Treatment of Process Losses

Treatment of Process Losses in Process Costing

1. Introduction

• Real‑world reality: Processes incur losses, wastage, defective units.
• Loss timing:
  • Throughout process (e.g., chemical evaporation)
  • At end of process (e.g., assembly defect detected)
• Loss classification:
  • Normal loss → expected in efficient operations
  • Abnormal loss → unexpected, avoidable

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2. Cost Treatment Principles

Loss Type	Treatment
Normal Loss	Cost absorbed into unit cost (WG & WIP)
Abnormal Loss	Separated and charged as period cost below COGS

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3. Example Setup

• Input: 100 L chemical @ ₹100/L → Material cost = ₹10,000
• Conversion cost: ₹8,000
• Outputs:
  • Finished goods = 60 L
  • Work‑in‑Process = 35 L (100% mat, 40% conv)
  • Loss = 5 L

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4. Normal Loss Treatment

1. Determine equivalent units (EU)

   • Material EU = 60 + 35 = 95 EU
   • Conversion EU = 60 + (35 × 40%) = 74 EU

2. Compute cost/EU

   • Material cost/EU = ₹10,000 ÷ 95 ≈ ₹105.26
   • Conversion cost/EU = ₹8,000 ÷ 74 ≈ ₹108.11

3. Unit cost = ₹105.26 + ₹108.11 ≈ ₹213.37

4. Allocate costs

   • Completed (60 L × ₹213.37) ≈ ₹12,802
   • WIP (35 EU mat × ₹105.26 + 14 EU conv × ₹108.11) ≈ ₹5,198
   • Loss cost buried in unit costs

5. Profit

   • Sales (60 L × ₹250) = ₹15,000
   • Cost of goods = ₹12,802
   • Profit = ₹2,198

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5. Abnormal Loss Treatment

1. Re‑compute EU including loss

   • Material EU = 60 + 35 + 5 = 100 EU
   • Conversion EU = 60 + 5 + (35 × 40%) = 79 EU

2. Cost/EU

   • Material cost/EU = ₹10,000 ÷ 100 = ₹100
   • Conversion cost/EU = ₹8,000 ÷ 79 ≈ ₹101.27

3. Unit cost = ₹100 + ₹101.27 ≈ ₹201.27

4. Allocate

   • Completed (60 L × ₹201.27) ≈ ₹12,076
   • WIP (35 EU mat × ₹100 + 14 EU conv × ₹101.27) ≈ ₹4,918
   • Abnormal loss (5 L × ₹201.27) ≈ ₹1,006 (period cost)

5. Profit

   • Sales = ₹15,000
   • COGS = ₹12,076
   • Gross margin = ₹2,923
   • Less abnormal loss = ₹1,006
   • Net profit = ₹1,917

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6. Comparison & Managerial Implications

• Normal loss treatment → higher current profit (shifts loss cost forward)
• Abnormal loss treatment → immediate recognition as expense
• Behavioral risk: Managers may prefer normalizing loss to inflate profit
• Recommendation:
  • Clearly define normal vs. abnormal causes
  • Enforce consistent costing policy to avoid misuse

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