Cost Accounting: How to Allocate Rework
When cost accounting, you might allocate the cost of rework to a specific job or to all jobs. It’s common to find some normal spoilage at job inspections, so it’s good to become familiar with these two types of journal entries.
Cost accounting — rework allocation to a specific job
Say you’re putting up special wallpaper. The wallpaper is used only for one job. It’s not unusual for different remodeling jobs to have completely different material and labor costs. After all, a bath remodel requires different materials from a new kitchen, and even two bathrooms won’t be exactly alike.
The wallpaper is 20 inches wide and comes in a 60-foot roll. After putting up the wallpaper, you find that a 3-foot-long area is discolored. The defect is 5 percent of the total roll of wallpaper (3 feet ÷ 60 feet x 100).
Based on your industry experience, you expect a 5 percent defect rate in a typical roll of the wallpaper. You also know the product well enough that you can treat the discolored area with chemicals and fix the color. It takes an employee 30 minutes ($15 of labor cost), and the chemicals (material) cost $50. Here’s the journal entry for the rework costs:
Debit (increase) work in process $65, credit (decrease) material control $50, and credit (decrease) labor control $15
Cost accounting — rework allocation to all jobs
If you determine that normal spoilage should be allocated to all units, the cost of rework should be charged to manufacturing overhead. Overhead can then be allocated to all products, based on the overhead allocation rate.
Say your remodeling business uses two-by-four treated lumber for many jobs during a particular month. You inspect the lumber for knots and other flaws before you use it in production. During the month, you find that about 3 percent of the lumber is defective. Given your industry experience, that defective rate is expected. You judge the defects to be normal spoilage.
Fortunately, your work crews have the experience to rework the lumber so it’s usable. Workers sand the wood and fix flaws in its shape or appearance. Your rework cost is labor cost.
Because nearly every job uses some type of two-by-fours, you allocate all normal spoilage for two-by-fours to all jobs.
The good news is that you were able to rework the lumber and use it in production. You incurred more costs, but it’s better than investing the time and money to get replacement two-by-fours and incurring the cost of the unused pieces of lumber.
When labor is assigned to a job, you debit work in process and credit either cash or wage payable control. Labor cost for rework is handled differently. When you compute the rework cost, you make this accounting entry:
Debit manufacturing overhead control, credit wage payable control
There’s a final step to get the rework costs into production. The rework costs are in manufacturing overhead control. You allocate overhead cost based on a predetermined overhead rate. You determine a budgeted overhead rate in planning.
If you really want a gold star on your report card, consider budgeting for rework costs when you plan your overhead rate. As a remodeler, you know that a 3 percent defect rate is acceptable for two-by-fours. You also have some idea of the cost to rework the two-by-fours. Because two-by-fours are allocated to all jobs, you know that the rework cost end up in a budgeted overhead account.
Your knowledge allows you to budget more precisely. Consider the normal spoilage rate for as many costs as you can. Then consider the rework costs for as many costs as you can. You can add the total dollar amount to your budgeted overhead for the year.