Chapter three

1. Costing methods: The costing of resource outputs

Costing methods: Costing system is also called as product costing system or cost accounting
system. It is a frame work used by a firm to estimate the costs of their product. Estimating the
accurate costs of product is a critical for profitable operation. A firm must know which product is
profitable and which one are not. This can be ascertained only when it has estimated the correct
cost of the product. Further, a product costing system helps in estimating the closing value of
material inventory, work in progress and finished goods inventory for the purpose of financial
statement preparation.
Any product costing system is acceptable in practice if it is effective and efficient in serving the
company’s unique production needs, provides information desired by management, meets
external reporting demands, and can be maintained at a cost that is reasonable when compared to
the benefits received. These criteria apply equally well to both manufacturers and service
companies.
Purpose of product costs-Product costs are needed for a variety of purpose in both financial
accounting and managerial accounting.
Use in financial accounting- in financial accounting, product costs are needed to value
inventory on the balance sheet and to compute cost of goods sold expense on the income
statement. Under generally accepted accounting principles, inventory is valued at its cost until it
is sold. The cost of the inventory becomes an expense of the period in which it is sold.
Use in managerial accounting- In managerial accounting, product costs are needed for planning,
for cost control, and to provide managers with data for decision making. Decisions about product
price, the mix of products to be produced, and the quantity of output to be manufactured are
among those decisions for which product cost information is needed.
In addition to financial statement preparation and internal decision making, there is an ever-
growing need for product cost information in relationships between firms and various outside
organizations. For example, Hospitals keep track of the costs of medical procedures that are
reimbursed by insurance companies or by the federal government under the Medicare program.
Some manufacturing firms sign cost-plus contracts with the government, where the contract
price depends on the cost of manufacturing the product.
The need for product costs is not limited to manufacturing firms. Merchandising firms include
the costs of buying and transporting merchandise in their product costs.
Service firms and nonprofit organizations- their production output consists of different services
that are consumed as they are produced ie since services cannot be stored and sold later like

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manufacturing goods, there are no inventor able costs in service industries firms and nonprofit
organizations. However, organizations such as Banks, insurance companies, restaurants, airlines,
law firms, hospitals, and city governments all record the costs of producing various services for
the purposes of planning, cost control, and decision making. For example, in making decision
about adding a flight from Addis Ababa to New York, Ethiopian air lines’ management needs to
know the cost of flying the proposed route.
Types of product costing systems-The accounting procedures of companies use different
product costing systems depending on the nature of the activities being undertaken. Accordingly,
companies may use one or more of the following product costing systems- Activity Based
Costing system, Job order costing system, batch costing system, contract costing system and
Process costing system.
Job order, batch and contract costing methods
1. Job order costing system: is a type of cost system that provides for a separate record of
the cost of each particular quantity of product that passes through the factory.
Job order costing system is commonly used by companies with products that are unique and
divisible. In this system, costs are assigned to a distinct unit, batch or lot of product or service.
Job is a task for which resources are expended in bringing a distinct product or service to market
A job order cost system accumulates costs for each quantity of product, or “job,” that passes
through the factory. Direct materials, direct labor, and factory overhead are accumulated on the
job cost sheet, which is the subsidiary cost ledger for each job. Direct materials and direct labor
are assigned to individual jobs based on the quantity used. Factory overhead costs are assigned to
each job based on an activity base that reflects the use of factory overhead costs. As a job is
finished, its costs are transferred to the finished goods ledger. When goods are sold, the cost is
transferred from finished goods inventory to cost of goods sold.
Examples of business that use job order costing includes: construction companies, Furniture
manufacturers, printing firms, Repair shops, Service giving organization and Garages etc.
2. Batch costing

