Losses/Idle Time/Rejects/Waste

When budgeting one must take into account that not everything that goes in comes out as finished product.

That’s an issue in Process Costing when there are regularly losses during the process.

Think when you are cooking how much steam is produced – that’s water that’s not going to be in the final meal, think about the food left in the pan – that’s food that isn’t going to be in the final meal.

Factories have the equivalent.

In the same way that you can’t get all of the ketchup out of the bottle, the pipes in the factory making ketchup will have ketchup within them.

This is all taken into account in process costing and generally is entirely predictable.

Idle Time

However hard you work, you are not going to be completely productive every minute of your 40 hour working week.

That’s not to suggest that you are being lazy. There’s a whole host of things that will slow you down. 

Setting up the machine.

Cleaning the machine.

Going to get materials.

The machine is broken.

A meeting.

Going to the toilet.

You will be able to think of many more.

Because we know people can’t be 100% effective we can’t say that someone working a 40 hour week making a product that needs 2 labour hours is going to make 20 units. It just isn’t possible.

To work out how many people we need to make 100 units in a week we need to take the time into account (2 hours per unit), but also the idle time/effectiveness we would expect per employee.

100 units requires 200 hours at 40 hours per person = 5 people this week. Theoretically.

What if effectiveness is 90% though? That’s an Idle Time of 10%.

We do the calculation by recalculating how many hours we need staff for (paid hours) rather than how many hours a person does.

So we need 200 hours of good work to make 100 units. We also need to factor in the 10% idle time.

Wrong Method. 200 x 1.1 = 220 hours required. NO!

In case you don’t believe me about this being wrong.

22o – 10% (22 hours) = 198 hours. That’s not enough. We needed 200 hours.

Correct Method.

We need 200 good hours after we have lost 10% of the time.

That means that all the time needed is 100%. That’s all the hours we need to pay for.

The time lost is 10% of all the time.

That the actual hours we make the product is 90% of all the time.

So, in this example, 200 hours = 90% of all the time required.

200/90 x 100 = all the time we need to get the work done.

222.22 hours required and need to be paid for.

10% lost = 22.22 hours.

Worked hours = 200.

We divide 222.22 (let’s say 223 hours) by 40 per week to get 5.575 employees needed to get the work done.

Materials lost in manufacturing.

It’s the same approach.

Say you lose 5% of material in manufacturing, then you need more material to start with than in the final product. Think sawdust when we cut wood for the tables.

If it is standard production, you will be able to work out what percentage of the materials used doesn’t end up in the finished product.

So if we need 100 metres of wood in the final product and 5% is lost in sawdust, we are going to need more than 100 metres of wood to start with.

100% – 5% = 95%

The 100 metres we need is therefore 95% of all the wood.

100/95 x 100 = 105.26 metres of wood required. You need to budget for the cost of 105.26 metres of wood rather than 100 metres.

105.263 might sound daft, but I’ve used a simple example to illustrate the principle.

Rejects.

If your product doesn’t meet certain standards, you won’t be able to sell it. You won’t know though until you have the product sitting in front of you. (Yes, in some scenarios, you might be able to identify rejects at stages of production. The principle is the same).

You probably, from experience, know what percentage of production, that is likely to be.

What if 8% of your televisions weren’t at a high enough standard to sell? If you want to make 80 good ones a day, you will need to make more than 80.

100% – 8% = 92% of televisions are saleable.

80 therefore = 92% of all the ones you need to make.

80/92 x 100 = you need to make 86.95 televisions. Well, in reality, you need to make 87.

You will need to budget to make those 87 to be able to sell 80.

You can see therefore that real budgeting needs to take into account the cost of materials that won’t be in the final product, the time that people are being paid but not actually making the product and the cost of units produced that aren’t good enough to sell.

Reading.

Items that may help your understanding.