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8 Spoilage, Rework, and Scrap Learning Objectives +. Understand the definitions of spoilaga, rev/ork, and scrap . Identify the differences between normal and abnormal spoilage . Account for spollage in process costing using tha weighted-averaga method and the first-in, first-out (FIFO) method Account for spoilage at various stages of completion in process costing 5. Account for spoilaga in job costing e. Account for rework in job costing 7. 644 Account for scrap When a product doesn't meet specification but is subsequently repaired and sold, it is called rework. Firms try to minimize rework, as well as spollage and scrap, during production. Why? Because higher-than-normal levels of spoilage and scrap can have a significant negative effect on a company's profits. Rework can also cause substantial production delays, as the following article about Boeing shows. Rework Delays the Boeing Dreamliner by Three Years! In 2007, Boeing was scheduled to introduce its newest airplane, the Dreamliner 787, Engineered to be the most fuel-efficient commercial plane, the Dreamliner received nearly 600 customer orders, making it the fastest selling commercial airplane in history. By 2010, however, the first Dreamliner still had not rolled off the production line. The design and assembly process was riddled with production snafus, parts shortages, and supply-chain bottlenecks. The Dreamliner was Boeing's first major attempt at giving suppliers and partners far-ranging responsibility for designing and building the wings, fuselage, and other critical components to be shipped to Boeing for final assembly. The approach did not work as planned, with many of the 787's components delivered unfinishea, with flaws, and lacking parts. As a result, the Boeing Dreamiliner aircraft required significant rework. The company's engineers had to redesign structural flaws in the airplane's wings. repair cracks in the composite materials used to construct the airplane, and fix faulty software among many other problems. In 2009, one of Boeing's unions calculated that half of its members' time was spent doing rework. This rework led to costly delays for Boeing. Many of its customers, including Virgin Atlantic and Japan's All Nippon Airways, asked the company to compensate them for keeping less fuel-efficient planes in the air, Other customers cancelled their orders. Australia's Quantas Alrways and a Dubai-based aircraft leasing firm each cancelled its Y Sources: Lunsford, J. Lynn. 2009, Dubai firm cancel: 16 of Boeings Dreamiliners, Wall Street fourmaí Ecbrwary 5; Marlack, Carol. 260%. Moro Bocing 787 wocs as Quantas drops order Business Week, June 26; Sanders, Peter 2009. Ar Boeing, Dreamliner fix turns up new glitch. Wali Street Jowrna!, November 13; West Karen. 2009, Boeing has much to prove with 787. MSNBC.com, December 16; Wilhelm, Steve. 2009. Boeing engineers seek credit for fixing gocto. Pages Sond Business Journal, August 17. orders for 15 airplanes, which cost Boeing at least $4.5 billion. The company also took a $2.5 billion charge in 2009 related to development costs on the Dreamliner program. Like Boeing. companies are increasingly focused on improving the quality of, and reducing defects in, their products, services, and activities. A rate of defects regarded as normal in the past is no longer tolerable. In this chapter, we focus on three types of costs that arise as a result of defects—spoilage, rework, and scrap—and ways to account for them. We also describe how to determine (1) cost of products, (2) cost of goods sola, and (3) inventory values when spoilage. rework, and scrap occur. Defining Spoilage, Rework and Scrap While the terms used in this chapter may seem familiar, be sure you understand them in the context of management accounting. Learning Spoilage is units of production—whether fully or partially completed—chat do not Objective meet lhe specifications required by customers for good units and lhal are discarded or sold at reduced prices. Some examples of spoilage are defective shirts, jeans, shoes, and carpeting sold as “seconds,” or defective aluminum cans sold to aluminum manufacturers Understand the detinitions of spoilage, for remelting to produce other aluminum products. Unacceptable units Rework is units of production that do not meet the specifications required by cus- otiprodellón torners but that arc subsequently repaired and sold as good finished units. For example, rework, detective units of products (such as pagers, computers, and telephones) detected during or AO after the production process but before units are shipped to customers can sometimes be of production reworked and sold as good products. subsequently repaired Scrap is residual material that results from manufacturing a product. mples are short lengths from woodworking operations, edges from plastic molding operations, and frayed cloth and end cuts from suit-making operations. Serap can sometimes be sold for relatively small amounts. In that sense, scrap is similar to byproducts, which we studied in Chapter 16. The difference is that serap arises as a residual from the manufacturing process, and is not a product targeted for manufacture or sale by the firm. Some amounts of spoilage, rework, or scrap are inherent in many production processes. For example, semiconductor manufacturing is so complex and delicate that some spoiled units are commonly produced; usually, the spoiled units cannot be reworked. In the manufacture of high-precision machine