Steel Signs Limited produces roadside signs using two separate processes. The company has recently employed a new CFO, Bob Chen, who previously worked in the service industry and is unfamiliar with some of the issues arising in manufacturing operations. In particular, Mr Chen is concerned about the level of spoilage and wants advice on how this could be better managed. The company’s production processes are split into two separate departments. The Fabrication Department produces the blank signs (“the units”), where steel sheeting is cut into the required shapes and steel posts are welded to the signs. These blank units are then transferred to the Finishing Department, which prints the required signage onto the units and then fires them to set the paint finish.

The production process in the Fabrication Department is illustrated below. Conversion costs are added evenly through-out the production process:

Addition of steel (0%) --- Addition of steel posts (80%) --- Inspection (85%) --- Completion (100%) --- Transfer out of unit (At end)

The production process in the Finishing Department is illustrated below. Conversion costs are also added evenly through-out this production process:

Transfer in of units (At start) --- Addition of paint (30%) --- Inspection (90%) --- Packaging of units (95%) --- Completion (100%)

At the start of September 2018 the Fabrication Department had 275 partially finished units that were 90% complete. During the month 2,200 units were completed and transferred to the Finishing Department and the ending work-in-progress was 250 units, 75% complete. The total spoilage for the month was 210 units, and normal spoilage is 2% of the good units passing inspection in the current month, on average.

The costs for the Fabrication department are collated below:

Costs	Fabrication Department
Opening work-in process:
Steel	$6,180
Steel posts	$4,125
Direct Labour	$1,000
Overheads	$1,200
Costs added during October:
Steel	$60,000
Steel posts	$25,000
Direct Labour	$8,300
Overheads	$10,200

The Finishing Department had 260 units 25% complete at the start of the period. During the month 2,300 good units were completed and transferred to finished goods, and closing work-inprogress was 30 units, 50% complete. Normal spoilage is 5% of the good units passing inspection in the current month, on average

A summary of the costs in the Finishing Department has been provided below:

Costs	Finishing Department
Opening work-in process
Transferred-in costs	$11,500
Direct Labour	$600
Overhead Costs	$600
Costs added during October:
Transferred-in Costs	???
Paint	$12,500
Packaging	$5,000
Direct Labour	$25,000
Overhead Costs	$27,000

Required:

Taking the role of the management accountant for the company:

Your CFO, Bob Chen, doesn’t understand why spoilage is included in the process costing report and, in particular, asks you “why don’t we just eliminate the spoilage?” and “what do we do with all these spoiled units?”.

Prepare a memo for Mr Chen that explains how normal and abnormal spoilage is treated in process costing. Discuss why spoilage arises in the production process and why the targeted normal spoilage is not, usually, 0%. Include in your discussion, a consideration of how the normal spoilage percentage is determined and what procedures need to be put in place to monitor the levels of spoilage. Highlight for the CFO when corrective action should be taken in managing spoilage. Finally, discuss what happens to the spoiled units once they have been identified and how this does or does not affect the process cost report.