Input to a process was 5,000 litres at a total cost of $27,000. Normal loss is 10% of input and is sold as scrap for $1.50 per litre. Actual output transferred to finished goods was 4,620 litres. What is the NET effect of the abnormal gain on the profit for the period?

Correct answer: A) $520 increase

Explanation

Expected output = 5,000 x 90% = 4,500 litres, so there is an abnormal gain of 4,620 - 4,500 = 120 litres. Cost per litre of expected output = ($27,000 - 500 x $1.50) / 4,500 = $26,250 / 4,500 = $5.8333. The abnormal gain is valued at 120 x $5.8333 = $700 (credited to the abnormal gain account). However, because 120 litres less were actually lost, scrap income falls by 120 x $1.50 = $180. Net effect on profit = $700 - $180 = $520 increase.