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Chapter 3 - Production Losses-1 2021
Bachelor of Science and Accoutancy (BSA)
University of San Carlos
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Introduction
Shoemaking is part of the heritage of the people of Carcar, Cebu. It has been passed down from generation to generation and has become a major industry adopted by around 435 skilled workers of this small town. The shoe capital in Cebu had its glory days back in 80’s. The shoe industry was one of the city’s big income and employment generator. It was also every family’s means of supporting the education of their children.
Carcar's shoemaking industry benefits from the One Town, One Product (OTOP-Philippines) project of the DTI. A priority program of President Gloria Macapagal –Arroyo to promote entrepreneurship and create jobs, OTOP-Philippines encourages the country’s micro, small and medium enterprises (MSMEs) to produce and market distinct products or services using indigenous raw materials and manpower. The DTI has been assisting the Carcar local government and other LGUs in identifying the specific product or service and coordinates all forms of assistance from various agencies including the Department of Agriculture (DA), Department of Environment and Natural Resources (DENR), Department of Interior and Local Government (DILG),Department of Science and Technology (DOST), Department of Tourism (DOT) and the Technical Education Skills Development Authority (TESDA).
At present, DTI-CPO is providing technical assistance to the Carcar United Footwear Manufacturers Association Inc. Despite the industry’s quality products, Carcar shoes had a difficult time competing price- wise with other shoe manufacturers because of the high cost of raw materials, which are bought in small quantities. With bulk buying, the cost of raw materials will go down, resulting in cheaper products. DTI- CPO had facilitated CUFMAI’s linkage with Bulacan-based leather tannery Eastern Tanning Corp. for the raw material bulk buying.
The declining trend in shoe manufacturing resulting from trade liberalization in the country is a wake up call to our legislators. The entry of cheap goods from China, Korea, Taiwan and other countries affected our local industry as many consumers would prefer going for cheaper priced products aside from the Filipinos' continuing preference for foreign shoe brands such as Sketchers, Nike, Adidas and Converse, most of which are imported from China. Part of the innovation that the shoe industry is embracing now is on automation and tweaked production methods. The shoe manufacturer’s core business is in mass production but while automation led to fewer workers, this will also lead to better yield in production. They also offer customized shoes, like for members of the Philippine National Police (PNP) that require a certain sole height and finish. There is also a need to educate the shoe manufacturers on how to avoid production wastage and enhancing marketing opportunities.
The level of revival the shoe industry has reached today couldn’t have been realized without the partnership of the private sector and the government. With these positive developments, Carcar shoemakers can now look forward to a much brighter future.
Mass Production
China is the world’s number one largest producer of shoes. Ninety-nine percent (99%) of shoes sold in
the U. are imported, many of them from China, Vietnam and Indonesia. Look at the label on your
computer, loor lamp, appliances and shoes – Made in China. Most of the things you see at home
have been mass produced. Mass production (also called mass manufacturing) is a method of production that involves the continuous production of goods in large scale using a standard process. Mass production reduces the time that factory workers spend on each individual product. In a bicycle factory for instance, production involves 12 steps that are performed in 12 work stations. All the 12 steps are in process at the same time and will be repeated every time the bicycle is completely done meaning 12 bicycles are always at various stages of assembly. Each step takes one minute hence it takes 12 minutes to build a bicycle and the factory produces one bicycle every minute, thus producing 60 bicycles per hour.
The greatest challenge faced by most manufacturers is managing product quality. An inevitable and well-known outcome of mass production is product defects. These defects, no matter how minor or insignificant they may be, may turn out to be in unacceptable quantities leading to shipping delays, dissatisfied customers, product returns, or in some cases, legal repercussions and product recalls.
Overview of Production Losses
It is normal for a manufacturing company to experience production losses. The incidence of employee errors, technical failures, machine and human inefficiencies, low quality materials and unusual occurrences can disrupt the flow of the production process and causes damages and material cost within the company. But no matter how common and ordinary these losses are, management should not tolerate it and continuous quality improvement must be maintained.
Improving and implementing different quality concepts that could enhance the efficiency of every production will help the management to control the costs associated with these production losses. Many of the manufacturing companies already aspire for the accreditation
The procedures used in accouning for scrap are determined by the expected sales value of the scrap.