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 3. Contract costing, also known as terminal costing, is a variant of job costing. Contract
means a big job in which work is done at site and not in factory premises. The cost of each
contract is ascertained. Thus, in this method of costing, each contract is a cost unit and an
account is opened for each contract in the books of contractor to ascertain profit/loss
thereon.
 Characteristics of Contract Costing
Contract costing usually shows the following features:
1. Contracts are generally of large size and, therefore, a contractor usually carries out a small
number of contracts at a particular point of time.
2. A contract generally takes more than one year to complete,
3. Work on contracts is carried out at the site of contracts and not in factory premises.
4. Each contract undertaken is treated as a cost unit.
5. A separate contract account is prepared for each contract in the books of contractor to
ascertain profit or loss on each contract.
6. Nearly all labor cost will be direct.
7. Most expenses (e.g., electricity, telephone, insurance, etc.) are also direct.
8. Specialist subcontractors may be employed for say, electrical fittings, welding work, glass
work, etc.
9. Plant and equipment may be purchased for the contract or may be hired for the duration of
the contract.
 Contract Costing and Job Costing — Distinction
Main points of distinction between contract costing and job costing are as follows:
1. Contract is generally big while job is small. It is well said, “a job is a small contract and a
contract is a big job.”
2. The number of jobs undertaken at a time is usually large as compared to number of
contracts because contracts are generally much bigger in size.

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 3. In contract costing most of the costs are chargeable direct to contract accounts. Under
job costing, direct allocation to such an extent is not possible.
4. Allocation and apportionment of overhead costs is simpler in contract costing as
compared to job costing.
5. Jobs are usually carried out in factory premises while contract work is done at site.
3.2. Accounting procedures for job order costing system.
Accounting procedures for job order costing
Job order costing system requires a subsidiary ledger for each job order and general ledger
(controlling account) for the total amount. Entries in subsidiary ledger will be made frequently
and summarized in control account in weekly or monthly interval.
Major Accounting procedures in job order costing system
Receiving job order and purchase of raw materials
Transferring raw material to work in process
Recording labor to work in process.
Recording actual manufacturing overhead cost incurred
Allocating manufacturing overhead cost to work in process
work in process to finished goods
Transferring finished goods to customers.
Manufacturing overhead cost is incurred for the benefit of all jobs produced during a period and
cannot be related to any particular job. As manufacturing overhead costs are incurred, they are
accumulated as manufacturing overhead control account.
Some manufacturing costs such as utility will not be known until the end of the period. Hence,
rather than holding a finished good job until all costs can be attributed to it, it is necessary to
develop a method of allocating manufacturing overhead cost to the job completed. This is called
normal costing. In normal costing direct material and direct labor costs are directly traced to the
job completed but MOH cost is allocated to it using budgeted rate and actual allocation base. To
determine budgeted rate:
 Estimate manufacturing overhead cost for the year.
 Choose allocation base such as labor hour, direct labor cost or machine hour.
 Estimate the allocation base for the year
 Calculate the budgeted rate using the formula
Budgeted rate = Budgeted MOH cost
Budgeted allocation base
3.3. Job order costing system- - illustration
To illustrate the procedures used in job-order costing, we will examine the accounting entries
made by Alpha-manufacturing co. during November 2003. The company uses machine hours to

