Many factors like shrinkage, seepage, evaporation, weight loss and use of inefficient equipment often cause a loss or spoilage of units in processing departments. In process costing, this loss of units is categorized as normal and abnormal loss. This categorization is essential mainly because of two reasons. Firstly, the normal loss and abnormal loss are accounted for differently in most of the costing systems and the process costing system is not an exception. Secondly, this categorization is helpful in finding and fixing any abnormalities present in the production processes carried out in various processing departments.
Before exemplifying the treatment of normal loss, let’s briefly explain what is normal loss or spoilage in the context of process costing.
What is normal loss or spoilage in process costing?
The normal loss is the unavoidable loss of units in a processing department that occurs majorly due to the nature of production operation or the nature of raw materials being processed. This loss cannot be avoided under normal and efficient production environment and is considered within the normal or acceptable tolerance limit for machines and human errors.
In many industries, the normal loss is a highly expected or anticipated loss and is sometimes also termed as the standard loss. It is a known loss and in many situations its quantum can be easily estimated in advance of the start of production process. Since, the normal losses are inherent in certain manufacturing processes, the companies mostly make a provision for such losses before starting their manufacturing processes.
The normal loss is not presented as a separate cost element on the cost of production report (CPR) of the concerned department. The cost of lost units is just spread over the number of good units which results in an increased per unit cost for total output of the relevant processing department.
Treatment of normal loss while preparing departmental cost of production report
Normal loss in first department
If the normal loss occurs in first processing department, it only increases the unit cost of the remaining good output because the total cost is divided by only the good units to obtain the per unit cost of the departmental output. The normally lost units are not considered while computing equivalent units which results in a decreased number of equivalent units and increased unit cost for materials, labor and manufacturing overhead. The increased per unit cost of these three cost elements results in an increased total per unit cost in the department.
To sum up the above discussion, we can say that the normal loss in first department is fully ignored and is not made part of any computation while preparing the cost of production report of first department.
Normal loss in department subsequent to first
When normal loss occurs in a department subsequent to first department, the per unit cost from preceding department needs to be adjusted for the units lost in the subsequent department. It is done using one of the flowing two formulas:
Lost unit cost = [Cost from preceding department ÷ Good units] – Unit cost from preceding department before adjustment
Lost unit cost = (Lost units × Unit cost from preceding department before adjustment) ÷ Good units
Both of the above formulas produce the same result.
Now consider the following example for a proper understanding of the treatment of normal loss while preparing cost of production report for the first and subsequent departments:
The David Corporation produces a chemical which is processed through two separate departments. For November, the following data has been taken from the 1st and 2nd Department of the corporation:
All materials are added in 1st department at the time of start of manufacturing process. The 2,000 units in work in process ending inventory of 1st department were 100% complete as to materials and 50% complete as to labor and manufacturing overhead costs. The 1,500 units in work in process ending inventory of 2nd department were 1/3 complete as to labor and manufacturing overhead costs. No abnormal loss was observed in any department during the month. There was no work in process inventory in 1st and 2nd Department at the beginning of November.
Required: Using the data given above, prepare a separate cost of production report for 1st and 2nd department of David Corporation.
1. Cost of production report – 1st Department
Equivalent units of production and unit cost – 1st Department:
Computation of equivalent units:
Materials: 22,500 units + 2,000 units = 24,500 units
Labor and overhead: 22,500 units + (2,000 units × 50%) = 23,500 units
Computation of unit cost:
Materials: $12,250/24,500 units = $0.50
Labor: $14,570/23,500 units = $0.62
Overhead: $14,100/23,500 units = $0.60
2. Cost of production report – 2nd Department
Equivalent units of production and unit cost – 2nd department
Computation of equivalent units:
Labor and overhead: 20,000 units + (1500 units × 1/3) = 20,500 units
Computation of unit cost:
Labor: $18,655/20,500 units = $0.91
Overhead: $16,400/20,500 units = $0.80
*Adjustment for lost units
In 2nd department, the per unit cost of 1.72 transferred in from preceding department must be adjusted for the lost units. The adjustment amount is $0.08 which can be worked out using one of the following two methods:
[Cost from preceding department/Good units] – Unit cost from preceding department before adjustment
= [38,700/(22,500 – 1,000)] – $1.72
= $1.80 – $1.72
(Lost units × Unit cost from preceding department before adjustment)/Good units
= (1,000 × $1.72)/21,500
Normal loss at the end of process
In the above discussion, we have assumed that the normal loss is identified during the production process. However, when normally lost units are identified at the end of production process, a different treatment is adopted.
Where the normal loss is identified at the end of production process, the cost of lost units is charged to units completed and transferred out during the period. In such situation, no part of normal loss is charged to unfinished or work in process ending inventory in the department.
This situation is illustrated by the following cost of production report of Department Y of Roberts Company. The normal loss is 900 units (5% of good output) which is identified at the end of production process.
Materials: 18,000 units
Labor and overhead: 18,000 + (4,000 × 0.7) + 900 + 1,100
= 22,800 units
Materials: $36,000/18,000 units = $2.00 per unit
Labor and overhead: $91,200/22,800 units = 4.00 per unit
Notice that the normal loss of 900 units identified at the end of process has been charged to good units transferred to finished goods store room. No part of this loss has been charged to ending inventory.