Suppose the following example:
900 units of material have been input into a production process at a total cost (material, labor, overheads) of Rs. 1,00,000 i.e. @ Rs. 100 per unit. 100 units of material has been lost in the production process. These 100 loss units would fetch a price of Rs. 1 per unit if sold in the market.
Considering the loss as abnormal
In such a situation, the cost incurred for getting an output of 800 units (900 - 100) can be interpreted in the following ways:
The cost incurred for 800 units is Rs. 80,000 (800 × 100)
The cost incurred for 800 units is Rs. 1,00,000 being the total cost incurred.
This would result in the unit output cost working out to Rs.125 (1,00,000 ÷ 800)
The cost incurred for 800 units is Rs. 99,900 (1,00,000 − 100) being the total cost incurred reduced by the amount realised on selling the loss units.
This would result in the unit output cost working out to Rs. 124.88 (99,900 ÷ 800)
Where the loss is abnormal, the first idea would be the most appropriate one for deciding the cost per unit of output.
This would give an idea how much would we be required to spend if we are to produce an output of 800 units again. If the loss is abnormal in nature, we need not assume its occurrence every time. Simply we introduce only 800 units the next time we need the 800 units of output.
Therefore the amount to be spent for getting an output of 800 units would be equal to the total cost relevant to 800 units i.e. Rs. 80,000.
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