Method of accounting for the cost of lost units

The method of accounting for the cost of lost units depends on whether the loss is considered normal or abnormal and whether the loss occurred continuously in the process or at a discrete point.

The traditional method of accounting for normal losses is simple. Normal loss cost is considered a product cost and is included as part of the cost of the good units resulting from the process. Thus, the cost of the loss is inventoried in Work in Process and Finished Goods Inventories and expensed only when the good units are sold. This treatment has been considered appropriate because normal losses have been viewed as unavoidable costs in the production of good units. If the loss results from shrinkage caused by the production process, such as the weight loss of roasting coffee beans, this treatment seems logical.

Alternatively, consider the company producing fragile scientific lenses: If the company allows for losses by virtue of the level at which some acceptable quality was set, then management will not receive valuable information about the cost of quality losses. In contrast, if the same company were to institute a zero-defect policy, there would by definition be no “normal” loss. All losses would be outside the tolerance specifications for acceptable quality.