Process loss and sell-or-process decision at Bargarh Rice Mill
Bargarh Rice Mill processes paddy in a single process. In March it introduced 20,000 kg of paddy at Rs 18 per kg. Normal loss is 4% of input and the lost units sell as scrap at Rs 6 per kg. Conversion cost was Rs 1,10,000. Actual output was 19,000 kg of rice. The mill can either sell the paddy without processing for Rs 22 per kg or process it and sell rice at Rs 30 per kg. The manager is unsure whether the abnormal loss should be charged to the process or to profit and loss, and whether the conversion operation adds value once the abnormal loss is considered. A customer has offered to buy all the rice at the stated price. There is enough capacity to process the entire input, and no other use for the paddy if it is not processed.
1. Compute the normal loss, abnormal loss/gain, cost per kg of normal output and the value of actual output.
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Input cost = 20,000 kg × Rs 18 = Rs 3,60,000. Normal loss = 4% × 20,000 = 800 kg. Scrap value of normal loss = 800 kg × Rs 6 = Rs 4,800. Normal output = 20,000 − 800 = 19,200 kg.
Total process cost = input Rs 3,60,000 + conversion Rs 1,10,000 − scrap Rs 4,800 = Rs 4,65,200.
Cost per kg of normal output = Rs 4,65,200 ÷ 19,200 kg = Rs 24.2292 per kg.
Actual output is 19,000 kg, so abnormal loss = 19,200 − 19,000 = 200 kg.
Value of abnormal loss = 200 × Rs 24.2292 = Rs 4,845.84. Value of actual output = 19,000 × Rs 24.2292 = Rs 4,60,354.16. Check: Rs 4,845.84 + Rs 4,60,354.16 = Rs 4,65,200.
2. Using relevant costing, advise whether the mill should sell paddy or process it into rice. Show the incremental analysis.
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If the paddy is sold without processing, revenue = 20,000 kg × Rs 22 = Rs 4,40,000.
If processed, revenue from actual rice output = 19,000 kg × Rs 30 = Rs 5,70,000.
Incremental revenue = Rs 5,70,000 − Rs 4,40,000 = Rs 1,30,000. Incremental processing cost = Rs 1,10,000. Net incremental benefit = Rs 20,000.
The mill should process the paddy. The conversion operation adds Rs 20,000 even after allowing for the abnormal loss. If there had been no abnormal loss, the benefit would have been larger. The paddy cost is common to both alternatives and is not an incremental cost, but the forgone sale value of Rs 4,40,000 is the opportunity cost of processing. The recommendation assumes the rice price of Rs 30 and conversion cost of Rs 1,10,000 are reliable and that no additional fixed costs are incurred.
3. Explain how an abnormal loss and an abnormal gain are treated in the process account and in cost profit.
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Abnormal loss is valued at the normal cost per kg of good output. In the process account it is credited with Rs 4,845.84, and the abnormal loss account is debited. Any scrap proceeds from the abnormal loss units are credited to the abnormal loss account. The balance is transferred to the costing profit and loss account as a debit. It is not charged to good output, because doing so would penalise normal production.
Abnormal gain is the opposite. It is valued at normal cost and appears on the debit side of the process account, with the corresponding credit to the abnormal gain account. It is ultimately transferred to the costing profit and loss account; it is not used to reduce the cost of good output. In both cases the principle is that abnormal items are separated from normal product cost so that cost per kg remains comparable from period to period.