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 recycled paper with virgin (new) pulp material. The combination of virgin pulp and recycled is sent to the paper machine for papermaking. Broke is fed into this recycle process continuously from all over the facility.
In the industry, it is typical to charge the papermaking operation with the cost of direct materials, which is a mixture of virgin material and broke. Broke has a much lower cost than does virgin pulp. Therefore, the more broke in the mixture, the longer the average cost of direct materials to the department. Papermaking managers will frequently comment on the importance of broke for keeping their direct materials cost down.
How do you react to this accounting procedure?
What “hidden costs” are not considered when accounting for broke as described?