The material requirements of production are issued on the basis of material requisitions. The output is obtained along with wastage, scrap, spoilages and defectives. The accurate cost of output can be computed after taking the losses into account.
Losses in the form of waste, scraps, spoilage and defectives are inherent and inevitable with any manufacturing activity. These losses can be controlled through adequate reporting and responsibility accounting. Standard for each type of loss is fixed. Actuals are compared and action is to be taken by the management to control the abnormal losses, based on the variances.
The different types of material losses are discussed below:
Waste is inherent in any manufacturing activity. Waste is a part of raw material lost in the process of production having no recoverable value. Waste occurs invisibly in the form of evaporation or shrinkage. It can be visible and solid also. Examples of visible wastes are gases, dust, valueless residue, etc. Sometimes disposal of waste entails additional expenditure. Example- atomic waste. Loss in the form of waste increases the cost of production.
Control of Waste:
A waste report is prepared periodically. The actual waste is compared with standard waste and remedial action is taken to control abnormal waste.
Waste has no value. The accounting treatment differs according to waste being normal or abnormal.
- Normal Waste:
This is the inherent waste while manufacturing. It is in the form of evaporation, deterioration etc. The total cost of normal waste is distributed among the good units of output.
- Abnormal Waste:
The abnormal waste is transferred to costing profit and loss A/c to avoid fluctuation in production cost.
Scrap, is the residue from certain manufacturing activities usually having disposable value. It can also be the discarded materials which can fetch some income. Examples of scrap are outlined material from stamping operations, filings, Saw dust, short lengths from wood working operations, sprues and ‘flash’ from foundry and moulding processes. Scrap may be sold or reused.
Control of Scrap:
Scrap is controlled by fixation of standards for scrap, fixation of department wise responsibilities for scrap, etc. Keeping up proper records of scrap and periodical reporting helps in control of scrap. Actual scrap is compared with standard scrap. Suitable action is taken for excessive actual scrap over standard scrap.
(a) Sale Value of Scrap Credited to Profit and Loss A/c:
The sale value is credited to profit and loss account as other income. The cost of output is inclusive of scrap cost. This method of accounting treatment is adopted when the value is negligible.
(b) The Sale Value Credited to Overhead or Material Cost:
The sale value is reduced with selling cost of scrap and the net sale value is deducted from factory overhead or from material cost. This method is adopted when several jobs are done simultaneously and it is not possible to segregate the scraps jobwise.
(c) Crediting the Sale Value to the Job or Process in which Scrap Arises:
The sale value of scrap is credited to the job or process concerned from which the scrap has arisen. This method is followed when identification of scrap with specific jobs or processes is easy.
Spoilage occurs when goods are damaged beyond rectification. Spoilage is disposed off without further processing. Spoilage cost is the cost upto the point of rejection less sale value.
The method of sale of spoilage depends on the extent of spoilage. Some of the spoilage is sold as seconds if the extent of damage is less; rest may be sold as scrap or treated as waste.
Control of Spoilage:
Spoilage is controlled through proper reporting about the extent of spoilage. Standards are fixed as a percentage on production. Actual spoilage is compared with standard and variance is recorded. If the actual spoilage is more than the standard, suitable action is suggested to control it.
Accounting Treatment of Spoilage:
Accounting treatment depends on whether the spoilage is normal or abnormal. Normal spoilage is borne by good units of output since it is inherent with production and it happens even under efficient conditions. Abnormal spoilage is avoidable under efficient conditions. The cost of abnormal spoilage is charged to profit and loss account.
It is a part of production which can be rectified and made into good units with additional cost. The defective work occurs due to raw materials of inferior quality, bad planning and poor workmanship. Defective units are rectified with additional cost of material, labour and overheads and sold as ‘first quality’ or ‘seconds’.
(a) Control of Defectives:
As in the case of other losses, defectives are controlled by accurate and periodical reports. Standards are fixed for defectives. Actual defective work is compared with standards. If actuals are more than the standards remedial action is taken to control it.
(b) Accounting Treatment of Defectives:
The accounting treatment depends on the extent of defectives production. If it is normal being inherent with production, it is identified with specific jobs. The cost of rectification is charged to specific jobs. If the cost is not traced with a job, the cost of rectification is treated as factory overhead.
If the defective work is out of abnormal circumstances the cost of rectification is transferred to profit and loss account.
- Obsolete, Slow Moving and Dormant Stocks:
These items are part of inventory. They need suitable and timely action on the part of the management to avoid occurrence of loss in due course and to prevent locking up of working capital.
(a) Obsolete Stocks:
They are those stocks in the inventory which have been lying unused due to change in product process and design or method of manufacturing. They are generally out of date.
(b) Slow Moving Materials:
They are items in stock used at long intervals and thus lying idle for long periods.
(c) Dormant Stocks:
They are items in stock not at all in use for a significant period of time.
The store keeper should highlight such items in his periodical reports so that the management may try- (a) to dispose them off at any price or (b) clear them out to save space in the stores (c) exercise caution in future purchase of such items of materials.