tools, spoiled units can be acia reworked to meet standards, but only at a considerable cost. And in the mining industry, rawork, and scrap? companics process ore Lhat contains varying armounts of valuable metals and rock. Sorne amount of rock, which is scrap, is inevitable. and serap - leftover material 4 Decision Point SPOILAGE IN PROCESS COSTING USING WEIGHTED-AWERAGE AND FIFO 0 647 Spoilage in Process Costing Using Weighted- Average and FIFO How do process-costing systems account for spoiled units? We have already said that units of abnormal spoilage should be counted and recorded separately in a Loss from Abnormal Spoilage account. But what about units of normal spoilage? The correct method is to count these units when computing output units—physical or equivalent—in a process-costing system. The following example and discussion ¡llustrate this approach. Count All Spoilage Example 1: Chipmakers, Ino., manufactures computer ohips for television sets, All direct materials are added at the beginning of the production process. To highlight issues that arise with normal spoilage, we assume no beginning inventory and focus only on direct material costs. The following data are available for May 2012 | Home | insert PageLayout Formulas Dita ReMeWw View A B E Physical Diroct 1 Units Materials 2 |Work in process, beginning inventory (May 1) y 3 [Started during May 10,000 4 |Good units completed and transferred out during May 5,000 5_JUnits spoiled (all normal spollage) 1,000 6 [Work in process, ending inventory (May 31) 4,000 3 JDirect material costs added ln May $270,000 Spoilage is detected upon completion of the process and has zero net disposal value. An inspection point is the stage ofthe production process at which products are examined to determine whether they ate acoeptable or unacceptable units. Spoilage is typically assumed to occur at the stage of completion where inspection takes place. Ás a result, the spoiled units in our example are assumed to be 100% complete with respect to direct materials. Exhibit 18-1 calculates and assigns cost per unit of direct materials. Overall, Chipmakers generated 10,000 equivalent units of output: 5,000 equivalent units in good units completed (5,000 physical units x 100%), 4,000 units in ending work in process | Home | Insert Pagelayout Formulas Data Review View A B Approach Counting Spoiled Units When Computing Output in d) Equivalent Units 2 |Coststo accountfor $270,000 3 Divide by equivalent units of output + 10,000 4 |Cost per equivalent unit of output $ 21 5 |Assignment of costs: 6 [Good units completed (5,000 uns x $27 per uni) $135,000 3. |Add normal spollage (1,000 units x $27 perunit) 27,000 8 [Total costs of good units completed and transferred out 162,000 a [Work in process, ending (4,000 units < $27 per unit) 108,000 10 |Costs accounted for $270 000 Learning Objective Aoceunt for speilage in prosess oosting using the weighted-average method . «spollage cost based ontotal costs and equivalent units completed to date and the first=in, first-out (FIFO) method spoilage oost based on ousts of current period and equivalent units ofwork done in current period Effect of Recognizing Equivalent Units in Spollage for Direct Material Costs for Chipmakers, Inc., for May 2012 648 0 CHAPTER18 SPOLAGE, REWOPK, AND SCRAP (4,000 physical units x 100%), and 1,000 equivalent units in normal spoilage (1,000 physical units x 100%). Given total direct material costs of $270,000 in May, this yields an equivalent-unit cost of $27, The total cost of good units completed and trans- ferred out, which includes the cost of normal spoilage, is then $162,000 (6,000 equiva- lent units x $27), while the ending work in process is assigned a cost of $108,000 (4,000 equivalent units x $27). There are two notewort hy features of this approach. First, the 4,000 units in ending work in process are not assigned any of the costs of normal spoilage. This is appropriate because the units have not yet been inspected. While the units in ending work in process undoubtedly include some that will be detected as spolled when inspected, these units will only be identified when the units are completed in the subsequent accounting period. At that time, costs of normal spollage will be assigned to the good units completed in that period, Second, the approach used in Exhibit 18-1 delineates the cost of normal spoilage as $27,000. By highlighting the magnitude of this cost, the approach helps to focus management 's attention on the potential economic benefits of reducing spoilage. Five-Step Procedure for Process Costing with Spoilage Example 2: Anzio Company marufactures a reoyoling container in its forming department. Direct materials are added at fe beginning of the production process. Gorwersión costs are added evenly during the productión process, Some units of this produot are spoiled as a result of defeots, which are detectable only upon inspection of finished units. Mormally, spolled units are 1096 of the fin- ished output of good units. That is, for every 10 good units produced, there is 1 unitof normal spoilage. Summary data for July 2012 are as follows Home | Insert Pagetayout Formulas Data Review View A B £ D | Physical Direct Conversion Total Units Materials Costs Costs EN 10) 12) El (4 =(2) +(2) 2_ [Work in process, beginning inventory (July 1) 1500 $12,000 $ 9,000 $ 21,000 3 | Degree of completion of beginning weork in process 100% 50% 4 [Started during July 8,500 5 [Good units completed and transferred out during July: 7,000 6 |Workcin