In process costing, abnormal loss can be defined as the loss or spoilage of units in a processing department that should not occur under normal and efficient working conditions. The abnormal loss signifies that the production operation has one or more serious issues that need to be identified and fixed quickly. Major factors that may contribute towards the occurrence of abnormal loss in a production process include use of faulty equipment, unskilled or untrained workers, use of substandard raw materials, improper supervision, frequent electricity breakdown and working conditions with a lot of room for improvements etc.
Difference between normal and abnormal loss
The core factor considered for differentiating between normal and abnormal loss or spoilage is the degree of controllability. The degree of controllability in case of a normal loss is much smaller than in case of an abnormal loss.
Normal loss is referred to as uncontrollable because it is inherently attached to certain production processes and can’t be avoided even under most efficient working conditions. Examples of such losses include weight loss, evaporation and shrinkage of materials. We can’t do too much to stop these losses from occurring as the degree of controllability is usually very small to zero in case of normal losses.
The abnormal loss, on the other hand, is referred to as controllable loss because it can be avoided under normal and efficient working conditions. It is essentially an unnecessary loss because it occurs due to carelessness, use of low quality materials, use of inefficient or faulty machines in manufacturing process and other similar factors that are controllable in nature.
Treatment of abnormal loss in process costing
There are two methods for the treatment of abnormal loss in a process costing system. It is either charged to factory overhead or an expense account for the current period and is presented as a separate line item on the cost of goods sold statement. Under first treatment, the abnormal loss causes an additional unfavorable factory overhead variance.
The following example illustrates the presentation of abnormal loss on the cost of production report.
The Maria Inc. has two processing departments and uses a process costing system. During April, the 2nd department received 30,000 units from 1st department at a total cost of $106,200. Costs added in the 2nd department were:
- Materials: $20,825
- Labor: $50,850
- Factory overhead: $28,250
Out of 30,000 units received from 1st department, 25,000 units were transferred to 3rd department; 4,500 units were in process at the end of April (all materials, 2/3 labor and factory overhead costs); 500 units were lost in process(1/2 complete as to materials, labor and factory overhead costs). There was no work in process beginning inventory.
The entire loss occurred in 2nd department is abnormal. The Maria Inc. charges all abnormal losses to factory overhead.
Required: Prepare a cost of production report (CPR) for April for 2nd department of Maria Inc.
Equivalent units and unit cost
Materials: [25,000 + 4,500 + (500 × 1/2)] = 29,750 units
Labor and factory overhead: [25,000 + (4,500 × 2/3) + (500 × 1/2)] = 28,250 units
Materials: $20,825/29,750 units = $0.70/unit
Labor: $50,850/28,250 units = $1.80/unit
Factory overhead: $28,250/28,250 units = $1.00/unit
Notice that not only the units transferred to next department and the stage of completion of units in work in process ending inventory but also the stage of completion of abnormally lost units have been taken into account while computing equivalent units of production of the department.