Process Costing: Losses, Gains, By-Products and Joint Products

Learning objectives

By the end of this chapter you should be able to:

• Prepare process accounts that include normal loss and scrap proceeds, and calculate a reliable unit cost.
• Record and explain abnormal loss and abnormal gain, including the correct double entries and profit or loss impact.
• Explain the practical accounting treatment of by-products and apply a net realisable value (NRV) offset method.
• Explain joint products and allocate joint costs at the split-off point using common allocation bases.
• Decide whether to process a product further using incremental (relevant) costing, distinguishing relevant costs from sunk joint costs.

Overview & key concepts

Process costing is used where production is continuous and units are broadly identical (for example, chemicals, food, beverages, and other flow processes). Costs are accumulated by process (or department) for a period and then averaged over the units produced.

In many processes:

• Some loss is expected(normal loss) and may generatescrap proceeds.
• More than one output can arisefrom the same inputs, including by-products and joint products.

This chapter assumes no opening or closing work in progress (so there is no equivalent units calculation). Many exam-style questions include WIP and equivalent units; the process-account logic here is the same, but the unit-cost calculation would be based on equivalent units rather than simple units.

Core theory and frameworks

1) Normal loss and scrap proceeds

Normal loss is the expected, unavoidable loss under efficient operating conditions for a given process and period. It is absorbed into the cost of good output rather than treated as a separate period expense.

Normal loss is usually expressed as a percentage of input units. Where normal-loss units have a scrap value, the proceeds reduce the net process cost to be shared by good units.

Key mechanics:

• Normal loss units = Input units × normal loss %
• Expected good output = Input units − Normal loss units
• Scrap proceeds reduce the process cost to be allocated

Net process cost:
Net process cost = Total process cost − Scrap proceeds (normal loss)

Cost per unit (typical process-account approach):
Cost per unit = Net process cost / Expected good output

Signpost on denominators:

• In process accounts that include normal loss, the unit cost is typically based onexpected good output(because normal loss is treated as unavoidable).
• Some simplified questions useactual good outputas the denominator (especially where loss treatment is simplified). Always follow the question requirement and be consistent throughout your workings.

2) Abnormal loss

Abnormal loss is the excess of actual loss over normal loss. It is shown separately to highlight inefficiency or unusual events.

• Actual loss units = Input units − Actual good output
• Abnormal loss units = Actual loss units − Normal loss units (if positive)

Abnormal loss is valued using the same unit cost as good output (calculated using expected good output, after crediting normal-loss scrap proceeds).

Abnormal loss value:
Abnormal loss value = Abnormal loss units × Cost per unit

Double-entry (common approach):

• Transfer the cost of abnormal-loss units from the process account into an Abnormal Loss account.
• Credit the Abnormal Loss account with any scrap proceeds from selling abnormal-loss units.
• Transfer the remaining balance on the Abnormal Loss account to profit or loss.

3) Abnormal gain (with explicit scrap-value adjustment)

Abnormal gain arises when actual loss is less than normal loss. Fewer units are lost than the normal-loss expectation built into the costing system. This creates two effects: (i) there are extra good units to account for at the process unit cost, and (ii) the scrap proceeds originally assumed on the normal-loss units will be overstated unless corrected. The entries therefore both record the extra output and remove the scrap credit that will not be realised on the units that were “saved”.

Valuation:

• Use the same unit cost as for good output (based on expected good output and after crediting normal-loss scrap proceeds).

Abnormal gain value:
Abnormal gain value = Abnormal gain units × Cost per unit

Where:

Abnormal gain units = Normal loss units − Actual loss units (if positive)

Precise ledger treatment (common exam approach)

Recognise the extra good output at process cost

• Dr Process account (Abnormal gain units × unit cost)
• Cr Abnormal Gain account (same)

Reverse the scrap value that was expected but will not arise

• Dr Abnormal Gain account (Abnormal gain units × scrap value per unit)
• Cr Process account (same)

Transfer the net abnormal gain to profit or loss

• Dr Abnormal Gain account (balance)
• Cr Profit or loss (balance)

4) By-products

A by-product is a secondary output of relatively low value compared with the main product, arising incidentally from the same process.

A common practical method is the NRV offset method, where the by-product’s NRV is credited to the main process, reducing the cost assigned to the main product.

NRV (generic):
NRV = Final sales value − Further processing costs − Further selling/distribution costs (if relevant)

Clarifying sentence for accounting logic:

• Under the NRV offset method, the credit to the main process is acosting convention, not a measurement of the by-product’s “share” of joint cost, and it is applied when the by-product becomes identifiable/saleable (policy-dependent).

5) Joint products and the split-off point

Joint products are two or more significant outputs produced together from the same inputs up to a point where they become separately identifiable.

