Cost Accounting: Normal Spoilage Allocated to One or All Jobs
Normal spoilage needs to be allocated when cost accounting. Specifically you need to decide whether the cost should be assigned to a specific job or to all jobs. Say you own a plumbing company and work with small commercial buildings. You’re reviewing your plumbing supply costs for the week, and you notice that some brackets were defective.
The bracket defect isn’t unique to one job. The defect could happen on any job, particularly because you use the bracket frequently. To allocate the normal spoilage to all jobs, the cost needs to be posted to manufacturing overhead. Those overhead costs are then moved to the work in process. Overhead costs, by definition, can’t be traced to a specific product.
The bracket, however, is first considered a material cost put into production. When you write the check for the bracket, you debit (increase) material control and credit (decrease) cash. (You may also credit accounts payable instead of cash.)
The work in process account is assigned material, labor, and overhead costs that are put into production If you consider the bracket defect to be normal spoilage, you add the cost to production. Here are the accounting entries:
Debit (increase) manufacturing overhead control and credit (decrease) material control. The cost of the brackets was originally posted to material control. This entry moves the cost into an overhead account.
Debit (increase) work in process and credit (decrease) manufacturing overhead control. This entry allocates the cost of the brackets to production.
Now consider that if the bracket is defective, you replace it (true especially if you’re using a lot of them on every job). When you buy the replacement bracket, you debit (increase) material control and credit (decrease) cash. One cost is the defective item (normal spoilage), and the other is a material cost for the job.
If the bracket defect is considered normal spoilage for one particular job, the cost should be added to production. Here are the accounting entries:
When the brackets are purchased, debit (increase) material control and credit (decrease) accounts payable or cash.
Debit (increase) work in process and credit (decrease) material control. This entry allocates the cost of the brackets to production for a specific job.
Unlike normal spoilage, which you expect, abnormal spoilage is a defect you don’t expect. The normal spoilage for brackets is 2 percent. That rate assumes that your plumbers are using the bracket for normal use. In fact, you see the phrase normal use on packaging for many products.
Abnormal spoilage can happen when a part is used incorrectly. Say that a plumber uses the bracket in completely the wrong way. Not surprisingly, the defect rate (failure rate) of the part is much higher — call it 30 percent.
One more time: Abnormal spoilage cost for job costing is posted to a loss account. The idea is that you recognize the expense (loss) immediately. Here are the accounting entries:
When the brackets are purchased, debit (increase) material control and credit (decrease) accounts payable or cash. This is an entry you make for just about any purchase.
Debit (increase) loss from abnormal spoilage and credit (decrease) material control by the cost of the abnormal spoilage. This transaction allocates the cost of the spoiled brackets to a loss account.
“Writing down” abnormal spoilage is consistent with the accounting principle of conservatism. The conservative approach is to recognize losses as soon as possible. Those losses will make their way into the financial statements. The financial statement reader will see a better picture of business activity.