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allocate overhead costs to the individual jobs. It has worked on two production jobs during the
month.
Job-1: 80 deluxe wooden tables
Job-2: 80 deluxe aluminum boats
The company undertaken the following activities/transaction during the month of November and
a balance of beginning direct material 30,000, , working in process inventory 4,000, finished
good 12,000
Transaction-1: Acquisition of direct materials
4000-square feet of rolled aluminum sheet metal were purchased on account for $10,000. The
purchase is recorded with the following journal entry.
Raw-material Inventory----------------------10,000
Accounts payable------------------------------10,000
Transaction-2: Use of direct material
On November -1, the following material requisitions were filed.
Requisition number-001 (for job-1) ---------8,000 board feet of lumber, at $2 per board foot, for a
total of $16,000
Requisition number-002 (for job-2) ---7,200 square feet of aluminum sheet metal, at $2.50 per
square foot, for a total of $18,000
The following journal entry records the release of these raw materials to production.
Work-in-process inventory---------------34,000
Raw-material inventory--------------------34,000
Transaction-3: Use of indirect material
On November 15, the following material requisition was filed.
Requisition-003: 5-gallons of bonding glue, at $10 per gallon, for a total cost of $50
Manufacturing overhead-------------------50
Manufacturing supplies inventory----------50
Since only small amounts of bonding glue are used in the production of all classes of boats
manufactured by the company, the costs incurred is small, and no attempt is made to trace the
cost of glue to specific jobs. Instead, glue is considered an indirect material, and its cost is
included in manufacturing overhead. The company accumulates all manufacturing-overhead cost
in Manufacturing Overhead account. All actual overhead cost is recorded by debiting the account
when indirect materials are requisitioned, when indirect-labor costs are incurred, when utility
bills are paid, when depreciation is recorded on manufacturing equipment, and so on.
Transaction-4: Use of direct labor
At the end of November, the cost-accounting department used the labor time tickets filed during
the month to determine the following direct-labor costs of each job.
Direct labor: Job-1----------------$9,000
Direct labor: Job-2---------------12,000

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 Total direct labor------------------$21,000
The journal entry used to record these costs should be
Work-in-process Inventory---------------21,000
Wages payable--------------------------------21,000
Transaction-5: Use of indirect labor
The analysis of large time card undertaken on November-30 also revealed the following use of
indirect labor that is not charged to either of the products specifically amounts to $14,000.
This cost is comprised of the production supervisor’s salary and the wages of various employees
who spent some of their time on maintenance, general cleanup duties and salary of guards and
store keepers during November.
Manufacturing overhead--------------------14,000
Wages Payable------------------------------------14,000
No entry is made on any job cost sheet, since indirect-labor costs are not traceable to any
particular job. In practice, journal entries (4) and (5) are usually combined into one compound
entry as follows:
Work in process inventory------------------21,000
Manufacturing overhead---------------------14,000
Wages payable------------------------------------35,000
Transaction-6: Other manufacturing overhead costs
During November, the company incurred the following other manufacturing overhead cost
besides the indirect materials and indirect labors costs.
Rent on factory building (expired prepaid rent) ------------$3,000
Depreciation on equipment-------------------------------------5,000
Utilities (electricity, water, telephone) -----------------------4,000
Property taxes-----------------------------------------------------2,000
Insurance (amount expire during the month) -----------------1,000
Total --------------------------------------------------------------$15,000
The following compound entry is made on November-30, to record these costs.
Manufacturing overhead------------------------15,000
Prepaid Rent----------------------------------------------3,000
Accumulated depreciation-Equipment----------------5,000
Accounts Payable (utilities and property tax) --------6,000
Prepaid Insurance-----------------------------------------1,000
Application of manufacturing overhead
Various manufacturing-overhead costs were incurred during November, and these costs were
accumulated by debiting the Manufacturing-Overhead accounts. However, no manufacturing-
overhead cost have yet been added to Work- in-Process Inventory or recorded on the job-cost