process, ending inventory (July 31) 2,000 7] Degree of complellon of ending work in process 100% 50% 8_|Total costs added during July $76,500 $89,100 4105,600 9_|Normal spollage as a percentage of good units 10% 10 | Degree of completion of normal spollage 100% 100% 11 | Degree of completion of abnormal spoilage 100% 100% The five-step procedure for process costing used in Chapter 17 needs only slight modifica- tion to accommodate spoilage. Step 1: Summarize the Flow of Physical Units of Output. Identify the number of units of both normal and abnormal spoilage. Total ( Units in beginning Units Spoilage — Aworkein-process inventory — started, = (1,500 + 8,5001 — (7 000 + 2,000) = 10,000 — 9,000 = 1,000 units Good unit ) = | completed and + transferred out Units in ending work-in-process inventory 650 0 CHAPTERS SPOLAGE, REWOPK, AND SCRAP MENTE wWeigtrod-Averaga Method of Process Costing with Spoilaga far Forming Department of PANEL A: Stops 1 anel 2-Summariza Output in Physical Units and Computo Equivalont Units the Anzio Company for July 2012 Home | Insert Pagelayout Formulas Data Review View. A B dl D ] E ñ (Step 1) (Step 2) 2 Equivalent Units Physical Direct Conversion 3 Flow of Production Units: Matorials Costo 4 Work in process, beginning (given, p. 648) 1,500 5 Started during current pertod (given, p. 648) 8,500 6 To account for 10,000 EA Good units completed and transferred out during current period 7,000 7,000 7,000 g Normal spoilage? 700 a (700 100%, 700 x 100%) 700 700 10 Abnormal spollago? 300 11 (200 100%; 300 100%) 300 300 12 Work in process, encling? (given, p. 640) 2,000 13 (2,000 x 100%; 2,000 x 50%) o 2,000 1,000 14 ¡Aceounted for 10,000 15 Equivalent units of work done to date 10,000 9,000 16 17 Normal spollage is 10% of good units transferred out: 10% x 7,000 = 700 units. Degree of completion of normal spolage 18 | in thisdopartment direct materials, 100%; conversión costs, 100%, 19 l'abnormal spollage = Total spoilage - Normal spoilage = 1,000 - 700 = 300 units. Degree of completion af abnormal spollage 20 | in this depariment direct materials, 100%; corwersión costs, 100% 21 [Degree al completion in this department: direot materials, 100%, conversion costs, 50%. PANEL B: Stops 3, 4, and 5-Summarizo Total Costs to Account For, Computo Cost por Equivalont Unit, and Assian Total Costs to Units Completed, to Spoiled Units, andl to Units in Ending Work Process Total Procluction Direct Conversion 23 Coste Matarialo Conta 24 (Stop 9) Work in process, beginning (given, p. 648) $ 21,000 $12,000 $ 9,000 25 [Costs adeied in current period (given, p, 648) 105,600 76,500 19,100 26 [Total costs to account for $106,600 $08,500 $98,100 27 (Step 4) ¡Costs incurred to date $88,500 $99,100 28 Divide by equivalent units ofwork done to date (Panel Aj 10,000 9,000 29 ¡Cost per equivalent unit FUE] FA 30 (Step 5) ¡Assignment of costs 31 ¡Good units completed and transferred out (7,000 units) 32 Costs before adding normal spoilage $190,250 (7,00% x $8.85) (7.00% Xx $10.90) 33 Normal spoilago (700 units) 13,825 | (700% $8.85) + (700%x $10.90) 34 (4) Total costs of good units completed and transferracl out 152,075 35 |(8) ¡Abnormal spollage (300 units) 5,925 | (300%x $8.95) (300 x $10.90) 36 10) liYorkcin process, ending; (2,000 units) 28,600. |(2,000% x $8.85) + (1,000%x $1 0.90) 37 1(4+18)+0) [Total costs accounted for 186,600 588,500 598,100 38 39 | Equivalent units of direct materials and conversion costs calculated in Step 2 in Panel A. PANEL A: Stops 1 anel 2 Sun SPOILAGE IN PROCESS COSTIMG USING WEIGHTED-AVERAGE AND FIFO € 651 » Output in Physical Units and Computo Equivalont Units Home | insert Pagelayout — Formulas Data Remew View As B E po] E El EN EJE] A Equivalent Units S Physical | Direct | Conversion 3 ic Unite | Mateñals Costs a WWark in process, Feginniag (ghen, p. 648) 150 5 ¡Started during curent poriod (given, p. 648) 1] ¡To escountlor 10,000 7 ¡Goa unio completed and bara fened out during coment period M For beginning oh in process" 1500 y [1500 > (1004% — 10085), 1,800 x (100% 80%] 0 57 10 Staredand completed 550 EA (5,500 100%, 5,500 +100%) 5500, 5500 32 Nomalspailage" 70D 13 800 10096, 700 « 10086) 300 700, ja [Abrormalspoilag=! 300 15 (900 100%, 9004100] EN 0 16 [Work in process, ending" (given, p. 849) 2000 17 12,000 x 1009%, 2.000 50%) 2.000 1,000 10 'ccounted lor 10,000 — Equivalent unts ofwork done in cument period 8500 20 21 |'Degras ofcomplalicnin ts department direct materials, 100%; conversion coste, 60%. 2 |!7 000 chysicalurits ocmgietad and tanstared cut minus 1,£00 physical units completed and tansfared ast fre beginning 23 | wodingrocess inventory. 24 |homral spcilaye is 1058 good units transiered cut 10% + 7,000 =700 uni, Degree ofocmpleion ofnormal sralage 5 | in tis dapariment direct materials, 1(10'%; conversion costs, 100%. 26 ['Atnamal erollaga= Acwal spdlage - Normal spcilaga ="1,000.-700= 300 units. Degrea.of completian of donarmal spcilaga: 27] ln tio deparimant direct matestalo, 10074; converdlon costa, 1004. 