Brookvale Chemicals: Process 1 Losses and a Marginal Export Order
Brookvale Chemicals processes a single raw material in Process 1. In March, 5,000 kg of material costing $6.00 per kg were input and conversion costs of $12,000 were incurred. Normal loss is 20% of input; lost units have a scrap value of $2.00 per kg, credited to the process. Actual output for March was 3,800 kg. There was no opening or closing work in progress. Separately, an overseas customer has offered to buy 500 kg of the same output at $9.50 per kg from an additional batch run after normal hours. The batch would require 625 kg of material input and additional conversion cost of $1,200, and would not affect normal production. The special output would carry no additional selling or distribution cost.
1. Calculate the cost per kg of good output for March, the value of output transferred out, and the value of the abnormal loss.
Read the worked answer
Step 1 - Normal loss and scrap Normal loss = 20% × 5,000 kg = 1,000 kg. Scrap value = 1,000 × $2 = $2,000.
Step 2 - Cost to be spread over good output Materials 5,000 × $6 = $30,000 Conversion = $12,000 Total process cost = $42,000 Less scrap proceeds of normal loss = $(2,000) Cost of good output = $40,000
Step 3 - Expected good output and unit cost Expected good output = 5,000 − 1,000 = 4,000 kg Cost per kg = $40,000 / 4,000 = $10.00 per kg
Step 4 - Valuation
- Output transferred to finished goods: 3,800 × $10 = $38,000
- Abnormal loss: expected 4,000 − actual 3,800 = 200 kg × $10 = $2,000 (charged as a period cost, not carried in inventory)
Check: 38,000 + 2,000 = $40,000. The key discipline is that the abnormal loss is valued at the full cost per kg, with any scrap received on it credited to the abnormal loss account, not netted into the normal-loss figure.
2. Evaluate the special order and recommend whether to accept it.
Read the worked answer
The order needs 500 kg of good output, so input must be grossed up for the 20% normal loss: 500 / 0.80 = 625 kg.
Incremental analysis
| $ | |
|---|---|
| Revenue: 500 kg × $9.50 | 4,750 |
| Material: 625 kg × $6.00 | (3,750) |
| Additional conversion | (1,200) |
| Scrap on normal loss: 125 kg × $2.00 | 250 |
| Net incremental gain | 50 |
Recommendation: accept only marginally - the gain is $50 on $4,750 of revenue (about 1%), so it is highly sensitive to small errors.
Sensitivities and caveats:
- A 1% rise in material price ($0.06/kg) or a small increase in conversion cost wipes out the gain entirely. Conversion of $1,200 for 500 kg is $2.40/kg against $12,000/4,000 = $3.00/kg normally - confirm this lower rate is achievable.
- Fixed costs are unchanged, so the contribution is real, but it uses after-hours capacity and any overtime premium must be inside the $1,200.
- Risk: the export customer may anchor future prices at $9.50 below the normal market price, and at $9.50 the order only just covers marginal cost. Accept as a one-off, with no commitment to repeat.
- Ignore the $10 average cost for decision purposes; only the incremental cost of $4,700 is relevant.