The split-off point is where products become separately identifiable and can be sold at split-off or processed further.

Joint costs incurred up to split-off must be allocated to products for inventory valuation. Common bases:

• Physical measures (units/weight/volume)
• Sales value at split-off
• NRV after further processing (when sales value at split-off is not available)

Allocation proportion:
Allocation proportion (product i) = Basis for product i / Total basis

Joint cost allocated:
Joint cost allocated to product i = Total joint cost × Allocation proportion

Examiner-style emphasis:

• For further processing decisions,ignore joint costsand compareincremental revenue vs incremental post–split-off costsfor each product separately.

6) Incremental analysis for further processing

Further processing decisions must be based on relevant cash flows after split-off.

Incremental profit:
Incremental profit = (Revenue after further processing − Revenue at split-off) − Further processing costs − Additional selling costs

Decision rule:

• Process further only if incremental profit is positive.

Allocated joint costs are sunk at split-off and must not be used to justify further processing.Worked example

Narrative scenario

A manufacturing company produces chemicals in a continuous process. During March, Process A receives 15,000 units of raw materials. Normal loss is 5% of input. Normal-loss units can be sold as scrap for £0.60 per unit.

Costs added in March:

• Direct materials: £60,000
• Direct labour: £30,000
• Production overhead: £20,000

Actual output was 14,200 good units.

The process also produces a by-product. At the split-off point it can be sold immediately for £3,800. Alternatively, it can be given minor finishing and then sold for £5,000. Minor finishing costs £700, and additional selling/distribution costs after finishing are £200. (If sold at split-off, no additional selling costs are incurred.)

This example assumes no opening or closing work in progress.

Required

1. Calculate the cost per expected good unit, allowing for normal loss and scrap proceeds.
2. Determine the abnormal loss or abnormal gain and its value.
3. Apply the NRV offset method for the by-product and calculate the revised main-product unit cost.
4. Use incremental analysis to assess whether the by-product should be sold at split-off or processed further.

Solution

1) Normal loss, expected output, and unit cost

Normal loss units:

Normal loss units = 15,000 × 5% = 750 units

Expected good output:

Expected good output = 15,000 − 750 = 14,250 units

Scrap proceeds from normal loss:

Scrap proceeds (normal loss) = 750 × £0.60 = £450

Total process cost added:

Total process cost = £60,000 + £30,000 + £20,000 = £110,000

Net cost to be allocated over expected good output (after crediting normal-loss scrap):

Net process cost = £110,000 − £450 = £109,550

Cost per expected good unit:

Cost per unit = £109,550 / 14,250 = £7.6877 (≈ £7.69)

In process accounts, keep unit cost unrounded until the final line to reduce rounding differences.

2) Abnormal loss or abnormal gain

Actual loss units:

Actual loss units = 15,000 − 14,200 = 800 units

Normal loss units were 750, so the excess is an abnormal loss:

Abnormal loss units = 800 − 750 = 50 units

Value of abnormal loss:

Abnormal loss value = 50 × £7.6877 = £384.39 (≈ £384.40)

3) By-product treatment using the NRV offset method

First compute the by-product’s NRV at the point it becomes saleable (after finishing).

By-product final sales value (after finishing): £5,000
Less finishing costs: £700
Less additional selling costs: £200

By-product NRV = £5,000 − £700 − £200 = £4,100

Because this question treats the by-product as saleable after finishing, the offset is based on NRV after finishing; if the policy were to recognise the by-product at split-off, the offset would instead be based on split-off NRV/sales value.

Under the NRV offset method, the main process is credited with this NRV as a costing convention.

Revised net cost attributable to main product:

Net cost for main product = £109,550 − £4,100 = £105,450

Revised unit cost for main product (based on expected good output):

Main product cost per unit = £105,450 / 14,250 = £7.4000 (≈ £7.40)

4) Incremental analysis: sell at split-off or process further (by-product)

Compare cash outcomes:

Option A: Sell at split-off
Revenue at split-off = £3,800
Further costs after split-off = £0
Net cash benefit = £3,800

Option B: Process further and sell after finishing
Revenue after finishing = £5,000
Less finishing costs = £700
Less additional selling costs = £200
Net cash benefit = £5,000 − £700 − £200 = £4,100

Incremental analysis (B compared with A):

Incremental revenue = £5,000 − £3,800 = £1,200
Incremental cost = £700 + £200 = £900
Incremental profit = £1,200 − £900 = £300

Decision:

• Process further, because incremental profit is positive (£300).

Reminder:

• Any joint costs incurred before split-off are unchanged by this choice and are excluded from the incremental comparison.

