Here are two methods of cost accounting for normal spoilage. You calculate equivalent units including spoiled units first. Then you look at the results when you exclude spoiled units from equivalent units.
Say you manufacture men’s leather belts. Consider this information for the example:
Material costs enter production at the beginning of the process. There is no beginning inventory for this month (January).
Because material costs are incurred at the beginning of the process, assume that the units are 100 percent complete for material costs. So material equivalent units equal physical units. Other costs (like conversion costs) may not be complete. This analysis considers only material costs.
You produce 6,000 units during January. Of these, 5,800 are good units that can be sold to customers. The other 200 units are spoiled. The spoilage is about 3 percent of total production (200 spoiled units ÷ 6,000 units produced x 100). Based on your experience and knowledge of the process, a 3 percent level of spoilage isn’t unusual. You consider the defective units to be normal spoilage.
Spoiled units are treated as completed goods that are transferred out.
Ending work in process is 2,000 units. Good units completed and transferred out are 3,800 units (5,800 good units – 2,000 ending work in process).
The total material costs to be allocated are $150,000.
The following table is the calculation of equivalent units with spoiled units included in the calculation. It calculates cost for material only.
| Units | Cost/Unit | Cost | |
|---|---|---|---|
| Costs incurred to date (A) | $150,000 | ||
| Equivalent units (B) | 6,000 | ||
| Cost per equivalent unit (A)/(B) | $25.00 | ||
| Assignment of costs | |||
| Units completed, transferred out | 3,800 | $25.00 | $95,000 |
| Add spoiled units | 200 | $25.00 | $5,000 |
| Goods transferred out | 4,000 | $100,000 | |
| Work in process, ending | 2,000 | $25.00 | $50,000 |
| Costs accounted for | 6,000 | $150,000 |
Work your way from the top of the table toward the bottom. Cost per equivalent unit is the total cost to date ($150,000) divided by the 6,000 equivalent units cited in the text.
Any goods you work on during the period (whether in work in process or started during the period) end up in one of two places. They are goods completed and transferred out to finished goods inventory, or they are considered work in process. Keep in mind, however, the actual spoiled units aren’t transferred to finished goods. Spoiled units aren’t sellable. Finished goods are units that can be sold to a customer.
In the table, there are 4,000 units transferred out, 3,800 of which are good units (units you can sell to a customer). You treat the 200 spoiled units as completed, too. They’re bad units, and you can’t sell them to a customer — but you are finished working on them.
This costing method for normal spoilage equivalent units assumes spoiled units are completed. It makes sense, if you assume there’s an inspection at the point of completion, and some units are spoiled.
Defective units could be reworked and sold as good units. That’s not always the case, but it’s possible. To be clear, this table and the following table don’t take reworks into account.
In the first table, the work in process units (2,000 units), plus the completed and transferred-out units (4,000 units), total the 6,000 equivalent units at the top of the table. You’ve accounted for all of the units. Finally, the cost accounted for ($150,000) at the bottom of the table agrees with the costs incurred to date at the top of the table.
So you just calculated equivalent units and accounted for normal spoilage. The first table assumes that spoiled units were included in the equivalent unit calculation. Now give it a try with spoiled units excluded from equivalent units.
The next table excludes the spoiled units. All the other variables are the same.
| Units | Cost/Unit | Cost | |
|---|---|---|---|
| Costs incurred to date (A) | $150,000 | ||
| Equivalent units (B) | 5,800 | ||
| Cost per equivalent unit (rounded) (A)/(B) | $25.86 | ||
| Assignment of costs | |||
| Good units completed | 3,800 | $25.86 | $98,276 |
| Add spoiled units | 0 | $0 | |
| Goods transferred out | 3,800 | $98,276 | |
| Work in process, ending | 2,000 | $25.86 | $51,724 |
| Costs accounted for | 5,800 | $150,000 |
Here’s how this table differs from the first calculation of equivalent units:
There are 5,800 equivalent units. You get that number by taking 6,000 total units produced and subtracting 200 spoiled units.
Your total material costs remain at $150,000. You’re spreading the same cost over fewer equivalent units. Your cost per equivalent unit is $25.86 ($150,000 total cost ÷ 5,800 units). The cost per equivalent unit is $0.86 higher than the cost per equivalent unit in the first table.
The good units completed are the same as in the first table (3,800 units). However, no spoiled units are added to the total goods transferred out. So those same 3,800 units are transferred out (instead of 4,000 in the previous example).
Work in process (2,000 units) is the same as in the first table. The total units accounted for are 5,800 (not 6,000, as in the first table.
The costs accounted for is the same $150,000. That agrees with the cost incurred to date at the top of the table. You assign the same cost to 200 fewer units than you did in the first table, because the cost per equivalent unit is higher.