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Cost Accounting for Waste

In a perfect world of cost accounting, there would be no waste in manufacturing and retailing. In the real world, however, some material is flawed, some products are made wrong, and items bought for retail sale get broken. Here’s how to account for the waste in manufacturing, retailing, and craft services.

The inspection point in cost accounting

The inspection point is the stage in production when you inspect the units produced to determine if they meet your standards. If so, they are units you can sell to a customer. If not, you consider whether the units can be reworked and sold later. The inspection point is also the time when you determine if any spoilage is avoidable or unavoidable.

Consider the timing of the inspection. Ideally, units should be inspected at each stage of the production process. Cost accountants assume that the spoilage occurs at the completion of a particular production stage, and that that’s when the goods are inspected. So, for example, if your company bakes 200,000 cookies per day, the inspection point would be when the cookies exit the oven. Then it’s obvious that any spoilage happened in the baking department.

Spoilage and scrap in cost accounting

The matching principle (a fundamental accounting principle) matches the costs incurred to produce a product with the revenue generated from selling it. The problem with the cost of spoilage and scrap is that you can’t directly trace it to a product you’ve sold. You have to allocate it.

Spoilage and scrap are not the costs making a single finished unit. Just the same, the units you sell must absorb some of this costs. So although spoilage and scrap don’t relate directly to finished units, they do relate indirectly.

If it’s any consolation, you may be able to sell scrap as something else — a different product with a lower sales value. For example, beef processors (also known as slaughterhouses) sell any usable scrap, edible or not, to a rendering plant. That decision allows you to increase the revenue you earn from your production process.

Even though the additional revenue is great to have, the revenue produced by scrap isn’t revenue from the primary product. They aren’t (and you aren’t) running production to generate scrap revenue.

A factory second is an item that’s spoiled, in that it failed quality inspection and doesn’t meet your standards. But with a factory second, there’s nothing intrinsically wrong with the product.

The finish on an electric guitar might have a blemish, but the guitar plays fine. A garment might have a “holiday” in the fabric, or a seam isn’t perfectly sewn. Still, it’s a wearable garment. And bread sold at a big bakery’s retail outlet (a “bakery thrift shop”) may be day-old bread, but it’s still good. The point is, you may be able to make money by selling so-called spoiled items.

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