Methods of Pricing issues, wastage, scrape spoilage and Defectives06/04/2020
Material losses may take the form of waste, scrap, defectives and spoilage. Problems of spoilage, waste, defective units and scrap are bound to arise in almost all manufacturing concerns, so there is usually a difference between the quantity of the output and the input.
Usually the quantity of the output is less than that of the input because of waste, scrap or spoilage. Efforts should be made to reduce the difference between the quantities of the output and the input so that cost of production may be reduced.
Methods of treatment of spoilage, waste etc. and the interpretations given to these terms vary considerably from one industrial concern to another because of different situations arising in different concerns. The terms are also loosely used; for example, waste and scrap may be taken to have the same meaning.
Waste is defined as discarded substances having no values. In many industries, some waste is inevitable. Such waste may arise due to the inherent nature of materials, chemical reaction, evaporation, drying, sublimation of goods etc. Waste can also be in the form of smoke, gas, slag or dust which arises in the course of a manufacturing process.
Waste may be invisible or visible. The former type of waste (i.e., waste due to drying, evaporation etc.) is invisible whereas the latter type of waste (i.e., gas, smoke, slag etc.) is visible. Waste has practically no measureable value. Rather in some industries, the waste instead of realising any value creates a problem for its disposal incurring further costs. The waste may be normal and abnormal from the point of view of treatment in costing.
It is the loss which is unavoidable on account of inherent nature of material. Some materials such as liquid materials lose their weight due to evaporation. Similarly, there are some materials (i.e. coal) which are wasted due to loading and unloading. Materials may be wasted due to breaking the bulk into smaller parts.
Normal waste is unavoidable and as such may be reduced to some extent if there is strict control but cannot be totally eliminated. Such loss can be estimated in advance on the basis of past experience or chemical data. As waste has practically no value, its treatment in costing is relatively simple. The normal process loss is recorded only in terms of quantity.
Any loss caused by unexpected or abnormal conditions such as sub-standard materials, carelessness, accident etc. or loss in excess of the margin anticipated for normal process loss should be regarded as abnormal waste.
All cases of abnormal waste should be thoroughly investigated and steps taken to prevent their recurrence in future. Responsibility for abnormal wastage should be fixed on purchasing, storage, production and inspection staff to maintain standards. Abnormal waste should not be allowed to affect the cost of production as it is caused by abnormal or unexpected conditions.
Such loss representing the cost of materials, labour and overhead incurred on the wastage should he transferred to Profit and Loss Account (Costing Profit and Loss Account where no integral system of accounting is maintained) and not added to the cost of production so as to make meaningful comparison of costs of production of different periods.
Scrap is discarded material having some values. It represents fragments or remnants of material that are left from certain type of manufacture. It is a material loss but has small value without further processing. Examples of scrap are available in operations like turning, boring, punching, sawing, shavings, moulding, etc. from metals on which machine operations are carried out; saw dust and trimmings in the timber industry; dead heads and bottom ends in foundries; and cuttings, pieces and splits in leather industry.
Such scrap can be solid because it can be used by other industries by melting in furnaces. Scrap is always physically available unlike waste which may or may not be physically present in the form of a residue. Thus scrap is always visible whereas waste may or may not be visible. Further, waste may not have any value whereas scrap must necessarily have a value.
There are three types of scrap, namely:
(a) Legitimate scrap,
(b) Administrative scrap,
(c) Defective scrap.
Legitimate scrap arises due to the nature of operation like turning, boring, punching etc. as discussed above. This type of scrap can be pre-determined and efforts should be made that it should not be more than the pre-determined quantity. Administrative scrap arises due to administrative action, such as, a change in the method of production.
Defective scrap arises because of use of inferior quality of material or bad workmanship or defective machines. Such type of scrap is abnormal because it arises due to abnormal reasons.
Treatment of Scrap:
The useful methods for the treatment of scrap are as follows:
- If realisable value of normal scrap is insignificant (i.e., legitimate scrap and administrative scrap) it may be credited to Profit and Loss Account like other income. This method of treatment of scrap is suitable when the scrap is of very little value and when the market for it is uncertain. This method is known as treatment by neglect.
This method is not suitable for effective control over scrap because detailed records of scrap are not kept and scrap cost is not shown as an element of cost in the cost sheet. Scrap which is not sold and is in stock is valued at nil for balance sheet purposes and thus vitiates the valuation of closing stock.
Accounting of scrap by this method is also inaccurate as there is a time lag between the sales and the production. There is also a possibility that scrap may arise in one period but may be accounted (i.e., sold) in another period and thus distorts the profits of two periods.
- The sale value of scrap may be deducted from the cost of materials consumed or factory overhead. This method is suitable when several production orders are commenced at a time and it is not possible to find scrap for each other. This method is, however, not effective in controlling scrap arising in different processes, jobs or orders.
When overheads are absorbed on the basis of pre-determined rates, it is more appropriate to credit an estimated allowance for the scrap instead of the amount of actual scrap.
The journal entries for recording the scrap are:
(i) Dr. Scrap Account (with an estimated allowance) Cr. Factory Overhead Control Account
(ii) Dr. Cash/Debtors (Amount realised on sale) Cr. Scrap Account.
Profit or loss on sale of scrap may be transferred to the Profit and Loss Account at the end of the year. When scrap is sold on a day-to-day basis and no stock is maintained, the journal entry is: Dr. Cash/Debtors Account (with realisable value) Cr. Factory Overhead Control Account
- The scrap may be assigned a cost if it can be related to the job which yielded the scrap. It will help in giving reasonable credit to the jobs which yielded scraps. This method of treatment is suitable when scraps from the various jobs widely differ in nature.