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sheets. The application of overhead to the firm’s products is based on a predetermined overhead
rate. This rate computed by the accounting department at the beginning of the period.
Transaction-7: Allocation of overhead costs
Factory machine-usage records indicate the following usage of machine hours during November.
Machine hour used: Job-1 -----------------------------1, 200 hours
Machine hour used: Job-2-------------------------------2,000 hours
Total machine hours--------------------------------------3,200 hours
The total manufacturing overhead applied to Work-in Process Inventory during November is
calculated as follows:
The total manufacturing overhead applied to Work-in-Process Inventory during November is
calculated as follows:
Machine hour Predetermined Manufacturing
Overhead rate overhead applied
Job-1 1,200 × $9.00 =
$10,800
Job-2 2,000 × $9.00 =
$18,000
Total manufacturing overhead applied $28,800
The following journal entry is made to apply manufacturing overhead to Work-in-Process
Inventory.
Work-in-Process Inventory ----------------------28,800
Manufacturing overhead---------------------------------28,800
NB. As the following time line shows, three concepts are used in accounting for overhead.
Overhead is budgeted at the beginning of the accounting period, it is applied during the period,
and actual overhead is measured at the end of the period.
Transaction-8: Selling and administrative costs
During November, Alpha-manufacturing co. incurred the following selling and administrative
costs.
Rental of sales and administrative offices--------------------------$1,500
Salaries of sales personnel---------------------------------------------4,000
Salaries of management------------------------------------------------8,000
Advertising---------------------------------------------------------------1,000
Office supplies used----------------------------------------------------- 300
Total---------------------------------------------------------------------------$14,800
Since these are not manufacturing costs, they are not added to Work-in-Process Inventory.
Selling and administrative costs are period costs, not product costs. They are treated as expenses
of the accounting period. The following journal entry is made
Selling and Administrative Expenses---------------------14,800
Wages Payable---------------------------------------------------12,000
Accounts payable-------------------------------------------------1,000
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 Prepaid Rent-------------------------------------------------------1,500
Office Supplies inventory------------------------------------------300
Transaction-9: Completion of production job
Job-2 was completed during November, whereas job-1 remained in process. The job sheet
indicates that the total cost of job-2 was $48,000. The following journal entry records the transfer
of these job costs from Work-in-Process Inventory to finished goods inventory.
Finished goods inventory--------------------48,000
Work-in- Process inventory-------------------48,000
Transaction-10: Sales of goods
Sixty deluxe aluminum fishing boats manufactured in job-2 were sold for $900 each during
November. The cost of each unit sold was $600 as shown on the job cost sheet. The following
journal entries were made
a) Accounts Receivable------------------54,000
Sales Revenue-----------------------------54,000
a) Cost of goods sold-----------------------36,000
Finished goods inventory-----------------36,000
The reminder of the manufacturing cost of job-2 remains in Finished –goods inventory until
some subsequent accounting period when the units are sold. Therefore, the cost balance for job-2
remaining in inventory is $12,000 (20 units remaining times $600 per unit.)
Transaction-11: Disposition of overhead balances
During November, Alpha-Manufacturing co. incurred total actual manufacturing-overhead costs
of $29,050, but only $28,800 of overhead was applied to Work-in-Process Inventory. The
amount by which the company’s actual overhead exceeds applied overhead, called under
applied overhead, is calculated below.
Actual manufacturing overhead*----------------------------------$29,050
Applied manufacturing overhead+-------------------------------- 28,800
Under applied overhead---------------------------------------------$ 250
The company disposes its overhead balances at the end of the year by directly writing the amount
to cost goods sold during the period. Accordingly, the following journal entry is made by the
company. This entry reduces the balance of Manufacturing Overhead accounts to zero and
increase the balance of cost of goods sold account by $250.
Cost of goods sold------------------------------250
Manufacturing Overhead control--------------250
Schedule of cost of goods sold
Schedule of cost of goods sold for Alpha-manufacturing Company is displayed in exhibit. This
schedule shows the November cost of goods sold and detailed the changes in Finished-Goods
Inventory during the month.
Schedule of cost of goods manufactured