20 |*Dagras af complace in ts daparment direct materials, 100%; conversion coto, 50%. PANEL B: Stops 3, 4, and 5—Surenarizo Total Costs to Account for, Computo Cost par Equivalont Unit, and Assign Total Costs to Units Complotad, to Spoiled Units, and to Units in Ending Work in Process Total Production| — Direct | Conversion 30 Costs_| Materialo Coste 31 J[6tep 0) [Work in process, beginnira fgiven, p. 648) $210] $200 491500 32 ¡Costs added in curent poried (gien, p.648) 185900 | 28500 20,10 3 Totalcosts ts account lor 165.000 | p92500 190.100 34 |[6tep 4) ¡Cost added in current period $76,600 469,100 Divide by exquivadent uni ol workecone n cument period (Panel A 8500 ¿8,100 35 [Costperequielent uni pera] LL 37 [Step $) [Assignmentofcosts En ¡God uns completed and tensred out (7000 uni] EN "ori in proosss, beginning 11,500 unis) 521000 | 912000 CE 0 ¡Costs added to beginning workcin process incunent peñod| 6900 | (039) 4 Bt En Total fon beginning invenbry befoes romal spollage | 27,900 Started and completed before normal spodags (5,500 uni) | 110,000 | (500190) 4 (5200911) 43 Nomuol spoilage (700 unit) 14000 | 70049 4 OO) E A) Total onete ol good unite comp hted and trarederred out 161800 as |(6) [Abnomal spollage (900 unto) 6000 | (20030) 4 00911) as lc) [Work in prooses, ending (2 000 units) 29,000 | (2,000'x99) 4 (10000 H11) az [AIBHc) — [Totalcosts ascounted tor BELO | 588500 xr] En 45 50 53 JEquivalentuniss of diractmaresials and conversion c0sts calculated in Ste 2in Panel a, First-In, First-Out (FIFO) Method of Process Costing with Spoilage for Forming Department ofthe Anzio Company for July 2012 INSPECTION POINTS AND ALLOCATING COSTS OF NORMAL SPOILAGE € 653 amount of normal and abnormal spoilage? As befoze, consider the forming department, and recall that direct materials are added at the start of production, while conversion costs ars added evenly during che process. Consider three different cases: Inspection occurs at (1) the 209, (2) the 55%, or 13) 1h6:100%completionsago The lastroption ipteons: we have:analyzed so Tar (see Exhibit 15-2). Assume that normal spoilage is 10% of the good units passing inspection. A total.o? 1,000 units arespolled. insall three cases. Normal spoilage ls: computed ox the basis of the number of good territs that pass the inspection point duririg the current period. The following data are for July 2012. Note how the number of units of normal and abnormal spoilage changes, depending on when inspection occurs. Home | Insert Pagetayout Formulas Data Reew View A B [ E [ D Physical Units: Stage of Completion at al, Which Inspection Occurs 2 Flow of Production 20% 55% 100% 3 | Work in process, beginning? 4,500 4,500 1,500 4 | Started during July 8,500 8,500 8,500 5 | To accounttor 10,000 10,000 10,000 6 | Good units completed and fransferred out 7) (10,000 - 1,000 spoiled - 2,000 ending) 7,000 7,000 7,000 3 | Normal spoilage 750" 550% z00* 9 | Abnormal spoilage (1,000 — normal spoilage) 250 450 300 10 | Workcin process, ending" 2.000 2,000 2.000 11 | Acoounted for 10,000 10,000 10,000 12 13 | "Degree of completion in (his: department: direct materials, 100%; conversion costs, 60%. 14 | PDagrae of complefion in this department: direct materials, 100%; conversion costs, 50%, 15 | “10% x (8,500 units started - 1,000 units spoiled), because only the units started passed (he 20% completion 16 | inspectian point in the current periad. Beginning work in process is excluded from this caloulafion because, 17 | being 60% complete at the startof the period, if passed the inspection point in the previous period. 18 | %10% x (8,500 units started — 1,000 units spoiled — 2,000 units in ending work in process). Both beginning and 19 | ending work in process are excluded since neither was inspected this period. 20 | *10%x 7,000, because 7,000 units are fully completed and Inspected In the current perlod, The following diagramn shows the flow of physical units for July and ¡llustrates the normal spoilage numbers in the table. Note that 7,000 good units are completed and transferred out—1,500 from beginning work in process and 5,500 started and completed during the period —while 2,000 units are in ending work in process. Do 20% 50 55% 80% 100%. t 1 Í 1,500 units from beginning work in process 5 500 units startedandicompleted Work done on 2,000 uns in ending work in process + To see the number of units passing each inspection point, consider in the diagramthe ver- tical lines at the 20%, 55%, and 100% inspection points. Note that the vertical line at 20% crosses two horizontal lines—5,500 good units started and completed and 2,000 units in ending wrork in process—for a total of 7,500 good units. (The 209 vertical line does not cross the line representing work done on the 1,500 good units completed 654 0 CHAPTER18 SPOILAGE, REWOPK, AND SCRAP Decision Point How does inspection at various stages ol completion affed the amount of normal and abnormal spollago? Computing Equivalent Units with Spoilage Using Weighted- Average Method of Process Oosling with Inspection at 209 of Completion for Forming Depariment ofAnzo Company for July 2012 from beginning work in process, because these units are already 60% complete at the start ofthe period and, hence, are not inspected this period.) Normal spoilage equals 10% of 7,500 = 750 units. On the other hand, the vertical line at the 55% point crosses just the second horizontal line, indicating that only 5,500 good units pass this point. Normal spoilage in this case is 10% of 5,500 = 550 units. At the 100% point, normal spoilage = 10% of 7,000 (1,500 + 5,500) good units = 700 units. Exhibit 18-4 shows the computation of equivalent units under the weighted -average method, assuming inspection at the 20% completion stage. The calculations depend on the divect materials and conversion costs incurred to get the units to this inspection point. The spoiled units have a full measure of direct materials and a 20% measure of conversion costs. Calculations of costs per equivalent unit and the assignment of total costs