Chapter 8 - Completing the Cost Cycle and the Accounting for Production Losses

Completing the Cost Cycle

When the jobs are completed, the finished goods are moved from the factory to the warehouse. The
cost of completed jobs is transferred to the Finished Goods Inventory from the Work in Process
Inventory account. When finished goods are sold, their cost is transferred to the Cost of Goods Sold
account.¹

Recording Jobs Completed

The cost of the jobs completed is recorded by the following entry:

Finished Goods Inventory xxx

Work In Process xxx

To record cost completed job.

Recording Sales of Finished Goods

When finished goods in stock are sold to customer, the warehouse clerk receives a copy of the sales
invoice. The sale is recorded on the stock ledger card and the sales journal.¹

At the end of the month, the total of the sales journal is taken to determine the selling price and the
cost of goods sold. These are recorded in the general journal by the following entry:

Accounts Receivable xxx

Sales xxx

To record sales.

Cost of Goods Sold xxx

Finished Goods Inventory xxx

To record cost of goods sold.

¹Pedro P. Guerrero, Cost Accounting – Principles and Procedural Applications, 2018 Edition
Accounting for Production Losses in a Job Order Costing System

In a job order costing system, production losses that happens in the manufacturing process includes cost
of scrap materials, spoiled goods (spoilage) and reworking defective goods.¹

A cost accounting system must be designed to record these losses, so that the unit cost figures will be
as accurate as possible. The accounting technique varies according to the type of losses involved.¹

Accounting for Scrap

Scrap is the residue of manufacturing process. These are materials left over when making a product.
Examples are sawdust and discarded end pieces in a sawmill operations.¹

Scrap materials often has a value. It is usually store until it is sold to scrap dealers, other individuals, or
other industries.¹

The accounting procedures for scrap will depend on the following:

1. When should the value of scrap be recognized in the accounting records - at the time scrap is
produced or at the time scrap is sold?

2. How should revenues from scrap be accounted for?

To illustrate the procedures, assume that Tan Lumber Company accumulates sawdust and that the scrap
from a job has a net sales value of P2,000.

Recognizing Scrap at the Time of its Sale

If the value of scrap is low or immaterial, the simplest accounting is to make a notation of the quantity
of scrap returned to the storeroom and to record the scrap sales by the following entry:

Cash or Accounts Receivable 2,000

Scrap Revenues 2,000

To record the sale of scrap.

The Scrap Revenues is presented in the income statement as a separate line item of other revenues.¹

When the scrap is material and the scrap is sold quickly after it is produced, the accounting depends on
whether the scrap is attributable to a specific job or common to all jobs.

Scrap Attributable to a Specific Job

If it is possible to determine the specific job from which the scrap is accumulate, the proceeds from the
sale are deducted from the cost of materials that have been charged to that job. The debit is to Cash or
Accounts Receivable as before, but the credit is to Work in Process, as shown below:
Cash or Accounts Receivable 2,000

Work in Process Inventory 2,000

To record the sale of scrap.

The credit amount is also recorded in the job cost sheet under The Materials column in parenthesis to
indicate that the cost reduction is an offset against previous charges.¹

Scrap Common to All Jobs

If the scrap cannot be identified with a specific job, the proceeds from the sale is credited to
Manufacturing Overhead Control to reduce product costs as shown below:

Cash or Accounts Receivable 2,000

Manufacturing Overhead Control 2,000

To record sale of scrap.

The credit to Manufacturing Overhead Control account is also recorded in the overhead analysis sheet
as an entry in parenthesis.¹

Recognizing Scrap at the Time of Its Production

Sometimes, the value of scrap is material, and the time between storing it and selling or reusing it can
be long. In these situations, the company inventories scrap at a conservative estimate of its realizable
value so that production costs and related scrap revenues are recognized in the same accounting period.
At the time of its production, scrap materials returned to storeroom is recorded as follows:

Scrap Attributable to a Specific Job

The journal entry is:

Scrap Inventory 2,000

Work in Process Inventory 2,000

To record scrap returned to storeroom.

Scrap Common to All Jobs

The journal entry in this case is:

Scrap Inventory 2,000

Manufacturing Overhead Control 2,000

To record scrap returned to storeroom

When the scrap is sold, the journal entry is:

Cash or Accounts Receivable 2,000

Scrap Inventory 2,000

To record sale of scrap.

Sometimes scrap is sold for more or for less than the value at which it is recorded. Any difference
between the sales price and the recorded value is treated as an adjustment to the account that was
originally credited. (Work in Process or Manufacturing Overhead Control). For example, if the scrap in
our illustration is sold at P1,500, the entry to record the sale would be as follows:

Cash or Accounts Receivable 1,500

Work in Process Inventory 500

Scrap Inventory 2,000

To record sale of scrap at less than its recorded value.

Scrap is sometimes reused as direct materials rather than sold as scrap. In this case, the Materials
account is debited at its estimated net realizable value when returned to storeroom and then credited
when the scrap is reused. For example, the entries when the scrap is generated is common to all jobs
are:

Materials 2,000

Manufacturing Overhead Control 2,000

To record scrap returned to storeroom.

Work in Process Inventory 2,000

Materials 2,000

To record reuse of scrap.

Waste as distinguished from scrap materials refers to the amount of raw materials left over from a
production process for which there is no further use.¹
Accounting for Spoiled Goods

Goods that have been damaged through imperfect machining or processing are called spoiled goods.¹

Spoiling usually occurs in batches or in unusual cases, while scrap is unavoidable and recurs constantly in
specific manufacturing process. Spoiled goods cannot be corrected either because it is not technically
possible or economical to correct them.¹

The basic accounting problem in accounting for spoiled goods is how loss due to spoilage should be
charged.

