Brenmoor Chemicals: abnormal loss and an offer for work in progress
Brenmoor Chemicals runs a single process. In October, 10,000 kg of material costing £6.10 per kg were input (£61,000). Normal loss is 8% of input and the 800 kg of normal loss is sold as scrap for £1.50 per kg. Conversion costs were £27,060. Actual output was 8,700 kg of completed product. Closing work in progress was 300 kg, complete as to material but only 40% complete as to conversion. The remaining 200 kg was lost through a valve failure on one shift; these units have no scrap value. There was no opening work in progress. The production manager argues that the loss should simply be spread across the good output so that 'the cost per kg does not look bad in the management accounts'. A pet-food manufacturer has offered £7.00 per kg for the 300 kg of closing work in progress, to be taken away immediately.
1. Calculate the cost per equivalent unit, the value of completed output, closing work in progress and the abnormal loss.
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Equivalent units
| Material | Conversion | |
|---|---|---|
| Completed output | 8,700 | 8,700 |
| Closing WIP (300 kg; 100% / 40%) | 300 | 120 |
| Abnormal loss | 200 | 200 |
| Equivalent units | 9,200 | 9,020 |
Costs to account for
- Material: £61,000 − scrap (800 kg × £1.50 = £1,200) = £59,800
- Conversion: £27,060
Cost per equivalent unit
- Material: £59,800 ÷ 9,200 = £6.50
- Conversion: £27,060 ÷ 9,020 = £3.00
- Total: £9.50 per kg
Valuations
- Completed output: 8,700 × £9.50 = £82,650
- Closing WIP: (300 × £6.50) + (120 × £3.00) = 1,950 + 360 = £2,310
- Abnormal loss: 200 × £9.50 = £1,900
- Check: 82,650 + 2,310 + 1,900 = £86,860 = £59,800 + £27,060 ✓
2. Evaluate the production manager's suggestion to spread the abnormal loss over good output.
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The suggestion should be rejected.
- It is not a product cost. Normal loss is a cost of producing good output and is absorbed into the £9.50 per kg. An abnormal loss arises from a failure that should not recur and is not caused by producing good units.
- It would distort decision-making. Absorbing £1,900 into 8,700 kg would raise the cost per kg by about £0.22 (around 2.3%), overstating inventory and cost of sales, and understating the gross margin. Any pricing or make-or-buy decision based on that figure would be wrong.
- It hides the problem. Charged separately as an abnormal loss in the profit and loss account, the £1,900 is visible to management and prompts investigation of the valve failure, maintenance regime and shift supervision. Buried in product cost, it disappears.
- Control comparison. The loss was 200 kg against a normal allowance of 800 kg - the process is not 'losing' in normal terms, so the abnormal loss stands out clearly as a one-off event that needs a cause and a corrective action.
The correct treatment is to credit the abnormal loss account with £1,900 and write it off to profit and loss, keeping product cost at £9.50 per kg.
3. Advise whether to accept the £7.00 per kg offer for the 300 kg of work in progress.
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Compare the incremental cash flows, ignoring the £1,950 of material already spent (a sunk cost).
Option 1 - sell now: 300 kg × £7.00 = £2,100
Option 2 - complete and sell as normal product:
- Conversion still required: 300 kg × 60% × £3.00 = £540
- Sales value: 300 kg × £9.50 = £2,850
- Net: 2,850 − 540 = £2,310
Completing is better by £210 (£2,310 − £2,100), so the offer should be refused - but only just. Note that the £540 of conversion is based on average cost per equivalent unit; if the additional conversion is mostly variable cost, the margin on completing is larger; if it requires a special run or overtime, the margin narrows.
Additional judgement: if the conversion resource is scarce and could be used on new production earning more than £210 of contribution in the time taken, selling now is the better use of capacity. The offer is also a useful floor price: any future disposal of WIP below £7.00 per kg is clearly value-destroying.