to units com- pleted and to ending work in process are similar to calculations in previous ¡llustrations in this chapter Because ending work in process has passed the inspection point, these units bear normal spoilage costs, just like the units that have been completed and transferred out. For example, conversion costs for units completed and transferred out include conversion costs for 7,000 good units produced plus 209 x (10% x 5,500) = 110 equivalent units of normal spoilage. We nelly by 20% to obtam eguivelert urtits of normal spoilage because cormersion costs are orly 20% complete at the inspection pott, Conversion costs of ending work in process include conversion costs of 50% of 2,000 = 1,000 equivalent good units plus 20% x (10% x 2,000) = 40 equivalent units of normal spoilage. Thus, the equivalent units of normal spoilage accounted for are 110 equivalent units related to units completed and transferred out plus 40 equivalent units related to units in ending work in process, for a total of 150 equivalent units, as shown in Exhibit 184. Early inspections can help prevent any further direct materials and conversion costs being wasted on units that are already spoiled. For example, ¡finspection can occur when units are 70% (rather than 100%) complete as to conversion costs and spollage occurs priorto the 70% point, a company can avoid incurring the final 30% of conversion costs on the spoiled units. The downside to conducting inspections at too early a stage is that spoilage that happens at later stages of the process may go undetected. lt is for these rea- sons that firms often conduct multiple inspections and also empower workers to identify and resolve defects on a timely basis. Home | insert Pagelayout Fommulas Data Review View A Bl | D 1 (Step 1) (Step 2) Z Equivalent Units Physical | Direct | Conversion 3 Flow.of Production Units | Materials Coste 4 | Workin process, beginning” 1,500 5 | Started during current perlod 8,500 6 | To account for 10,000 7. | Good unifs completed and transterred out: 7,000 7,000 7,000 3 | Normal spolage 750 a (750 x 100%; 750 x 20%) 750 150 10 | Abnormal spollage 250 11 (250 x 100%; 250 X 20%) 250 E) 12 | Workin process, ending” 2,000 13 (2,000 x 100%; 2,000 * 50%) 2,000 1,000 14 | Accounted for 10,000 15 | Equivalent units of work done fo date 10,000 8,200 16 17 | "Degree of complefion: direct materials, 100%; conversion cosís, 60%. 18 | 'Dagree of completion: direct materials, 100%; conversion costs, 50%. 656 0 CHAPTER18 SPOILAGE, REWORK, AND SCRAP Decision Point How do job-costing systems account for spoilage? Leaming Objective Account for rework in job costing normal rework assigned directly or indirectly to job; abnormal rework written off as a loss of the period Abnormal Spoilage Tf the spoilage 1s abnormal, the net loss is charged to the Loss from Abnormal Spoilage account. Unlike normal spoilage costs, abnormal spoilage costs are not inchided as a part of the cost of good units produced. Total cost of the 45 good units is $90,000 (45 units X $2,000 per unit). Cost per good unit is S2,000 ($90,000 + 45 good units). Materials Control (spoiled goods at current disposal value): 5 units >< $800 per unit 3,000 Loss from Abnormal Spoilage ($10,000 — $3,000) 7,000 Work-in-Process Control (specific job): 5 units < 52,000 per unit 10,000 Even though, for external reporting purposes, abnormal spoilage costs are written off in the accounting period and are not linked to specific jobs or units, companies often iden- tify the particular reasons for abnormal spoilage, and, when appropriate, link abnormal spoilage with specific jobs or units for cost management purposes. Job Costing and Rework Rework is units of production that are inspected, determined to be unacceptable, repaired, and sold as acceptable finished goods. We again distinguish (1) normal rework attributable to a specific job, (2) normal rework common to all jobs, and (3) abnormal rework. Consider the Hull Machine Shop data in Example 3 on page 655. Ássume the five spoiled parts are reworked. The journal entry for the $10,000 of total costs (Uhe details of these costs are assumed) assigned to the five spoiled units before considering rework costs is as follows: Work-in-Process Control (specific job) 10,000 Materials Control 4,000 Wages Payable Control 4,000 Manufacturing Overhead Allocated 2,000 Assumne the rework costs equal $3,800 (comprising S800 direct materials, $2,000 direct manufacturing labor, and $1,000 manufacturing overhead). Normal Rework Attributable to a Specific Job Tf the rework is normal but oceurs because of the requirements of a specific job, the rework costs are charged to that job. The journal entry is as follows: Work-in-Process Control (specific job] 3,800 Materials Control 800 Wages Payable Control 2,000 Manufacturing Overhead Allocated 1,000 Normal Rework Common to All Jobs When rework is normal and not attributable to a specific job, the costs of rework are charged to manufacturing overhead and are spread, through overhead allocation, over all jobs. Manufacturing Overhead Control (rework costs) 3,800 Materials Control 800 Wages Payable Control 2,000 Manufacturing Overhead Allocated 1,000 Abnormal Rework If the rework is abnormal, it is recorded by charging abnormal rework to a loss account. Loss from Abnormal Rework 3,800 Materials Control 800 Wages Payable Control 2,000 Manufacturing Dverhead Allocated 1,000 ACCOUNTING FOR SCRAP 6 657 Accounting for rework in a process-costing system also requires abnormal rework to be distinguished