Worked example: double-entry summary (process costing focus)

Record costs added to Process A (WIP):

• Dr Process A £110,000
• Cr relevant accounts (materials/ wages/ overhead control, payables, cash)

Record scrap proceeds from normal loss:

• Dr Cash/Receivable £450
• Cr Process A £450

Record abnormal loss at process unit cost:

• Dr Abnormal Loss £384.40
• Cr Process A £384.40
• (If abnormal-loss units are sold as scrap, credit Abnormal Loss with proceeds; transfer remaining balance to profit or loss.)

By-product NRV offset (costing convention):

• Cr Process A £4,100
• Dr By-product inventory (if recognised) or Dr By-product account (to be cleared on sale), depending on policy/materiality

Common pitfalls and misunderstandings

Losses and unit costs

• Treating normal loss as a period expense rather than absorbing it into the cost of good output.
• Using an inconsistent denominator for the unit cost (expected good output vs actual good output).
• Forgetting to credit the process with scrap proceeds for normal loss when scrap value is given.

Abnormal loss and abnormal gain

• Valuing abnormal loss/gain using the wrong unit cost (for example, using a cost that ignores scrap proceeds).
• Netting abnormal loss/gain into product cost instead of reporting it separately.
• For abnormal gain, failing to reverse the scrap value that was expected but will not be realised on the units that were “saved”.

By-products and joint products

• Treating by-product credits as if they represent a precise allocation of joint cost, rather than a practical costing convention.
• Using allocated joint costs to justify further processing, instead of incremental revenue and incremental post–split-off costs.

Summary

Process costing averages process costs over output units in continuous production. Normal loss is absorbed into the unit cost of good output, with any scrap proceeds reducing the net cost to allocate. Abnormal loss and abnormal gain are identified separately and transferred to profit or loss to highlight unusual performance; abnormal gain requires a clear scrap-value adjustment.

Where multiple outputs occur, by-products are often handled using practical approaches such as an NRV offset, while joint products require a joint-cost allocation at split-off for inventory valuation. Decisions on further processing must be made using incremental analysis, ignoring sunk joint costs.

FAQ

What is the key adjustment in abnormal gain?

Normal loss assumptions often include expected scrap proceeds. If actual loss is lower than normal loss, scrap proceeds on the “saved” units will not arise. Therefore, reverse that scrap credit:

• Dr Abnormal Gain
• Cr Process

for abnormal gain units × scrap value per unit.

Why is the unit-cost denominator often “expected good output”?

Normal loss is unavoidable under efficient conditions, so the cost of expected loss is carried by the good units. Using expected good output aligns the unit cost with that logic. If a question specifies a different approach, apply it consistently.

Under the NRV offset method, what exactly is being credited to the process?

The by-product’s NRV is credited as a costing convention to reduce the main product’s cost. It is applied when the by-product becomes identifiable/saleable, and it is not intended to represent a precise allocation of joint cost.

Why are joint cost allocations not used for further processing decisions?

Joint costs are sunk at split-off. Further processing decisions should be based on incremental revenue and incremental post–split-off costs for each product.

Summary (Recap)

This chapter covered process costing for continuous production, focusing on normal loss, abnormal loss/gain, scrap proceeds, by-products, and joint outputs. Normal loss is absorbed into the cost of good output, with scrap proceeds reducing the process cost. Abnormal loss and abnormal gain are separated to highlight unusual performance; abnormal gain requires reversing the scrap value that was expected but will not be realised. By-products are commonly handled using an NRV offset to reduce the main product’s cost, while joint products require joint-cost allocation at split-off for reporting. Further processing decisions are made using incremental analysis, ignoring sunk joint costs.

Glossary

Process costing
A costing approach used where production is continuous and units are similar, accumulating costs by process and averaging them over output.

Normal loss
Expected production loss under efficient operating conditions, absorbed into the cost of good output.

Scrap proceeds (scrap value)
Cash (or receivable) from selling units lost as normal loss, credited to the process to reduce the net cost allocated to good output.

Abnormal loss
Loss above the normal expected level, recorded separately and transferred to profit or loss (net of any scrap proceeds).

Abnormal gain
A favourable outcome where actual loss is less than normal loss. It is recorded separately and includes a scrap-value adjustment because scrap proceeds expected on the “saved” units will not arise.

By-product
An incidental secondary output of relatively low value compared with the main product, often accounted for using practical methods such as an NRV offset.

Joint products
Two or more significant outputs produced together up to a split-off point, requiring joint-cost allocation for inventory valuation and reporting.

Split-off point
The stage where joint outputs become separately identifiable and can be sold or processed further independently.

Further processing
Additional work after split-off intended to increase a product’s selling value.

Incremental analysis
A decision method comparing additional revenues and additional post–split-off costs arising from a choice, ignoring sunk costs such as joint costs incurred before split-off.