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Alpha-Manufacturing company
Schedule of cost of Goods Manufactured
For the month of November, 2003
Direct material:
Raw-material inventory, November-1-------------------------$30,000
Add: November purchase of raw material---------------------10,000
Raw material available for use----------------------------------$40,000
Deduct: Raw-material inventory, November-30---------------6000
Raw material used---------------------------------------------------------------------$34,000
Direct labor------------------------------------------------------------------------21,000
Manufacturing overhead:
Indirect material---------------------------------------------------- $50
Indirect labor---------------------------------------------------------14,000
Rent on factory building------------------------------------------- 3,000
Depreciation on equipment-----------------------------------------5,000
Utilities----------------------------------------------------------------4,000
Property taxes---------------------------------------------------------2,000
Insurance---------------------------------------------------------------1,000
Total actual manufacturing overhead------------------------------$29,050
Deduct: Under applied overhead----------------------------------- 250*
Overhead applied to work in process---------------------------------------------28,800
Total manufacturing costs-------------------------------------------------------- $83,800
Add: Work in process inventory, November-1----------------------------------4,000
Subtotal------------------------------------------------------------------------------$87,800
Deduct: Work in process, November-30, ---------------------------------------39,800
Cost of goods manufactured-------------------------------------------------------- $48,000
The schedule of cost of goods manufactured lists the manufacturing costs applied to Work in
Process. Therefore, the under applied overhead of $250 must be deducted from total actual
overhead to arrive at the amount of overhead applied to work in process during November. If
there had been over applied overhead, the balance would have been added to total actual
manufacturing overhead.
Schedule of cost of goods sold
Alpha-Manufacturing company
Schedule of cost of goods sold
For the Month of November, 2003
Finished goods inventory, November-1-------------------------------------$12,000
Add: Cost of goods manufactured*--------------------------------------------48,000
Cost of goods available for sale---------------------------------------------- $60,000

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Deduct: Finished-goods inventory, November-30-------------------------- 24,000
Cost of goods sold (before adjustment) -------------------------------------$36,000
Add: Under applied overhead +------------------------------------------------ 250
Cost of goods sold (adjusted for under applied overhead) ----------------$36,250
Income statements
Alpha-Manufacturing company
Income statement
For the Month of November, 2003
Sales revenue----------------------------------------------------------------------$54,000
Less: Cost of goods sold*------------------------------------------------------- 36,250
Gross margin----------------------------------------------------------------------$17,750
Selling and administrative expenses---------------------------------------------14,800
Income before taxes---------------------------------------------------------------$ 2,950
Accounting for the treatment of waste, scrap, spoilage and re work costs,
 Spoilage, reworked units and scrap
Spoilage, rework and scrap in general: Spoilages (Defective): are units of production whether
fully or partially completed that don’t meet the standard required by customers for good units
and that are discarded or sold for reduced price. Example, Defective shirts, shoes, electronic
devices
Types of spoilage
Normal spoilage: is spoilage inherent in a particular production process that arises even under
efficient operating condition. Depending on the production process, management decides the
spoilage it considers normal.
Cost of normal spoilage is typically included as a component of cost of good unit’s manufactured
because good units cannot be made without also making some units that are spoiled.
Abnormal spoilage: is spoilage that would not arise under efficient operating condition. It is not
inherent in a particular production process. It arises because of machine break down and
operators’ error. Abnormal spoilage is usually avoidable or controllable. Abnormal spoilage cost
is recorded separately and treated as loss of the current year.
Reworks: are units of production that don’t meet the standard required by customers for finished
units that are subsequently repaired and sold as acceptable finished unit.
In job order costing system, like spoilage, they are divided as normal rework attributable to a
specific job, normal rework common to all jobs and abnormal rework.
Scrapes: are materials left over when making a product. They have low sales value compared
with the sales value of the main products. Example, short lengths from wood working operations,
frayed cloth etc.
The treatment of spoilage in job order costing

