Process costing account for a single product with normal loss: introduction; normal loss; normal output; actual loss; actual output; accounting treatment and examples
1.1 Introduction
Is it possible for you to handle a case of process costing account where there is only normal loss? How do we prepare process costing accounts for a case of single product where normal exists? As a student, and even as a scholar you think this is hard to understand or grasp with your mind! No, this task is easy. To successfully prepare the respective accounts, first of all, you need to understand the meaning of terms that accompany this concept. They are as discussed below;
1.1.1 Normal Loss
Definition-1: Normal loss is the expected number of substandard units of output which arises at the end of the production process. In other words, it is the expected number of damaged units at the end of the production process. Examples of Normal Loss is substandard/damaged units due to expected issues such as evaporation due to heat; ash due to chemical reaction etc.
1.1.2 Normal Output/Production
Definition-2: Normal output is the standard output expected to be realized or gotten at the end of the production process. It is also referred to as good output or average production.
1.2 Facts about Normal Loss and Normal Output
The following are the facts that you should know and you need to know about normal loss and normal output.
1.2.1 Normal Loss
NB1: Normal loss is a computed value. It is the number of sub-standard units computed on the basis of the initial direct material being used in the beginning of every stage of a new process. Most of the times a percentage is used to compute the value.
For example, 5% of 100,000 units of the input material of raw materials. This translates to normal loss of 5,000 units (i.e., 5%*100,000).
NB2: Normal Loss is an estimation done before the actual process starts. The estimate is based on the probability of occurrence of expected or normal losses as per past or historical data. For example, expected evaporation of milk when it is boiled.
NB3: Normal loss is unavoidable. This is lost economic resource that cannot be eliminated for in the natural phenomenon, it must occur.
NB4: Normal Loss is the difference between the original number of units of raw materials used and the final number of units of the output arising at the end of that particular process.
Normal Loss=Initial units of raw materials-Final units of the output produced.
NB4: Normal loss can either be;
- Equal to Actual Loss: A case of NO loss or Abnormal gain.
- More than Actual Loss: A case of Abnormal Loss.
- Less than Actual Loss: A case of Abnormal Gain.
NB5: Absorption of Normal Loss-this refers to incorporation of normal loss in the cost of producing the output. Such that when computing the average cost or cost per unit of a product, it is assumed that the normal loss did not occur. So, the total cost which entails cost of the good and damaged (i.e., normal loss) units divided by the good production (expected output as computed theoretically) computed at the end of the process.
1.2.2 Normal Output
NB1: Normal output is the expected output after factoring in the expected loss to take place at the end of the production process.
NB2: Normal output is also referred to as good output.
NB3: Good output is the only number of units used in computation of cost per unit/average cost used when transferring output from the current process account to the next one or to the finished goods account.
NB4: Normal output is an estimation. It is derived at by establishing the difference between the initial units of direct raw materials used in the beginning of the production process and the normal/expected loss.
Normal Output=initial raw materials (units)-Normal Loss.
1.3 Facts about Actual Loss and actual Output
The following are the facts that you should know and you need to know about Actual Loss and actual Output.
1.3.1 Actual Loss
NB1: Normal loss is NOT a computed value, instead, it is an observable value. It is the number of sub-standard units actually realized at the end of the production process. It is determined by physically counting the total number of sub-standard units produced at the end of that particular production process.
For example, if 100,000 units of the input material of raw materials were used in production and at the end of the process physical counting of actual units produced were 98,000 units. Then actual loss is 2,000 units.
NB2: Actual Loss is NOT an estimation done before the actual process starts It is an actual physical unit with defects gotten at the end of the production process.
NB3: Actual Loss can only be;
- Equal to Normal Loss: A case of NO Abnormal loss or Abnormal gain.
And CANNOT be
- More than Normal Loss: A case of Abnormal Loss.
- Less than Normal Loss: A case of Abnormal Gain.
1.3.2 Actual Output
NB1: Actual output is the physical output after actual loss has taken place at the end of the production process.
NB2: Actual output is NOT as good as good output. This is the physical units actually realized at the end of the production process.
Accounting treatment of normal loss
2.1 Introduction
When the process of a product involves realization of normal loss, the accounting treatment is guided by the conditions that are prevailing. This is treated as follows;
2.2 Condition 1: Units associated with normal loss were not sold/not disposed a).
If the damaged units (normal loss) are NOT disposed/sold. That is, if the units arising from normal loss have NOT been sold. The formula is;
NB: In condition 1, the total cost of producing the good output and the damaged output is spread over the expected/good output.
2.2.1 Implication of this action;
-The cost burden per unit is high
-Profitability of the output will decline
-No recovery of the cost of the damaged units for they are NOT sold/disposed.
If this is the case, then when computing the cost per unit of the output, the total cost associated with the units representing normal loss is absorbed.
2.2.2 Example 1
The following is the production report for White Highlands co. ltd.
2000 litres of direct materials @ $5 per Litre were introduced in process 1
Labor cost paid was $3,000
Factory overhead $2,300
Expected loss was 10%. After the end of process 1, the actual output was 1,800 litres
Required
Prepare the relevant ledger accounts and record the above transactional activities
Solution
Workings
NB: This implies that the expected/normal loss of 200 units is exactly the one arrived at. But of course, you should note that this is a very rare occurrence.
NB: I want you to look at what we call absorption of normal loss-in our account above, you can see that the 200 units indicated on the credit side of this account implies that the considered units to compute cost per unit is NOT 2,000 but 1,800. While on the credit side the cost of the corresponding 200 units is not charged. Therefore, it means that the total cost of $15,300 for the 2,000 remains and it is the cost which is divided against 1,800 unit which is less. This is what is known as absorption of the normal loss.
2.3 Condition 2: Units associated with normal loss were sold/not disposed a).
If the units arising from normal loss HAVE BEEN sold. The formula is
NB: In condition 2, it is only the cost of producing the good output which is spread over the expected/good output.
2.3.1 Implication of this action;
-The cost burden per unit is low
-Profitability of the output will go up
-There is recovery of the cost of the damaged units for they are sold/disposed.
If the units with normal loss are disposed/sold
2.3.2 Example 2
The following is the production report for White Highlands co. ltd.
Required
Prepare the relevant ledger accounts and record the above transactional activities
Solution
This implies that the expected/normal loss of 200 units is exactly the one arrived at. But of course, you should note that this is a very rare occurrence.
W-2: Determination of per unit cost of good production