- It is possible that scrap arising in one job may be used in another job. In such a case material transfer note for transfer of scrap from one job to another job should be prepared and credit should be given to the job where scrap arises and debit should be given to the job for the amount of scrap transferred to it.
Sometimes, scrap may be returned to stores when some further processing has to be done before that can be utilised for other jobs. Job returning the scrap is credited with the value of the scrap returned to stores.
- When the actual scrap is in excess of the pre-determined quantity (i.e., normal quantity), the cost of the excess scrap is transferred to Costing Profit and Loss Account after deducting there-from the sale proceeds of such excess scrap. The valuation of excess scrap is done in the same way as the valuation of abnormal waste is done.
- The cost of defective scraps after deduction there-from the sale a proceeds of such scrap is transferred to Costing Profit and Loss Account because it is an abnormal loss.
Defective products or units are those which do not meet with dimensional or quality standards and are reworked for rectification of defects by application of material, labour and/or processing and salvaged to the point of either standard product or substandard product to be sold as seconds. Therefore, defectives are that portion which can be rectified at some extra cost of re-operation.
Defectives may arise due to the following reasons:
- Sub-standard materials.
- Poor workmanship.
- Poor maintenance of machines.
- Wrong tool setting.
- Faulty design of products.
- Bad supervision.
- Careless inspection.
- Poor working conditions.
- Lack of control, such as humidity, furnace temperature etc.
- Excessive short runs.
Defectives are bad products which are not totally spoiled and can be rectified or restored to original or near-original condition at some extra cost of re-operation. The additional cost of rectifying the defectives is added to the total cost and the quantity of defectives rectified is added to the quantity of good output because defective units rectified can be sold as “seconds”. Rectification of defective units is advisable only when the cost of rectification is low and more profitable than to sell as spoil 3d units.
Treatment of Cost of Rectification of Defectives:
Following methods may be adopted for the treatment of this cost:
- If the defective production is identified with a specific job or department, the cost of rectification is charged to that specific job or department.
- If the defective production is not identified with a particular job or department, the cost of rectification is added to general factory overhead.
- If the defective production is due to abnormal reasons, the rectification cost is transferred to Costing Profit and Loss Account.
Every possible effort should be made to reduce the number of defectives because they increase the cost of production. Control of defectives is an operational correction, so steps should be taken to eliminate the reasons responsible for defectives. Right from the design stage to the output of the final product stage, each one should be looked into carefully for avoiding defectives.
Standardisation of products and operations, comparison of actual performance with standards laid down in regard to defectives, feedback and reporting and incentive scheme for minimising defectives will go a long way in reducing the quantity of defectives.
Spoilage refers to production that does not meet with dimensional or quality standards in such a way that it cannot be rectified economically and is junked and sold for a disposal value. So it occurs when goods are so damaged in course of manufacturing process as to become not rectifiable with some additional cost.
Material used in spoiled units can be used again as material by the same or another process or product. Spoilage cost is the difference between the cost incurred upto the point of rejection less salvage value or cost of material used.
Spoilage arises due to sub-standard materials, poor workmanship, faulty tool setting, poor maintenance of machines, bad supervision and careless inspection.
Spoilage should not be confused with scrap. Scrap arises at the initial stages of production operations whereas spoilage takes place more towards the finishing production stages with larger loss of added value to the cost of material used.
Spoilage can be of two types:
(1) Normal spoilage and
(2) Abnormal spoilage.
According to Charles T. Horngren, “Normal spoilage is what arises under efficient operating conditions; it is an inherent result of the particular process and is thus uncontrollable in the short run.
Abnormal spoilage is spoilage that is not expected to arise under efficient operating conditions; it is not an inherent part of the selected production process”. Abnormal spoilage can be controlled because it arises as a result of inefficient operating conditions.
Normal spoilage is planned spoilage that management is willing to accept and is controllable by higher level of management which determines the nature of products and processes. On the other hand, abnormal spoilage can be controlled by first-line supervision which can exert influence over inefficiency.
Treatment of Cost of Spoilage:
The treatment of cost of spoilage depends upon the nature of spoilage. If the spoilage is normal, the cost is borne by good units of output. In case of abnormal spoilage, cost of spoilage is transferred to Costing Profit and Loss Account. When, however, the normal spoiled units are used again as raw material in the same manufacturing process, no separate treatment becomes necessary.
If they are used for another process, job or order, a proper credit should be given to the process job or order giving rise to the spoilage keeping in view the utility value of the spoilage to the process, job or order for which the same is used.
Control of Wastage, Scrap, Defectives and Spoilage:
Every effort should be made to reduce the cost of production by exercising control on wastage, scrap, defectives and spoilage.
Following steps may be taken in this direction:
- Reports relating to the wastage, scrap, defectives and spoilage should be prepared in time to locate the reason responsible for the wastage etc. An immediate corrective action should be taken on the basis of the reasons responsible for the loss.
- Wastage, scrap, defectives and spoilage should be standardised by following standard costing system. It should be seen that actual wastage, scrap, etc. should be within normal limits allowed.
- Good quality of materials should be used. Better the quality of materials less is the wastage, scrap and spoilage.
- Control of wastage, scrap, defectives and spoilage should start with the designing of the products. The type of materials that will result in the minimum wastage, scrap, defectives and spoilage are decided at the designing stage. Better quality of equipment should be used to get better return, so type and shape of equipments to be used for manufacturing process should be decided at the designing stage.
- Properly trained personnel should be employed to reduce the quantum of wastage, scrap, defectives and spoilage.