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There are normal and abnormal spoilages in job order costing. Costs of normal spoilage are
inventoriable whereas abnormal spoilage is not inventoriable and are written off as losses of the
period in which they are identified. In Job order costing system abnormal spoilage are regarded
as controllable by the first stage supervisor. Normal spoilage in Job order costing is two types
normal spoilage attributable to specific job and common to all jobs.
Normal spoilage attributable to a specific Job
When the spoilage is caused due to the specification related to a particular Job, that job should
absorb this cost of the spoilage by net of the salvage value of the spoiled units, if salable. To
recognize the estimated selling price (disposal value) of the spoilage, J. entry should be recorded
Materials ------------------------------xx
Work in process --------------------- xx
 Disposal value
Example:
In fasica machine shop, 10 machine parts of a job lot of 100 machine parts are spoiled. Costs
assigned period to the inspection point are Br. 4000 per part. The current disposal price of the
spoiled parts is estimated to be Br. 1200 per part.
Required: Prepare the necessary J. entry at the time the spoiled parts are identified and given
 That they are related to the particular job.
Materials -------------------------------- 12000
Work –in process --------------------- 12000
The cost of the spoiled units = (10 parts X Br 4000) - Br 12000)
= Br. 40,000 – Br. 12,000
= 28,000
The cost of good units =
= (90 units X Br.4000) + Br 28,000
= Br. 360,000 +Br.28,000
= Br. 388,000
Normal spoilage common to all jobs
Normal spoilage may coincidentally occur due to the inherent problem in the manufacturing.
Process where different jobs are being worked on. Under this condition, the costs of the spoilage
cannot be assigned to the particular job but to all jobs manufacturing overhead. The j. entry
based on the above examples is recorded as follows:

Manufacturing overhead control ------------ 28,000

Work in process ------------------------------------- 28,000
When normal spoilage is common to all jobs, the budgeted manufacturing overhead application
rate is applied to spoilage cost. Therefore, the normal spoilage cost is allocated, to all jobs based
on the application rate under this condition;

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 The costs of goods units = 90 parts X Br 4000 = Br. 360,000
Plus the allocated share of Br. 28000
Cost of good unit. = 388,000
Abnormal spoilage
If the spoilage is abnormal, the cost of the abnormal spoilage net of any disposal value is debited
to an account titled loss from abnormal spoilage. Abnormal spoilage is not part of the cost of
good units. If the spoilage in the above example was abnormal, the J. entry the cost of ab normal
spoilage net of salvage value would be:
Loss from abnormal spoilage --------- 28,000
Work – in process -----------------------28,000
Abnormal spoilage is reported as the loss of the period in which it is identified.
Reworked units
As it has been defined before is the cost of unacceptable units of production that are
subsequently repaired and sold as normal finished goods. Rework is distinguished
As
i. Normal rework attributable to specific jog
ii. Normal rework common to all jobs
iii. Abnormal rework
Assume the 10 spoiled machine parts in our previous illustration are reworked at a total costs of
Br 40,000 details of costs assumed) assigned to the 10 spoiled parts before considering rework
costs are as follows.
Work in process ----------------------------------- 40,000
Material ----------------------------------------------- 15000
Wages payable --------------------------------------- 15000
Manufacturing overhead control ------------------- 10000
Normal rework attributable to a specific job: - If the rework is normal and if it is related to
the specification of a particular job, the costs of the rework should be assigned to that particular
job.
Work – in process----------------------- 7600
Materials control -----------------------1600
Wages payable ------------------------ 4000
Manufacturing overhead control----- 2000
Normal rework common to all jobs
When rework is normal and is caused to the inherent problem of the manufacturing process
different jobs, the costs of the rework are charged to manufacturing overhead control account
and allocated to all jobs like the other overhead costs and the journal entry recorded the rework
costs is as follows – assume the rework costs in the previous example.
Manufacturing overhead control ---------------------------------- 7600

