Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 50

Spoilage, Rework, and Scrap (appendix)

Richport Company manufactures products that often require specification changes or modifications to meet customer needs. Consequently, Richport employs a job costing system for its operations.

Although the specification changes and modifications are commonplace, Richport has been able to establish a normal spoilage rate of 2.5% of good units produced (before spoilage). The company recognizes normal spoilage during the budgeting process and classifies it as a component of factory overhead. Thus, the predetermined overhead rate used to apply factory overhead costs to jobs includes an allowance for net spoilage cost for normal spoilage. If spoilage on a job exceeds the normal rate, it is considered abnormal and then must be analyzed and the cause of the spoilage must be submitted to management.

Randa Duncan, one of Richport’s inspection managers, has been reviewing the output of Job N1192-122 that was recently completed. A total of 122,000 units had been started for the job, and 5,000 units were rejected at final inspection, meaning that the job yielded 117,000 good units.

Randa noted that 900 of the first units produced were rejected due to a very unusual design defect that was corrected immediately; no more units were rejected for this reason.

Randa was unable to identify a pattern for the remaining 4,100 rejected units. They can be sold at a salvage value of $7 per unit.

The total costs accumulated for all 122,000 units of Job N1192-122 follow. Although the job is completed, all of these costs are still in the Work-in-Process Inventory account (i.e., the cost of the completed job has not been transferred to Finished Goods Inventory account).

Direct materials	$2,196,000
Direct labor	1,830,000
Applied factory overhead	2,928,000
Total cost of job	$6,954,000

Required

1. Explain the distinction between normal and abnormal spoilage.

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2. Distinguish between spoiled units, rework units, and scrap.

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3. Review the results and costs for Job N1192-122.

a. Prepare an analysis separating the spoiled units into normal and abnormal spoilage by first determining the normal input required to yield 117,000 good units.

b. Prepare the appropriate journal entries to account for Job N1192-122.

Step 1 of 4

1.

Spoilage refers to those units which are rejected or unaccepted at the time of quality inspection as it does not conform the standards. It differs from rework units in a way that the former has no possibility of becoming good units whereas the latter due to little or minor defects can be reworked to be included in good units.

For example:

A apparel manufacturing company is known for its high quality fabric used in Jeans. If the jeans produced, is rejected due to unmatched fabric quality, then this is an example of Spoilage or Spoiled Units.

In case the Jeans gets rejected as it is not stitched properly with missing buttons, then this deficiency can be reworked upon and are known as Reworked Units.

Spoilage can further be classified into two types:

• Normal Spoilage: The spoilage or spoiled units which are expected under normal operating conditions and cannot be prevented. The costs incurred on Normal Spoilage is borne by good units.

For Example:

If an entity has estimated that 5% of total input will be rejected due to quality issues and cannot be reworked. In the month of August, 100,000 units of Raw material costing $500,000 enters into production. Of this 2,500 units were spoiled and were disposed. Therefore, the spoilage of $12,500 ($5 per unit of Raw Material x 2,500 Units) will be absorbed by 97,500 good units resulting into a cost per unit of $5.13.

• Abnormal Spoilage: The spoilage or spoiled units which are over and above the normal budget will be treated as abnormal spoilage. This type of spoilage is not expected under normal operating conditions.

For Example:

If an entity has estimated that 5% of total input will be rejected due to quality issues and cannot be reworked. In the month of August, 100,000 units of Raw material costing $500,000 enters into production. Of this 3,500 units were spoiled and were disposed. The soilage of 1,000 units over the normal expectation of 2,500 units will be considered as Abnormal Spoilage. The cost related to abnormal spoilage will be charged to a special account “ Loss from Abnormal Spoilage”.