Question
CP 3-2 Accounting for materials costs In papermaking operations for companies such as International Paper Company, wet pulp is fed into paper machines, which press and dry pulp into a continuous sheet of paper. The paper is formed at very high speeds (60 mph). Once the paper is formed, the paper is rolled onto a reel at the back end of the paper machine. One of the characteristics of papermaking is the creation of "broke" paper. Broke is paper that fails to satisfy quality standards and is therefore rejected for final shipment to customers. Broke is recycled back to the beginning of the process by combining the recycled paper with virgin (new) pulp material. The combination of virgin pulp and recycled broke is sent to the paper machine for papermaking. Broke is fed into this recycle process continuously from all over the facility 0 In this industry, it is typical to charge the papermaking operation with the cost of direct materials, which is a mixture of virgin materials and broke. Broke has a much lower cost than does virgin pulp. Therefore, the more broke in the mixture, the lower the average cost of direct materials to the department. Papermaking managers will frequently comment on the importance of broke for keeping their direct materials costs down. a. How do you react to this accounting procedure? What "hidden costs" are not considered when accounting for broke as de- scribed above?
Explanation / Answer
a. The accounting procedure for the papermaking operation towards the cost of direct materials used is the minimisation of cost of direct materials with an appropriate mixture of the virgin materials and broke (lower cost material to the virgin material).
Such accounting procedure will reduce the cost of Direct Materials of production while keeping a appropriate level of quality of output of paper. The composition of the mixture between the virgin materials and broke is important in such cost reduction procedure.
b. The use of the broke to reduce the cost of Direct Materials of production will involve certain additional costs which would be considered before using broke in the Material mix. These cost are:
1) Increase in manufacturing overhead of production : When lower grade of Materials like broke is used in production, the manufacturing overhead expense would be more.
2) New mixture machine : For the mixture of the virgin and broke materials, a new mixing machine could be required.
3) Extra labor : For the processing of the broke, some extra labor cost could be involved.
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