Cost Accounting Procedure for Defective Work

Cost Accounting Procedure for Defective Work:

In the manufacturing processes, imperfections may arise because of faults in materials, labor, or machines.

If the unit can be reprocessed on one or more stages and made into a standard saleable product, it is often profitable to rework the defective units. Although spoiled work cannot usually be made into a first class finished unit without uneconomical expenditures, defective work can be corrected to meet specified standards by adding materials, labor, and factory overhead. Two methods of accounting for the added cost to upgrade the defective work are appropriate, depending upon circumstances:

If defective work is experienced in regular manufacturing, the additional cost to correct defective units (based on previous experience) is included in the predetermined factory over head and in the resulting factory overhead rate. Actual rework cost is charged to factory overhead control.

For example, assume that a company has an order for 500 units of a product that has direct production costs of $5 for materials and $3 for labor, with factory overhead charged to production at 200% of labor cost, 50 units are found to be defective and are to be reworked at a total cost of $30 for materials, $60 for labor, and overhead at 200% of direct labor cost. The journal entries are:


Work in process Materials
Work in process Labor
Work in process Factory overhead
Dr.
2,500
1,500
3,000
Cr.
    Materials
Labor
Applied Factory overhead
2,500
1,500
3,000
Factory overhead control 210
    Materials
Labor
Applied Factory overhead
30
60
120
Finished Goods 7,000
    Work in process Materials
Work in process Labor
Work in process Factory overhead
2,5000
1,500
3,000


The unit cost of the completed unit is $14 ($7,000 / 500 units)

Suppose, however, that the same company received a special order for 500 units with the agreement stating that any defective work is charge able to the contract. During production, 50 units are improperly assembled. The total cost to correct these defective units is $30 for materials, $60 for labor, and 200% of the direct labor cost for factory overhead. The entries in this case are:


Work in process Materials
Work in process Labor
Work in process Factory overhead
Dr.
2,500
1,500
3,000
Cr.
    Materials
Labor
Applied Factory overhead
2,500
1,500
3,000
Work in process Materials
Work in process Labor
Work in process Factory overhead
30
60
120
    Materials
Labor
Applied Factory overhead
30
60
120
Finished Goods 7,210
    Work in process Materials
Work in process Labor
Work in process Factory overhead
2,530
1,560
3,120


The unit cost in this case is$14.42 instead of $14

Whenever the defective work cost is charged directly to the job, a slight overcharge of factory overhead results because of the inclusion of rework cost in the factory overhead rate. One remedy to correct this discrepancy would be either to create a new independent overhead rate or to separate costs for the special job.

You may also be interested in other useful articles from “controlling and costing materials” chapter:

  1. Purchases of productive material
  2. Purchases of supplies, services, and repairs
  3. Materials purchasing forms
  4. Receiving materials
  5. Invoice approval and data processing
  6. Correcting invoices
  7. Electronic data processing (EDP)  for materials received and issued
  8. Cost of acquiring materials
  9. Storage and use of materials
  10. Issuing and costing materials into production
  11. Materials ledger card – perpetual inventory
  12. First-in-First-Out (FIFO) Costing Method
  13. Average Costing Method
  14. Last-in-First-Out (LIFO) Costing Method
  15. Other Methods-Month end average cost, last purchase price or market price at date of issue, and standard cost
  16. Inventory valuation at cost or market whichever is lower
  17. American Institute of Certified Public Accountant (AICPA) cost or market rules
  18. Adjustments for departures from the costing method used
  19. Inventory pricing and interim financial reporting
  20. Transfer of materials cost to finished production
  21. Physical inventory
  22. Adjusting Materials Ledger Cards and Accounts to Conform to Inventory Accounts
  23. Scrap and waste
  24. Spoiled goods
  25. Defective work
  26. Discussion Questions and Answers about Controlling and Costing Materials


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