufactured units are being measured in weights and volumes.
On the other hand, discrete manufacturing is the type of production process where components
of the finished goods can be easily counted. An example of a manufacturer using a discrete
production type is an automobile company of which each component can be counted on a per
item basis such as bumper, battery, axle, brakes, pistons, fuel injector, compressor, clutch etc.

Continuous Production Type

Under continuous production, losses can occur either at the beginning of the process,
during the production or even at the end of process. Once the occurrence of loss has
been determined, the following assumptions are being used in accounting for the
losses:
(1) If the loss is a normal loss and

i. If it occurred on the beginning of the production process, it is

deducted on the total units to account for and there would be no
equivalent units of production to be calculated and there is no
cost to account for since such losses are to be absorbed by all the
goods units to be produced.

ii. If it occurred during the production process, such losses are

treated as if it happened on the beginning of the production, thus,
accounting for such loss would be the same way as how losses at
the beginning of the production process are treated.

iii. If it occurred on the end of the production process, such losses

are to be absorbed by completed good units only, thus, it is
necessary that equivalent units of production would be
calculated. Since normal losses occurring in the end of
production are to be absorbed by completed good units, its
associated costs will be added to the transferred out and or
completed units' costs.

(2) If the loss is an abnormal loss, losses occur only either at the end of the
process or during the production process. Abnormal losses are to be
accounted as if it happened at the end of the process. Hence, accounting
treatment would be the same regardless when such losses occurred. Since
abnormal losses are to be accounted as if it happened at the end of the
process, equivalent units of production will be calculated and its
associated costs will form part as period costs.

Discrete Production Type

Under discrete production, losses are assumed to occur at quality inspection point.
With this, lost units are absorbed by all units which undergone and passed on the
inspection point.
Therefore, absorbing units which can either be the transferred-out units and work-in
process ending inventory will only absorbed such losses if the stage of completion has
already reached the inspection point. It is then by that point that equivalent units
production (EUP) of lost unit will be calculated.
To illustrate, suppose that the work-in process ending inventory is 30% completed and
inspection point occurs when units are 50% completed. On this aspect, work-in process
ending inventory will not absorbed the losses since it has not yet passed on the quality
inspection point. Thus, only the transferred out units will absorbed the lost units since
it is always accounted for as 100% completed.
If work-in process ending inventory is 75% completed, and assuming the same data
given above, both the work-in process ending inventory and transferred out units will
absorbed the lost units since both of them has already undergone the quality check.