This scrap should be collected and placed in storage awaiting sale to scrap dealers,
individuals or other industries that may find it useful. If the scrap value is relaively small, no
entry is made unil such ime that the scrap is sold. The entry to record the sale of the scrap would be:
Cash or Accounts Receivable .......................... xx
Scrap Revenue or Scrap Sales .......................... xx
The amount realized from the sale of scrap and waste may be credited to Scrap Revenue or Scrap Sales account on the date of sale and generally reported on the income statement under Other Income if it is considered as an additional source of income for the company. If such sale is considered as a primary source of income, then it may be reported under the Sales section of the income statement. Another alternative is to credit it to FOC account on the date of sale, thus reducing the total factory overhead costs and cost of goods manufactured. When scrap is collected from a job or department, the sales value of Scrap Materials is often treated as a reduction in the Material cost charged to the individual job, so you credit Work in Process account.
When the quantity and value of Scrap Materials is relatively high, it should be stored in a designated place under the supervision of a storekeeper. A scrap report is generally prepared in duplicate to authorize transfer and receipt of the scrap. Timely scrap reports for each producing department call attention to unexpected items and unusual amounts and should induce prompt corrective actions.
WEEKLY SCRAP REPORT
Department: Fabricating For Week Ending: November 20, 2018
Part No. Description Units Used Scrapped % Scrap Cost Reason
218 d Braces 7,200 108 1 P 7.
218 e Fines 9,400 305 3 30.
218 s Guides 15,600 520 3 41.
218 k Supports 8,500 42 0 25 Defective Parts Total for the Week P 104. Scrap Cost – Year to date 4,533. Predetermined Scrap Allowance for the Year 5,000.
The original copy is forwarded to the material ledger clerk and a copy remains on file in the department where the scrap originated. The said clerk may either:
open a material ledger card, filling in the quantity only. The peso value would not be needed; or
record both the quantity and peso value of the scrap delivered to the storekeeper. Such value would be based on scrap prices quoted on the market. So the entry will be:
Scrap Materials ---------------- xxx Scrap Sales / WIP / FOC -------------xxx
Any difference between the price at the time the scrap inventory was recorded and the price realized on the date of sale would be a + or – adjustment to the account previously credited at the time of storage.
To reduce accounting for scrap to a minimum, often no entry is made until the scrap is actually sold. This method is expedient and is justified when a more accurate accounting becomes expensive and burdensome, the sales value is relatively small or the price is uncertain.
To account for the sale of scrap, different accounting treatment is available. To illustrate, assume that there were scrap materials arising from the current month’s production due to trimmings valued at P2,400.
(a) Recognizing Scrap as part of Scrap Sales or Other Income
At the time of sale, one of the simplest accounting treatments is recognizing the value of scrap as part of the revenue; hence the journal entry is:
Cash or Accounts Receivable ------------------------------- 2, Scrap Sales or Scrap Income ----------------------- 2 ,
(b) As Reduction to Cost of Goods Sold
The value from the sale of scrap can also be treated to reduce the cost of sale for the period. The reduction to the product cost can result in an increase of the income having the same effect as to the first method mentioned earlier. If such will be the case, the accounting entry would be as follows:
Cash or Accounts Receivable -------------------------------- 2, Cost of Goods Sold ---------------------------------- 2,
(c) Scrap Directly Attributable to a Specific Job
If a particular scrap can be directly traced to a particular job, the sale of such scrap will be used to reduce the cost of the material of that specific job, crediting the Work in Process account. The entry would have been:
Cash or Accounts Receivable --------------------------------- 2, Work In Process ----------------------------------- 2,
If this entry was made, the amount credited to Work in Process must be reflected in the Job Order Cost Sheet as a reduction in the Material cost of such job. Furthermore, if the scrap is material and has a significant value, most of the manufacturing companies do not immediately sell these items. It will be returned to the storeroom and be held until such time that the market price for the scrap is high. In this case, Scrap Inventory account will be debited and Work in Process account will be credited.