The loss may be charged to a particular job from which the spoiled goods were recovered. Or the loss
may be charged to all the jobs worked on during the period.¹

Illustration:

Assume that Job 888 calls for the production of 200 painted office tables. These tables were put into
production and costs accumulated to date as follows:

Materials P456,000

Direct labor 240,000

Applied overhead (150% of DL cost) 360,000

Total cost charged to Job 888 P1,056,000

Unit cost (P1,056,000/200) P 5,280

Suppose that ten tables are spoiled because the lumber used was improperly cured. These spoiled
tables may be sold as seconds at its net disposal value of P3,000 each (a loss of P2,280 per table).

The journal entries under the two assumptions are presented as follows:

Spoilage Attributable to a Specific Job (Due to Customers Specifications)

If spoilage occurs because of some actions made by customers to change specifications of a particular
job, that job bears the cost of the spoilage reduced by the disposal value of the spoilage.¹

The loss on spoiled goods is left as part of the total cost of a specific job.¹

The journal entries are as follows:

1. Spoiled Goods Inventory 30,000

Work in Process Inventory 30,000

To remove estimated disposal value of spoiled goods from Work in Process (10 x
P3,000).
 2. Finished Goods 1,026,000

Work in Process Inventory 1,026,000

To record the cost of the 190 completed tables. (P1,056,000 – P30,000)

If Job 888 is sold with a 30% mark up on cost, the entry to record the sale to the customers would be:

3. Cash or Accounts Receivable 1,333,800

Sales 1,333,800

To record sales (P1,026,000 x 130%)

4. Cost of Goods Sold 1,026,000

Finished Goods Inventory 1,026,000

To record cost of goods sold.

When the spoiled goods are subsequently sold, the entry would be:

5. Cash or Accounts Receivable 30,000

Spoiled Goods Inventory 30,000

To record sales of spoiled goods at net disposal value.

Spoilage Common to All Jobs (Due to Internal Failure)

If spoilage occurs during the production cycle due to internal failure such as employee’s error or worn
out machinery, the estimated disposal or sales value of the spoiled goods is debited to Spoiled Goods
Inventory and any loss should be charged to Manufacturing Overhead Control.¹

The following are the required journal entries:

1. Spoiled Goods Inventory 30,000

Manufacturing Overhead Control 22,800

Work in Process Inventory 52,800

To record estimated sales value of spoiled goods and charged loss to Manufacturing
Overhead Control.
 2. Finished Goods Inventory 1,003,200

Work in Process Inventory 1,003,200

To record cost of good tables completed. (P1,056,000 – P52,800)

Assume that the good units are delivered to customers at 130% of cost. The entry to record sale is:

3. Cash or Accounts Receivable 1,304,160

Sales 1,304,160

To record sale of 190 good tables. (P1,003,200 x 130%)

4. Cost of Goods Sold 1,003,200

Finished Goods Inventory 1,003,200

To record cost of goods sold.

Accounting for Defective Goods

Units of production that fail to meet production standards but that can be brought up to standard by
adding more materials, labor, and overhead are generally referred to as defective goods.¹

The additional cost required to bring these goods up to standard are called rework costs.¹

Rework costs may either be charged to a specific job or to all the jobs.¹

Illustration:

Consider the data in the previous illustration. Assume the ten spoiled tables are reworked. The journal
entry to record the total costs of the ten spoiled goods before considering rework costs is:

Work in Process Inventory 52,800

Materials 22,800

Payroll 12,000

Applied Manufacturing Overhead 18,000

To record cost of 10 tables.

Rework Cost Charged to a Specific Job

If the rework is normal and occurs because of the requirements of a specific job, the rework costs are
charged in the usual manner to rework job. The journal entry is:

Work in Process Inventory (specific job) 9,500

Materials 2,000

Factory Payroll 3,000

Applied Manufacturing Overhead 4,500

To record rework costs of 10 tables.

The entry to record the transfer to the warehouse is:

Finished Goods Inventory (52,800 + 9,500) 62,300

Work in Process Inventory 62,300

To record cost of 10 tables transferred to finished goods.

Assume that the ten tables are sold at 130% of cost, the entries to record the sale are:

Cash or Accounts Receivable 80,990

Sales 80,990

To record sales of 10 tables. (P62,300 x 130%)

Cost of Goods Sold 62,300

Finished Goods Inventory 62,300

To record cost of 10 tables sold.

When rework is not attributable to a specific job, the costs of the rework are charged to manufacturing
overhead and spread through overhead allocation, over all jobs.¹

Manufacturing Overhead Control 9,500

Materials 2,000

Factory Payroll 3,000

Applied Manufacturing Overhead 4,500

To transfer cost of reworked defective units to Manufacturing Overhead.

Since the rework costs was charged to Manufacturing Overhead Control, the total cost of Job 888 does
not increase, the cost remains at P1,056,000.

The entry to record the total costs of Job 888 is:

Finished Goods Inventory 1,056,000

Work in Process Inventory 1,056,000

To record total costs of Job 888.

If the 200 tables are sold after the reworking of the 10 tables at 130% of cost, the entry is:

Cash or Accounts Receivable 1,372,800

Sales 1,372,800

To record sales of 200 tables (P1,056,000 x 130%)

Cost of Goods Sold 1,056,000

Finished Goods Inventory 1,056,000

To record cost of 200 tablets sold.

SOURCE AND REFERENCE:

Pedro P. Guerrero, Cost Accounting – Principles and Procedural Applications, 2018 Edition