Process Costing System - Case Study:

Case A. Accounting for Spoiled Units:

The House Hold Aids Company assembles clip clothespins in three sections, and uses process costing. Under normal operating conditions, each section has a spoilage rate of 2%. However, spoilage can go as high as 5% and is usually discovered when a faulty pin enters process or on final completion by a section.
The spring mechanism is the only material which can be saved from a spoiled unit. The production supervisor assigns a worker once or twice a week to remove the springs from spoiled units. The salvaged springs are placed in bins at the assembly tables in section No1 to be used again. No accounting entry is made of this salvage operation.
In the past, the controller has made no attempt to account for spoilage separately. Lost unit costs have been absorbed by the units transferred out of the section and those remaining in the process. However, because spoilage is increasing, a different method is needed.

Solution:

The spoiled work should be broken into normal and abnormal spoilage. The cost of normal spoilage should be absorbed by good completed units. All materials salvaged should be assigned a value and placed in materials inventory. Sectional materials costs should be reduced by the value assigned to salvaged materials.
Abnormal spoilage should be charged to factory overhead account. The cost to be included in this account should be the amount accumulated against a clothespin up to the point of being scraped, and the total loss in scraped clothespins should be shown in the cost of production report of the department responsible for the loss.