(d) Scrap Cannot be Traced to a Specific Job
Figure 3 Accounting for Scrap: Simplified
ACCOUNTING FOR SPOILED GOODS
Scrap is an unexpected by-product in the production of the main product. Spoiled or defective goods are not by-products but imperfect units of the main product. Spoiled units have imperfections that cannot be economically reworked. They are sold as items of inferior quality or “seconds”. Defective units have imperfections which can still be corrected by reworking those units. Scrap and Spoilage differs because Scrap is usually cannot be avoided and normally incurred in a specific manufacturing process. Spoilage, on the other hand, is avoidable, unusual and do not occur in every production run. If an item either partially or fully finished have some mutation that is irreparable or if it can be repaired, it will be costly and expensive, then the unit is classified as Spoiled Goods.
There are two possible causes of spoilage (1) caused by the customer and (2) due to internal failure. Accounting treatment of the spoiled units under these two causes differs.
(1) Spoilage Caused by the Customer or Attributable to a Specific Job If the spoilage occurs because the customer changes the specification or design of a particular order, the cost of production loss will be charged fully to that specific job. However if the spoiled items has a disposal value and can be resold, such amount will be deducted from the cost of that job.
To illustrate, let us assume that Job #103 of Papelus Inc. calls for a production of 25, pieces of A4 size white envelopes. After the first 10,000 pieces of envelopes, the customer called up to change the envelope size from A4 to A5. The A4 size envelopes cannot be used by the customer and uncorrectable to an acceptable condition. However, Papelus can sell these envelopes for P0 each, or a total amount of P1,000. The company manufactured an additional 10,000 pieces to meet the customer’s order resulting to a total production of 35,000 pieces of envelopes (including the 10,000 A4 size). Total cost incurred for Job# is as follows:
Materials ----------------------------------------------- P 45, Direct Labor ----------------------------------------------- 12,
Factory Overhead --------------------------------------- 6, Total Job Cost P 64,
To record the cost of the completed made to order job upon shipment to the customer: Spoiled Goods Inventory ------------------------- 1, Cost of Goods Sold -------------------------- 63, Work in Process -------------------------------------- 64,
If Papelus Inc. provides a selling price of 120% of cost, Job# 103 will be billed for (P63, x120%) P75,600. The journal entry to record the sale of Job #103 will be: Cash or Accounts Receivable --------------------------- 75, Sales ------------------------------------------------------- 75,
(2) Spoilage Caused by Internal Failure or Common to All Jobs If the spoilage is due to internal failure, like machinery or employee errors, the cost of the production loss will be charged fully to Factory Overhead Control. However if the spoiled goods will have a disposal value it must be deducted first to the Factory Overhead Control Account so that the value reflected will only be the unrecovered cost from the spoiled units. Furthermore if the cost of the production loss is material and can distort the financial report, the amount should be reported separately and accounted as a loss on the income statement.
Using the same example above but instead of a change in customer’s specification, an employee’s error took place. The employee’s miscommunication to the production about the proper size of the envelopes resulted to spoilage. To account for this, compute first the unit cost of the job by dividing the Total Cost of the Job by the total number of units produced (including the spoiled goods). The cost per envelope will be P1 (P64,000/35, envelopes).
Multiply the cost per envelope by the number of spoiled envelopes to get the total cost of spoilage which is P18,300 (10,000 spoiled goods x P1). However, the spoiled envelopes have a resale value totaling P1,000 and this will be deducted from the total spoilage cost of P18,300 to get the unrecovered cost of spoilage amounting to P17,300 and this amount will be charged to the Factory Overhead Control (FOC) account.
To summarize, the compound entry of recording both the cost and the loss from spoilage (charged to FOC account) caused by internal failure and the transfer of the completed Job#103 directly to CGS account: Spoiled Goods Inventory ---------------------- 1,00 0 Factory Overhead Control ---------------------- 17, Cost of Goods Sold --------------------- 45, Work in Process --------------------------------- 64, So if Papelus Inc. sets a price of 120% of cost, Job#103 will be billed for P54,840 (P45, cost x 120%). The journal entry will be:
Cash or Accounts Receivable ----------------- 54, Sales ----------------------------- 54,
ABNORMAL SPOILAGE
Spoilage beyond the acceptable level should be charged to a loss account and be part of the period cost. This occurs because of many reasons other than the customer’s unusual
spoiled units that cannot be reworked are similarly charged to the job if caused by the demands of the job, and to FOC if not.
