Normal Spoilage
Normal spoilage refers to the inherent worsening of products during the production or inventory processes of the sales cycle. The normal spoilage rate is calculated at 2% (two units of normal spoilage / 100 units produced). The firm will include this 2% spoilage rate in with its cost of goods sold (COGS), although the widgets were not actually sold. The normal spoilage rate is calculated by dividing the units of normal spoilage by the total units produced. Companies typically set a normal spoilage rate for lines of products which they produce and assign the costs of such spoilage to cost of goods sold (COGS). The COGS is deducted from net sales revenue to arrive at the gross margin, so normal spoilage is accounted for in a product line's gross margin.
What Is Normal Spoilage?
Normal spoilage refers to the inherent worsening of products during the production or inventory processes of the sales cycle. This is the deterioration of a firm's product line that is generally considered to be unavoidable and expected. For commodity producers, this is the natural resource that is lost or destroyed during extraction, transportation, or inventory. Companies typically set a normal spoilage rate for lines of products which they produce and assign the costs of such spoilage to cost of goods sold (COGS).
How Normal Spoilage Works
Normal spoilage occurs for companies operating in any sort of manufacturing or production environment. They will inevitably see at least part of their production line wasted or destroyed during extraction, manufacturing, transporting, or while in inventory. Consequently, firms will use historical data along with some forecasting methods to produce a number or rate of normal spoilage to account for such losses. The expenses incurred due to normal spoilage are often included as a portion of the COGS.
Example of Normal Spoilage
The normal spoilage rate is calculated by dividing the units of normal spoilage by the total units produced. For example, assume a firm produces 100 widgets per month. Historically, two of those widgets have not been up to standards. The normal spoilage rate is calculated at 2% (two units of normal spoilage / 100 units produced).
The firm will include this 2% spoilage rate in with its cost of goods sold (COGS), although the widgets were not actually sold. That is because this amount is the normal and expected rate of spoilage in this firm's typical course of business. The COGS is deducted from net sales revenue to arrive at the gross margin, so normal spoilage is accounted for in a product line's gross margin.
Normal Spoilage vs. Abnormal Spoilage
Abnormal spoilage, which is considered avoidable and controllable, is charged to a separate expense account that will show up on a line item further down the income statement. It, therefore, has no impact on gross margin. It is important for investors and other financial statement users to be able to quickly identify the expenses incurred due to abnormal spoilage, since is not expected as part of a normal course of business.
Related terms:
Abnormal Spoilage
Abnormal spoilage is the amount of waste or destruction of inventory beyond what is expected in normal business processes. read more
Absorption Costing
Absorption costing is a managerial accounting method for capturing all costs associated with the manufacture of a particular product. read more
Accounting
Accounting is the process of recording, summarizing, analyzing, and reporting financial transactions of a business to oversight agencies, regulators, and the IRS. read more
Berry Ratio
The Berry ratio measures a company's gross profit to operating expenses. Used in transfer pricing methods, this ratio is a financial indicator. read more
Cost of Goods Sold – COGS
Cost of goods sold (COGS) is defined as the direct costs attributable to the production of the goods sold in a company. read more
Gross Margin
The gross margin represents the amount of total sales revenue that the company retains after incurring the direct costs (COGS) associated with producing the goods and services sold by the company. read more
Gross Profit
Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of providing its services. read more
Income Statement : Uses & Examples
An income statement is one of the three major financial statements that reports a company's financial performance over a specific accounting period. read more
Inventory Management
Inventory management is the process of ordering, storing and using a company's inventory: raw materials, components, and finished products. read more