from normal rework. Process costing accounts for abnormal rework in the same way as job costing. Accounting for normal rework follows the accounting described for normal rework common to all jobs (units) because masses of identical or similar units are being manufactured, Costing rework focuses managers” attention on the resources wasted on activities that would not have to be undertaken if the product had been made correctly. The cost of rework prompts managers to seek ways to reduce rework, for example, by designing new products or processes, Lraining workers, or invesling in new machines. To elimi- Pando pocos nate rework and to simplify the accounting, some companies set a standard of zero systems account rework, All rework is then treated as abnormal and is written off as a cost of the cur- for reworlc? rent period. Decision Point Accounting for Scrap Serap is residual material that results from mannfacruring a product; it has low total sales value compared with the total sales value of the product. No distinction is made between Learning normal and abnormal scrap because no cost is assigned to scrap. The only distinction Objective made is between scrap attributable to a specific job and scrap common to all jobs. There are two aspects of accounting for serap: Accounifotscrap! reduces cost of job either at time of sale or 2. Inventory costing, including when and how scrap affects operating income at time of production 1. Planning and control, including physical tracking Initial entries to scrap records are commonly expressed in physical terms. In various industries, companies quantify items such as stamped-out metal sheets or edges of molded plastic parts by weighing, counting, or some other measure. Scrap records not only help measure efficiency, bul also help keep track of scrap, and so reduce the chances of theft. Companies use scrap records to prepare periodic sunimaries of the amounts of actual scrap compared with budgeted or standard amounts. Scrap is either sold or disposed of quickly or it is stored for later sale, disposal, or reuse. Careful tracking of scrap often extends into the accounting records. Many companies maintain a distinct account for serap costs somewhere in their accounting system. The issues here are similar to the issues in Chapter 16 regarding the accounting for byproducts: 1 When should the value of scrap be recognized in the accounting records—at the time serap is produced or at the time serap is sold? 1 How should revenues from serap be accounted lor? To illustrate, we extend our Hull example. Assume the manufacture of aircraft parts gen- erates serap and that the scrap from ajob has a net sales value of $900, Recognizing Scrap at the Time of lts Sale When (he dollar amount of scrap is inmaterial, the sirmplest accounting is lo record the physical quantity of scrap returned to the storeroom and to regard scrap sales as a sepa- rate line item in the income statement. Ln this case, the only journal entry is as follows: Sale ofscrap: Cash or Accounts Receivabla 900 Scrap Revenues 900 When the dollar amount of serap is material and the serap is sold quickly after it is pro- duced, the accounting depends on whether the scrap is attributable to a specific job or is common to all jobs. Scrap Attributable to a Specific Job Tob-costing s ap revenues Lo the jobs thal yi Thís method is used only when the traciog can be done in an economically feasible way. lor example, the llull Machine Shop and its customers, such as the U.S. Department of Defense, may reach an agreement that provides for charging specific jobs with all rework ms sometimes trace ACCOUNTING FOR SCRAP e 659 Managing Waste and Environmental Costs at Concepts in Action KB Home KB Home is one of the largest home huilders in the United States. In recent years, public awareness of environmental issues and interest in environmentally-friend ly products and services has led to increased demand for sustainable home construction. KB Home has responded by increasing the sustaina bility of its homebuilding operations, which includes reducing its waste and environmental costs. Through its “My Home. My Earth.” program, launched in 2007, KB Home has established environmental sustainability as to p-priority management ¡ssue. lt developed core principles to euide its efforts including using “innovation and our process-driven approach to reduce waste and natural resource usage throughout our organization.” Much of that focus involves reducing scrap, the residual materials that result from its homebuilding processes, These mate- rials pose additional problems for companies like KB Home, because many federal and state environmental laws dic- tate that scrap materials be deposed of in an environmentally friendly way; therefore, they add to the cost of generating waste. To reduce these costs durin g the homebuilding process, all new homes are built with pre-engineered roof trusses, while 90% also use preconstructed panels. These preconstructed materials are cut oftsite for greater precision, which reduces wood waste. Further, these precut materials are made of engineered wood products, which reduce the use of long solid boards that require larger trees to be cut. Beyond scrap reduction, these trusses and panels also eliminate the need for costly job-site rework, or the repair of defective materials during construction. Similarly, all new homes use oriented strand board, which is made from wood chip rather than plywood. Wood chip is both cheaper and more environmentally sustainable