It is nearly impossible to avoid all spoilage, or to never have lost units. Some common causes of spoilage and lost units are human error, machinery malfunctions, and good product being discarded with scrap in error. No matter what the cause is, the loss needs to be identified. Also, the cost of the loss must be determined, and that cost must be accounted for.
Spoilage can be identified as either normal or abnormal spoilage. Normal spoilage is the type of spoilage that cannot be avoided, and/or that occurs during the normal operations of the manufacturing entity. Management understands that good units cannot be produced without the risk of some spoilage. For this reason, the cost of spoilage is treated as a cost of manufacturing the good units. There are two methods that can be used to account for the cost of normal spoilage. The first is to absorb the cost of the spoilage into the cost of the good units, while not identifying it specifically as spoilage cost. The second method is to separately identify the total cost of the spoiled units, thereby reporting the amount by which the cost of the good units was increased by the cost of the spoilage.
If using the second method, where the cost of spoilage is separately identified, you must compute the cost of each spoiled unit. This cost of the spoiled unit is the cost to process that unit up to the point in production where the spoilage occurred or was identified. Then, the total cost of the spoiled units is the cost of one spoiled unit multiplied by the number of units spoiled.
In some cases, spoiled units are not totally worthless. Although the units are not good enough to meet the quality requirements, they may be able to be sold, even if at a bargain price. The revenue generated from these sales can offset, or even eliminate, the loss from spoilage.
Abnormal spoilage is spoilage that could have possibly been avoided, and that is not an expected part of the manufacturing process. An example of abnormal spoilage would be units that were lost during a power outage when the company’s backup generator failed to function. Costs from abnormal spoilage are not treated as a manufacturing cost, and therefore are not applied to the cost of the good units. Rather, the abnormal spoilage costs are expensed in the period they occurred in.
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