Spoilage can can be defined as the waste material released due to the normal manufacturing process wherein, the spoiled material so released is known as scrap material if it is of no use. Alternatively, it also means unintentional use of spoiled material in the production that leads to spoiled output of finished goods.
Types of Spoilage
Some of the types are as follows:
#1 – Normal
This is the expected spoilage due to the natural production process or and therefore, it is not recorded in the profit and loss statement. It is accounted for by increasing the cost of production. For example, if a company orders 100 liters of petrol for $1000 but can take out only 99.5 liters of petrol from its container, it will assume that the cost of oil is $1000 for 99.5 liters instead of 100 liters. Therefore normal loss increases the per-unit cost of production. It may also be the case that normal loss occurs after production, but before the sale, this kind of loss is also adjusted in the same manner, but in the cost of goods soldCost Of Goods SoldThe cost of goods sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company..
The formula for calculation of the percentage of normal spoilage is as follows:
Most of the time, there is a predetermined range within which this percentage should lie based on experience or industry best practices.
#2 – Abnormal
Loss of raw material or finished goods inventoryFinished Goods InventoryFinished goods inventory refers to the final products acquired from the manufacturing process or through merchandise. It is the end product of the company, which is ready to be sold in the market. due to unexpected reasons such as theft, fire, or in transit are some of the examples. It can be avoided and occurs only due to the lack of precautions. Therefore, this type is not adjusted in the cost of goods sold, but it takes to in the profit and loss statement. Thus, abnormal loss doesn’t increase the per-unit cost of goods sold. There is no formula for its calculations, as it is not fixed or expected.
- When chairs are produced from wood, the wood shavings released, similarly when the oil is transferred from barrels to smaller vessels, the oil that remains stuck to the barrel walls. These types of spoilage are expected, and therefore these are termed as normal in accounting theory.
- However, suppose certain inventory is supposed to be stored at a certain temperature, but due to power failure, this temperature level is not maintained. It is an example of abnormal spoilage, which was not predetermined or expected.
Why Do We Pay Attention to Spoilage?
- Normal Spoilage needs to be paid attention to keep track of the percentage of the same. If this is a stable percentage and equivalent to the competitor’s or prevalent in the industry, then there is nothing to worry about. Still, if a particular firm has a very high percentage, it is an indication for the company to revisit the production process or the points after production where it is occurring. It is done to pinpoint the cause of the same and assess how it can be improved. Any improvement will reduce the cost of production and increase the profit marginProfit MarginProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. .
- Abnormal spoilage is always a matter of concern. It is an avoidable loss, and therefore, it attracts a lot of flack from the higher-ups in the company. If the plant is not taking enough safety measures such as those against fire or theft, then it is on the plant supervisor because such mistakes cost a lot to the company, which can be prevented.
Difference Between Spoilage and By-Product
- Spoilage is the unusable material that is produced as a part of the manufacturing process. At the same time, the by-product is the usable material that is released from the manufacturing of another product. For example, in the production of sugar, several by-products are produced, such as molasses, beet pulp, and bagasse. These products are sold for a higher value than scrap as these are demanded in the consumer market.
- Abnormal spoilage is minimized, and its occurrence is not wanted. However, the production of by-products is wanted up to the degree that it doesn’t affect revenues from the main product. The amount of by-product is predetermined and depends upon how much raw material is being used in the manufacturing process. The main product generally sells for a higher price. Therefore the level of by-product should not exceed the point where the main product produce is lower than the general input-output ratio of raw material and the finished product.
Spoilage is the wastage occurring due to the production process, and in the normal course, because not entire raw material can be utilized, some become scrap. It is unavoidable and is expected and therefore known as normal spoilage. At times it can take place unknowingly and can be recognized only after production due to the use of spoiled inputs.
Normal spoilage is accounted for by increasing the per unit costUnit CostUnit cost is the total cost (fixed and variable) incurred to produce, store and sell one unit of a product or service. It is calculated by adding fixed and variable expense and dividing it by the total number of units produced. of goods sold while the abnormal storage is accounted for in the profit and loss or the income statementIncome StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements..
This article has been a guide to spoilage and its meaning. Here we discuss examples, types, and why do we pay attention to spoilage. You may learn more about financing from the following articles –