than traditional construction materials, These sustainable practices helped KB Home reduce the cost, exclusive of land, of each home manufactured in 2009 by nearly 39% over the previous year, while increasing profit margins by 13% despite the broader U.S. housing mar- ket collapse, Beyond the construction process, KB Home also includes earth-friendly standard features in all of its homes, at no cost to homebuyers, including energy-efficient win dows, recyclable carpets, programma ble thermostats, and faucets that reduce water usage. Beyond cutting costs, KB Home's efforts to effectively manage waste and environ- mental costs have helped the company partially stabilize revenues in a difficult real-estate market. Chief executive Jeffrey Mazger said, “Less than 2% of customers a few years ago were asking about enerey-efficient options. Since we introduced “My Home. My Earth” in April 2007, it's gone up to 75%.” This has helped KB Home differentiate itself within a very competitive market for homebuilders. Sources: KB Home. 2010. 2009 annual report. Los Angeles: KB Home; KB Home. 2010. 2009 sustainability report. Los Angeles: KB Home; Tischlex. Linda. 2008. The green housing boom. Fast Company, June 23. Scrap is sometimes reused as direct material rather than sold as scrap. In this case, Materials Control is debited at its estimated net realizable value and then credited when the scrap is reused. For example, the entries when the scrap is common to all jobs are as follows: Scrap returned to storeroom. Materials Control 900 Manufacturing Overhead Control 900 Reuse of scrap: Work-in-Process Control 900 Materials Control 900 Accounting for scrap under process costing is similar to accounting under job costing when scrap is common to all jobs. That's because the scrap in process cos ting is common to the manufacture of masses of identical or similar units. Managers focus their attention on ways to reduce scrap and to use it more profitably, especially when the cost of scrap is high (see Concepts in Action on p. 659). For example, General Motors has redesigned its plastic injection molding processes to reduce the scrap How ls seran plastic that must be broken away from its molded products. General Motors also regrinds accounted for? and reuses the plastic scrap as direct material, saving substantial input costs. Decislon Polnt 660 0 CHAPTER18 SPOILAGE, REWORK, AND SCRAP Problem tor Selft-Study Burlington Textiles has some spoiled goods that had an assigned cost of 540,000 and zero net disposal value. Prepare a journal entry for each of the following conditions under (a) process costing idepartment A) and (b) job costing: 1. Abnormal spoilage of $40,000 2. Normal spoilage of $40,000 regarded as common to all operations 3. Normal spoilage ol $40,000 regarded as attributable Lo specificalions o a particular job Solution (a) Process Costing (b) Job Costing 1. Loss trom Abnormal Spoilage 40,000 Lossfrom Abnormal Spailage 40,000 Workin Process—Dept. A 40,000 Work-in-Process Control 40,000 (specific job) 2. No entry until units are completed Manufacturing Overhead Control 40,000 and transferred out, Then the normal Work-in-Process Control 40,000 spoilage costs are transferred as (specific job) part of the cost of good units, Work in Process—Dept, B 40,000 Workin Process—Dept. A 40,000 3. Notapplicable No entry. Normal spoilage cost remains in Work-in-Process Control (specific job) Decision Points The following question-and-amswer format summarizes the chapters learning objectives. Each decision presents a key question related to a learning objective. The guidelines are the answer to that question. Decision 1. What are spoilage, rework, and scrap? 2. What 1s the distinction between normal and abnor- mal spoilage? 3. How do the weighted-average and WO methods of process costing calculate the costs of good units and spoilage? Guidelines Spoilage is units of production that do not meet the specifications required by customers for good units and that are discarded or sold at reduced prices. Spoilage is generally divided into normal spoilage, which is inherent to a partic- ular production process, and abnormal spoilage, which arises because of inetfi- ciency in operations. Rework is unacceptable units that are subsequently repaired and sold as acceptable finished goods. Serap is residual material that results frorm manufacturing a product; it has low total sales value compared with the total sales value of the product. Normal spoilage is inherent in a particular production process and arises when the process 1s operated in an efficient manner. Abnormal spoilage on the other hand is not inherent in a particular production process and would not arise under efficient operating conditions. Abnormal spoilage is usually regarded as avoidable and controlable. The weighted-average method combines costs in beginning inventory with costs of the current period when determining the costs of good units, which include normal spoilage, and the costs of abnormal spoilage, which are written off as a loss of the accounting period. 662 0 CHAPTER18 SPOLAGE, REWOPK, AND SCRAP Exhibht 18-5 Standard-Costing Mothod of Process Gosting with Spollage for Forming Department of the Anzio Company for July 2012 PANEL A: Stops 1 and 2-Summoriza Output in Physical Units anel Computo Exuivolo nt Units Home Insert Pagelayout Formulas Data Review View A 3 E b T E A (Step 1) [Step 2) a Equivalent Units: A Physical Direct Conversion A Hom products Unte Material Cos 4 vilo in proness, beginning iglven, p. 648) 1,500 5 ¡Started during ourrent period (given, p. 648) 8500 6 To account br 10,000 S ¡Good untscompltedard tarstenedoutdunng ourrent pend 8 From beginning work in pmcess* 1500 E 11,500 + (100% —100%); 1,500 * (100% 60%] 0 50 q Started and completed 5800 1 16,800 x 100%; 6,500 » 100%) 5,500 5,500 12 Normal spollaga* 700 13 (700 x 100%; 700 100%) 100 700 18 'Abnormal spollage? 