APPENDIXBSHRINKAGEANDLOSTUNITS

The illustrations presented in Chapter 6 of the textbook assume that units that are
in process are either completed or still awaiting completion at the end of each pe- LEARNINGOBJECTIVE 9
riod. In reality, units can disappear because of evaporation, losses, or rejection. Such Compute the cost of lost
missing units can be considered to be a normal part of the processing or may be units or shrinkage.
deemed to be abnormal. Abnormal losses can be thought of as costs akin to unusual
losses studied in financial accounting. Normal losses are normal costs of operating
the process department.
Two accounting treatments are prevalent for normal losses. One, the amount of
the loss can be charged to a specific loss account, which could be charged to manu-
facturing overhead. Two, the amount of the loss could be spread over all of the good
units of work done during the period.
If significant in amount and truly abnormal, losses should always be assigned to
the unusual section of the income statement, where they can be offset by any recov-
eries from insurance or other means.
The following cases illustrate the two alternative treatments of normal losses.
The weighted-average method of costing is used for illustration.

Case 1: Normal Loss Charged to Manufacturing

Overhead
Assume that Stabler Chemical had a machine breakdown, causing a loss of 10,000
units that were 100% complete as to materials and 60% complete for labour and
overhead. Exhibit 6B1 presents the cost of production report for Stabler Chemical,
assuming that normal losses are to be charged to manufacturing overhead. Note
that the lost units are included in the units accounted for, and the equivalent units
lost become a separate line in the equivalent units calculation. When costs are ac-
counted for, the lost units are costed according to their equivalent units completed.
The journal entry for normal losses is as follows:
Manufacturing Overhead . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,272
Work in Process. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,272

An assumption is needed here to avoid a significant complexity. The preceding

entry assumes predetermined overhead is used so that $11,272 is an actual overhead
cost that was previously estimated when the overhead rate was calculated. Because
the $11,272 includes $4,632 for overhead, overhead on lost units is being charged
tomanufacturing overhead, resulting in some cost duplication, but the amount of
error introduced is assumed to be minor.

Case 2: Normal Loss Charged to Good Output

Exhibit 6B2 presents the cost of production report for Stabler Chemical, assum-
ing that normal losses are to be charged to good output. In this case, the 10,000
lost units are accounted for but not assigned a value in equivalent units. Instead,
the total cost of $300,000 is distributed over fewer equivalent units, increasing
the cost per equivalent unit as compared to the costs calculated in Exhibit 6B1
(i.e., $1.706 versus $1.642). No special journal entry is needed to account for
costs related to spoiled units, since these costs are attached to the equivalent
units of production.
6B-2 Appendix 6B Shrinkage and Lost Units

EXHIBIT6B1 Production Report: Weighted-Average MethodLoss Charged to Overhead

Quantity Schedule and Equivalent Units

Quantity
Schedule
Units to be accounted for:
Work in process, beginning (all materials, 30% labour
and overhead added last month) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000
Started into production . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180,000
Total units to be accounted for . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200,000
Equivalent Units
Materials Labour Overhead
Units accounted for as follows:
Transferred out. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160,000 160,000 160,000 160,000
Units lost, normal (100% of materials, 60% labour and overhead) . . . 10,000 10,000 6,000 6,000
Work in process, ending (all materials, 40% labour and
overhead added this month). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,000 30,000 12,000* 12,000*
Total units accounted for . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200,000 200,000 178,000 178,000
Unit Costs Total Materials Labour Overhead
Work in process, beginning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 17,000 $ 8,000 $ 3,600 $ 5,400
Cost added by the department . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 283,000 63,000 88,000 132,000
Total cost (a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $300,000 $ 71,000 $ 91,600 $137,400
Equivalent units (b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200,000 178,000 178,000
Unit cost, (a) (b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1.642 = $0.355 + $0.515 + $0.772