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 Materials control --------------------------------------------------1600
Wages payable ----------------------------------------------------- 4000
Manufacturing overhead control----------------------------------- 2000
Abnormal Rework
If the rework is abnormal, it is charged to loss form abnormal rework account. The accounting
treatment for abnormal rework is the same in both job costing and process costing if the rework
cost in the previous example is abnormal; the J. entry is recorded as follows:
Loss from abnormal rework -----------------------------------7600
Materials control -----------------------------------------------1600
Wages payable ---------------------------------------------------4000
Manufacturing overhead control -------------------------------- 2000
Accounting for scrap
A scrap as has been defined before represents remains of materials left over from the
manufacturing process. They have low sales value as compared with the sales value of the main
products.
The accounting issue related to scrap is
1. When should the value of scrap be recognized in the accounting records- at the time
scrap is produced or at the time scrap is sold?
2. How should revenue from scrap be accounted for?
Recognizing scrap at the time of sale
Scrap is recognized at the time of sale when its dollar amount is immaterial (make no
difference). The accounting treatment is to make a memo of the quantity of the scrap returned to
the store room and to recorded the following J. entry at the time of sale.
Assume the selling price of a given quantity of material is Br. 500.
Cash (A/R) ------------------ 500
Sales of scrap ----------------------500
The sale of scrap is an account that represents the revenue generated from the selling of the
scrap.
It is reported the income statement as other income.
When the dollar amount of scrap is material and the scrap is sold quickly after it is known,
the accounting treatment depend on whether the scrap is attributable to a specific job or is
common to all jobs.
Scrap attributable to a specific job
If a scrap is feasible with the making of a specific job the selling price of the scrap reduces the
cost of the particular job.
Cash (A/R) ----------------------------------- 500
work in process job(x)----------------------------- 500

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. Scrap common to all jobs When it is not possible to identify scrap with a specific job, the
selling price of the scrap will be prorated and deducted from the costs of all jobs.

Cash (A/R) ----------------------------------- 500

Manufacturing overhead control --------- 500
Recognizing scrap at the time of its production
In the discussion of above it was assumed that the scrap is sold immediately as if is produced
(identified) however, there may be a time interval between its production and it’s selling or
reusing it. In this case, separate scrap inventory account is maintained or the scrap is recorded in
the materials control account like the other materials at its expected net realizable value. The
scrap is than stored until sold or reused. The scrap may be attributable to specific job or many be
common to all jobs.
Scrap Attributable to a Specific Job: The journal entry in the Company to record scrap returned
to storeroom is:
Material Control ……… xx
WIP……………………...xx
Scrap Common to All Jobs: The journal entry in this case Scrap returned to storeroom is :
Material Control …………. xx
MOH Control…………….…xx
Observe that Materials Control account is debited in place of Cash or Account Receivable.
When scrap is sold, the journal entry is:
Sales of Scrap:
Cash (Account Receivable) ……….xxx
Material Control………….……xxx
Scrap attributable to a specific job
It’s expected net realizable value should be deducted from the cost of that particular job’s and the
scrap inventory should increase the balance of the materials control account.
Let us assume that the estimate selling price of a given scrap is Br. 1000 and its related costs of
selling (disposal, is estimated to be Br. 200, the net realizable value of the scrap is Br. 800 (Br
1000 – Br 200) and, the storage of the scrap is recorded as follows:
Material---------------------800
Work - in process --------- 800
Scrap common to all jobs
When scrap is not identified with a specific job but caused due to the common to all jobs
associated in the prorated amount of manufacturing process, the expected net realizable value of
the scrap reduces the cost of all jobs.
Material control --------------------------- 800
Manufacturing overhead control ----- 800

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 (Returning to store)
Later, when the scrap is sold, the actual selling price of the scrap may be different from its
expected net realizable value; the situation could be one of the following.
 the selling price = net realizable value
 the selling price < net realizable value
 the selling price > net realizable value
Because of the difference in the selling price and net realizable value of the scrap the journal
entry that is recorded at the time of the sales also different.
Lt’s see the J. entry assuming the above example the selling price is Br. 800 Br.700 and Br. 900
is respectively.
If (i) the selling price = Net realizable value
Cash (A/R) ----------------------------800
Material control -----------------------800
(ii) The selling price < Net realizable value
Cash (A/R) ----------------------------------- 700
Work – in process (Manu OHD) ---------- 100
Material control -------------------- 800
(iii) The selling price > Net realizable value
Cash ----------------------------------- 900
Material control -------------------------------800
Work – in process (Manu OHD) ------------100
*Manufacturing overhead control.

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