300 1 (900 x 100%, 300 »100%) 300 300 16 Work ín process, ending' given, p. 648) 2.000 17 (2,000 10104 2,000 = 5046) 2,000 1,000 16 ¡focourted for 10900 15 Equivalent units otworkdone in current period 8,500 8,100 20 21 [Degree of completin in his department dimot materials, 100%; conve sion costs, 6016. "7,000 physical unas completed and trarsfermd out minus 1,500 physial units completed and traneterted out fm beginning 22] worken-pmosss Inventory. 24, Normal spollage is 10% of good units transfermd out: 10% x 7,000 = 700 units, Degree:of completlon al no mal spollage ln Iris. 25 | department direot materials, 100%, conue rs lan costs, 100%, 26 ['Abnormal spoilage = Actual spollage - Normal spoiage = 1,000 - 700 = 300 unts. Degee:of oompletion al abnormal spollage in this 27 | department dies materias, 100%, comes bn costs, 100%. 28 Degree of completan in this department direct materials, 100%, conversion cosls, 50%. PANEL B: Staps 3, 4, anel 5-Summariza Total Costs to Avcount for, Computo Cost par Equivalont Unit, and Assign Total Costs to Units Complotoel, to Spoilod Units, anel to Units in Encling Work in Process A E E [] E Total Production Direct Conversion 20 Costs Materials Costs 22 |ístep 3) [Woricin proves, beginning (glen, p. 661) $200 | (1504050) | (600x410.%0) 22 [Costs added in vunent periad atstandard pres 157.00 | (6504050) | 610000) 33 Tolalosst lo socomblor FO 00 J65)00 ESE 34 (Step 4) — [Standaricosts pereguivalent unit ighen, p. 651) 560 41850 51050 as [ístep 5) — [ássigamentolocsis atstamdaricosis. EN [Good unils completed and transteredout (7,000 units) 37 Workin process, beginning (1,500 uns) $ 22,200 11,500 40,50) | (900: P10.50) 38 Cost added to beginning work in proess in cument period 6,300 1050.60) (0d x $10.50) 29 Total from beginning Inventory before normal po lage 28,500 ab Started and complkted before normal spollage 5,500 units) 104,500 | 15,500'x 68,50) y (5,5006 H10:50) a Normal spollage (700 unis) Sao | cm0te be 50) y (rodx41050) az [A Total vosts of good units complted and transtered ou 145,00 as |18) baomal spo llge (300 units) 5,700 | (300's 38,50) 00» 410,50) aa [Ch kn process, ending (2,000 unts) 27500 | epod=$0.50) | qono'x4:10:50) as JtA)+H870) | Totaloosts accountad tor HAN 50 ETE Er] 47 |Equivatent unts ofdiect materials and conversion costs calculated in Step 2 in Panel A. ASSIGNIMENT MATERIAL 6 663 Finally, note that the journal entries corresponding to the amounts calculated in Step 5 are as follows: Finished Goods 146,300 Work in Process—Forming 146,300 To record transfer of good units completed in July, Loss from Abnormal Spoilage 5,700 Work in Process—Forming 5,700 To record abnormal spoilage detected in July. Terms to Learn This chapter and the Glossary at the end ofthe book contain definitions of the following important terms: abnormal spoilage (p. 646) normal spoilage (p. 646) scrap (p. 645) inspection point (p. 647) rework (p. 645) spoilage (p. 645) Assignment Material Questions MyAccouatinglal 18-1 Why is there an unmistekable trend in manufacturing to improve quality? 18-2 Distinguish among spoilage, rework, and scrap. 12-23 “Normal spoilage is planned spoilage.” Discuss 12-4 “Costs of abnormal spoilage are losses.” Explain. 18-5 “What has been regarded as normal spoilage in the past is not necessarily acceptable as normal spoilage in the present or futura.” Explain. 18-6 “Units of abnormal spoilage are inferred rather than identified.” Explain. 18-7 “In accounting for spoiled units, we are dealing with cost assignment rather than cost incur- rence.” Explain, 18-83 “Total input includes abnormal as well as normal spoilage and is, therefore, inappropriate as a basis for computing normal spoilage.” Do you agree? Explain. 18-9 “The inspection point is the key to the allocation of spoilage costs.” Do you agree? Explain. 18-10 “The unit cost of normal spoilage is the same as the unit cost of abnormal spoilage.” Do you agree? Explain 18-11 “In job costing, the costs of normal spoilage that occur while a specific job is being done are charged to the specific job.” Do you agree? Explain. 18-12 “The costs ot rework are always charged to the specific jobs inwhich the defects were originally discovered.” Do you agree? Explain. 118-132 “Abnormal rework costs should be charged to a loss account, notto manufacturing overhead.” Do you agree? Explain, 18-14 When is a company justified in inventorying scrap? 18-15 How do managers use information about scrap? Exercises MyAccountagian|J 18-16 Normal and abnormal spoilage in units. The following data, in physical units, describa a grinding process for January: Workin process, beginning 19,000 Started during current period 150,000 To accountfor Spoiled units Good units completed and transterred out Workin process, ending Accounted for Inspection occurs atthe 100% completion stage. Normal spoilage is 5% of tha good units passing inspection. 1. Compute tha normal and abnormal spoilaga in units. 2. Assume that the equivalent-unitcost of a spoiled unitis $10. Compute the amount of potential savings it all spoilage were eliminated, assuming that all othar costs would be unaffected. Comment on your answer.