Cost Reconciliation Costs

Cost to be accounted for:
Work in process, beginning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 17,000
Cost added by the department . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 283,000
Total cost to be accounted for . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $300,000
Equivalent Units
Cost accounted for as follows:
Transferred to cooking: 160,000 $1.642 . . . . . . . . . . . . . . . . . . . . . . . . $ 262,720 160,000 160,000 160,000
Normal losses
Materials (at $0.355 10,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,550 10,000
Labour (at $0.515 6,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,090 6,000
Overhead (at $0.772 6,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,632 6,000
Total normal losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,272
Work in process, ending:
Materials (at $0.355 30,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,650 30,000
Labour (at $0.515 12,000). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,180 12,000
Overhead (at $0.772 12,000). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,264 12,000
Total work in process, ending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26,094
Total cost accounted for . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300,086
Less: Rounding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86
Total cost accounted for. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $300,000

*40% 30,000 units = 12,000 equivalent units.

 Appendix 6B Shrinkage and Lost Units 6B-3

EXHIBIT6B2 Production Report: Weighted-Average MethodLosses Charged to Good Output

Quantity Schedule
Quantity
Schedule
Units to be accounted for:
Work in process, beginning (all materials, 30% labour and
overhead added last month) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000
Started into production . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180,000
Total units to be accounted for . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200,000
Equivalent Units
Materials Labour Overhead
Units accounted for as follows:
Transferred out . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160,000 160,000 160,000 160,000
Units lostnormal. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000* 0 0 0
Work in process, ending (all materials, 40% labour and
overhead added this month) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,000 30,000 12,000 12,000
Total units accounted for . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200,000 190,000 172,000 172,000

Unit Costs Total Materials Labour Overhead

Work in process, beginning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 17,000 $ 8,000 $ 3,600 $ 5,400
Cost added by the department . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 283,000 63,000 88,000 132,000
Total cost (a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $300,000 $ 71,000 $ 91,600 $ 137,400
Equivalent units (b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 190,000 172,000 172,000
Unit cost, (a) (b). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1.706 = $0.374 + $0.533 + $0.799

Cost Reconciliation Costs

Cost to be accounted for:
Work in process, beginning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 17,000
Cost added by the department . . . . . . . . . . . . . . . . . . . . . . . . . . . . 283,000
Total cost to be accounted for . . . . . . . . . . . . . . . . . . . . . . . . . . . . $300,000
Equivalent Units
Cost accounted for as follows:
Transferred to cooking: (160,000 $1.706) . . . . . . . . . . . . . . . . . . . $ 272,960 160,000 160,000 160,000
Work in process, ending:
Materials (at $0.374 30,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,220 30,000
Labour (at $0.533 12,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,396 12,000
Overhead (at $0.799 12,000). . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,588 12,000
Total work in process, ending . . . . . . . . . . . . . . . . . . . . . . . . . 27,204
Total cost accounted for . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300,164
Less: Rounding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164
Total cost accounted for. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $300,000

*Total units to be accounted for, 200,000 - Units transferred, 160,000 - Units in process, ending, 30,000 = 10,000 units lost.

40% 30,000 units = 12,000 EU.
EU = Equivalent unit.
6B-4 Appendix 6B Shrinkage and Lost Units

APPENDIXBQUESTIONSANDPROBLEMS
6B1 Describe two methods of dealing with normal losses in a process.

6B2 Which of the two methods of dealing with normal losses would you prefer from a
management control perspective? Why?

PROBLEM 6B1 Process Costing; Spoilage [LO9]

Milliners Flour Ltd. operates under a process costing system for one of its products. During the
month of June, 5,676 units were put into production and 5,000 units were completed and trans-
ferred to finished goods. There were 160 good units in ending work in process inventory
(100% complete for materials and 75% complete for conversion costs). Remaining units were
considered normal spoilage. There were no beginning inventories; during June, $56,760 of di-
rect materials were applied at the beginning of the process, and conversion costs of $52,820
were applied evenly during the process. There was no abnormal spoilage during June.
Required:
Compute the cost of goods completed and the cost of the ending inventory of work in process.
Charge the costs of all normal spoilage to good output.
(CGA, adapted)