(1) Rework Caused by the Customer or Attributable to Specific Job
If the defective item is caused by the customer, its cost will be charged to that particular job resulting to the increase in the billing price. To illustrate, Papelus Inc. received an order from the customer identified as Job#110 for 25,000 pieces of A4 size white envelopes. The total cost of the said production is as follows:
Materials -------------------------------------------P 45,
Direct Labor ------------------------------------------- 12,
Factory Overhead ----------------------------------- 6, Total Cost of Job #110 P 64,
However, before the shipment, the customer decided to provide a security mark on every envelope that can help every receiver of the mail to determine if the envelope has been previously opened or not. As a result, a total added cost of P 6,400 (comprising of P4, for direct labor and P1,800 for factory overhead, no material has been added) will be charged.
Figure 3 The process of manufacturing envelope Figure 3 A4 size white envelope
The journal entry to record the rework cost will be as follows: Work in Process----------------------------------------- 6, Payroll ------------------------------------------------ 4, Applied Factory Overhead ------------------------ 1,8 00
The total cost for Job#110 will now be P70,400, consisting of P64,000 the original production cost and P6,400 as the total rework cost. If Papelus will charge this job with 20% mark up on cost, the journal entries to record the cost of the job sold and its sale shall be as follows:
Cost of Good Sold ------------------------------------ 70, Work in Process ------------------------------------- 70,
Cash or Accounts Receivable---------------------------- 84, Sales ------------------------------ 84, P70,400 x 120%
(2) Rework Caused by an Internal Failure or Charged to All Jobs
If the defective units are caused by an internal failure, the cost of the rework will be charged to manufacturing overhead and it will be spread throughout the job. The same example as above, except that an error was made by the employees. Hence, the journal entry to record the additional cost will not be charged to Work in Process account but through Factory Overhead Control (FOC)as summarized below:
Factory Overhead Control-------------------------- 6, Payroll -----------------------------------------4,6 00 Applied Factory Overhead ----------------------------1,
However when Job#110 will be sold to customer, the original cost of the job will be reflected as the total production cost ignoring the rework cost. The effect of the additional rework cost will only be in the computation of the predetermined factory overhead rate. To record the cost of goods sold and the sale of the items with 20% markup based on cost will be: Cost of Goods Sold -------------------------------64, Work in Process --------------------------------- 64,
Cash or Accounts Receivable ----------------76, Sales ---------------------------- 76, P 64,000 x 120% Abnormal Rework
Rework costs that exceed the control limits are charged to a loss account called Loss from Abnormal Rework, which is a period cost. Conceptually, the approach is the same as that used for abnormal spoilage.
SUMMARY – PRODUCTION LOSSES JOB ORDER COSTING
A. SCRAP – trimmings, excesses and letovers
IF SOLD IMMEDIATELY IF NOT SOLD IMMEDIATELY NO INTENTION TO SELL DR:Cash/ Accounts Receivable CR:Other Income/CGS/WIP/FOH Control
DR: Scrap Inventory CR: WIP/FOH Control To recognize scrap for sale
If the scrap eventually sold DR: Cash/Accounts Receivable CR: Scrap Inventory
If the scrap will not be sold and instead reuse it DR:Materials CR:Scrap Inventory
If the scrap will be return to stockroom DR: Materials CR: FOH Control
If the scrap will be reuse instead DR: WIP CR: FOH Control
B. SPOILAGE – Defecive units that cannot be reworked or too costly but can be sold
CAUSED BY CUSTOMER/SPECIFIC JOB CAUSED BY INTERNAL FAILURE/ COMMON TOALL JOBS ABNORMAL SPOILAGE
DR: Spoiled Goods Inventory (resale value) DR: CGS (balance) CR: WIP (total cost of the job)
DR: Spoiled Goods Inventory (resale value) DR:FOH Control (cost of spoilage-resale value) DR:CGS (balance)
DR: Spoiled Goods Inventory DR:Loss from Abnormal Spoilage CR:WIP
Materials Materials Materials Payroll Payroll Payroll Applied Factory OH Applied FOH Applied FOH
Scrap At sale Cash (Accounts Receivable) Cash (A/R) Cash (A/R) Factory OH Control WIP Factory OH Control
At production Materials Materials Materials Factory OH Control WIP Factory OH Control
(Source: Cost Accounting by Horngren, 2009 ed.)
Chapter 3 - Production Losses-1 2021
Course: Bachelor of Science and Accoutancy (BSA)
University: University of San Carlos
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