PROBLEM 6B2 Process Costing; Spoilage [LO9]

Baker Company uses a process costing system to account for the costs of three production
departments (Departments 1, 2, and 3). Department 2 receives units from Department 1 and
applies conversion costs evenly throughout the process. During the month, 32,000 units were
completed and transferred to Department 3. When the units are 90% complete, they are in-
spected and all materials are then added to the good units.
The following is additional information related to Department 2 for the month of May:
a. The department had 2,000 units in process at the beginning of May. They were estimated
to be 40% complete. Costs associated with these units were as follows:
Department 1 costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $10,000
Department 2 costs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,800
b. During May, 35,000 units were received from Department 1 at a cost of $205,000.
c. Actual costs incurred by Department 2 during the month were as follows:
Materials. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 12,500
Conversion costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105,000
d. There were 4,000 units in process at the end of the month that were estimated to be 70%
complete.
Required:
1. Prepare a cost report for Department 2 for May using the weighted-average method, show-
ing the determination of equivalent units, the cost per equivalent unit, the disposition and
cost of spoiled units, the cost of goods transferred out, and the cost of the ending work in
process inventory. Charge the costs of normal spoilage to manufacturing overhead.
2. How much could Baker save if it were able to reduce its spoilage to zero? Would society
benefit from such an action?
(CGA, adapted)

PROBLEM 6B3 Process Costing; Second Department; Spoilage [LO9]

Mosley Co. Ltd. has two departments and uses a weighted-average process costing system. The
following information pertains to Department 2 for the month of April:
a. At March 31, the work in process inventory in Department 2 consisted of 6,000 units that
were 50% complete and had been charged $56,000 for Department 1 costs, and $24,000 for
conversion costs in Department 2.
b. During April, 22,000 units were received from Department 1 at a cost of $224,000.
c. Department 2 costs during April were $24,000 for materials and $156,000 for conversion costs.
d. 16,000 good units were completed and transferred to finished goods.
e. At the end of April, 10,000 units were still in process in Department 2. They were esti-
mated to be 60% complete.
 Appendix 6B Shrinkage and Lost Units 6B-5

In Department 2, it is expected that 5% of good output will be spoiled. Inspection takes place
at the end of the process. Materials are added after inspection in Department 2.
Required:
1. Prepare a cost report for Department 2 for April using the weighted-average method,
showing the determination of equivalent units, the cost per equivalent unit, the disposi-
tion and cost of spoiled units, the cost of goods transferred out, and the cost of the ending
work in process inventory. Charge the costs of normal spoilage to manufacturing
overhead.
2. Was the spoilage in Department 2 greater or less than normal? What was its cost to
Mosley? How should any abnormal spoilage be accounted for?
3. How much could Mosley save if it could cut its normal spoilage to 2%?
(CGA, adapted)

PROBLEM 6B4 Process Costing; Second Department; Spoilage [LO9]

The SMU Company operates under a weighted-average process costing system. It has two de-
partments, 1 and 2. In Department 2, materials are added at the end of the process, following
inspection. Normal spoilage is considered to be 10% of good output. Labour and overhead
costs are assumed to apply evenly throughout the process.
Inventory at the beginning of the period was one-half complete; ending inventory is two-
thirds complete.
Following are the costs and unit production statistics for November:
Beginning inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,200 units
Received from Department 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000 units
Completed good output transferred to
finished goods storeroom . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,000 units
Ending inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,500 units

Costs Transferred from Dept. 1 Materials Labour Overhead

Beginning inventory . . . . . . . . $ 6,100 $ 1,400 $ 550
Current costs . . . . . . . . . . . . . . $23,900 $7,000 $12,000 $5,050
Required:
Prepare a cost report for Department 2 for November using the weighted-average method,
showing the determination of equivalent units, the cost per equivalent unit, the disposition of
the cost of spoiled units, the cost of goods transferred out, and the cost of the ending work in
process inventory. Charge normal spoilage to good output.
(CGA, adapted)