Loss – the ‘Fated’ Part of Business
Dreading fear creeps over us when we hear ‘loss’. Business individuals too are alarmed with this term of ‘loss’. While this has to be scripted in our mind that loss is an inevitable part of any business. Thus, precautions and care are to be taken to avoid the loss or reduce the effect of any loss. In this context, we will be discussing a type of loss in business which is known as - ‘Normal and Abnormal loss’.
We will righty understand Normal and Abnormal Loss in case of Consignment. We will also study some problems where the accountability of such loss will be charged in the books of accounts. In a short we can say, it will be an interesting concept to grasp for the Commerce students.
What is Consignment? – Normal and Abnormal Loss in Consignment
Normal loss and abnormal loss are losses that may occur during consignment. So, what is Consignment?
Well, consignment is the act of sending the goods by the manufacturers or producers to their agents for the sale of goods. The person sending the goods is called a Consignor (the manufacturer or producer) and the agent who receives the goods is called a Consignee. Let’s understand in detail the nature of normal and abnormal loss.
Normal and Abnormal Loss – Concept in Detail
Goods sent on consignment do not become the property of the consignee since only the possession of goods is transferred during consignment. The ownership of goods stays with the consignor until the goods are sold. These goods are recorded as inventory in the books of the consignor and not the consignee.
It is the responsibility of the consignee to sell the goods according to the instructions of the consignor. Once the goods are sold, the consignee deducts his expenses and commission from the sale proceeds and remits the balance to the consignor. If the consigned goods are destroyed, the consignee is not held responsible. The consignor has to bear the burden of the loss.
There are two types of losses in consignment: Normal Loss And Abnormal Loss.
Let’s look at them in detail to know the normal loss and abnormal loss differences.
1. Normal Loss
Normal loss is an inherited loss that cannot be avoided. It should be taken into account while valuing the closing stock. For instance, if a consignment of fruits is sent, some of them will be destroyed in loading and unloading while some fruits will not be in a state to be sold. No entry is recorded for normal loss in the books.
Examples of Normal Loss are – Evaporation, Leakage, Breakage, Loss of goods in transit, Reduced Demand.
To find the cost per unit after the normal loss, the formula used is:
Cost per Unit= (Total cost+ Expense incurred) / (Total Quantity - Normal Loss)
2. Abnormal Loss
The meaning of abnormal loss is any accidental loss to the consigned goods or loss caused by carelessness. Examples of such losses are loss by theft or loss by fire, earthquake, flood, accidents, war, loss in transit, etc. Such losses are considered abnormal. Sometimes businessmen take an insurance policy for the goods sent or received. Such a policy can only be taken for the coverage of abnormal loss caused to goods.
How is Abnormal Loss treated in Accounting?
Let us find out how abnormal loss is being treated if a business incurs any.
If a part of goods is stolen, it will reduce the value of stock and in turn, will also reduce the profit on consignment.
The first step is to calculate the cost of goods that are lost.
The consignment account is credited with this value and the abnormal loss account is debited.
It is then transferred to the profit and loss account to arrive at the correct profit or loss of consignment.
Solved Problems based on the Losses
Solved Example for Normal Loss in Process Costing
1. A consignment of 10,000 mangoes was sent to the consignee at ₹60 per kg and freight of ₹50,000. The normal loss is considered to be 10%.
Ans: Cost per kg = (600,000 + 50,000) / 9,000 = ₹ 72
(10000 −10% loss) = 9,000
If the unsold quantity is 500 its value will be = 500 × 72 = ₹ 36,000
Solved Examples for Abnormal Loss Account
1. In the Case of Irrecoverable Loss:
2. In the Case of Insured and Recoverable Loss:
(a) When the Full Amount is Recoverable
b) When the Loss is Partly Recoverable
FAQs on Normal vs. Abnormal Loss: Differences Explained
1. What is the main difference between normal and abnormal loss in accounting?
The main difference lies in their cause and predictability. Normal loss is an unavoidable loss that occurs due to the inherent nature of the goods or production process, like evaporation or spoilage. It is expected and considered part of the cost of goods. In contrast, abnormal loss is an unexpected loss that happens due to accidents, negligence, or theft. It is avoidable and is not included in the cost of goods; instead, it's treated as a separate expense.
2. Can you provide a simple, real-world example of both normal and abnormal loss?
Certainly. Imagine a truck transporting 1,000 litres of petrol.
- A normal loss would be the 5-10 litres that evaporate during transit due to heat. This is expected and unavoidable.
- An abnormal loss would be if 200 litres were lost because the truck's tank had a leak that wasn't fixed, or due to an accident. This loss is unexpected and could have been prevented.
3. How is a normal loss accounted for in the books?
A normal loss does not require a separate journal entry. Instead, its cost is absorbed by the remaining 'good' units of stock. This effectively increases the per-unit cost of the goods that are in good condition. For example, if the total cost of 100 units is ₹1,000 and 10 units are lost normally, the remaining 90 units are valued at ₹1,000, making the cost per unit higher.
4. Why is abnormal loss treated differently and charged to the Profit & Loss Account?
Abnormal loss is charged to the Profit & Loss Account because it represents a financial loss to the business that is not related to the normal cost of production or operations. It arises from inefficiency, accidents, or other preventable causes. By recording it separately, a business can accurately track and analyse these unexpected losses to improve its operations, and it ensures that the cost of goods is not artificially inflated by non-operational issues.
5. How does identifying a normal loss help in determining the true cost of a product?
Identifying normal loss is crucial for accurate costing. By accepting that some loss is inherent to the process, its cost is spread over the saleable units. This ensures the selling price of the good units is set high enough to cover the cost of both the good units and the units that were naturally lost. It gives a more realistic valuation of inventory and helps in determining a product's true profitability.
6. In accounting, are 'normal loss' and 'normal wastage' the same thing?
While often used interchangeably, there can be a subtle difference. Normal loss often refers to a reduction in quantity or weight (like evaporation). Normal wastage or 'scrap' typically refers to the residue from a manufacturing process (like metal shavings or fabric cut-offs). However, in terms of accounting treatment, they are handled similarly: the cost is generally absorbed by the good units produced.
7. If there can be an abnormal loss, can there also be an abnormal gain?
Yes, there can be. An abnormal gain is the opposite of an abnormal loss. It occurs when the actual loss is less than the expected normal loss, or when the actual output is more than the expected output from a given amount of input. For example, if the normal loss in a process is 10% but due to high efficiency, only 5% is lost, the 5% difference results in an abnormal gain. It is treated as an income and is credited to the Profit & Loss Account.
8. Why is it so important for a business to distinguish between these two types of losses?
Distinguishing between normal and abnormal loss is vital for several reasons:
- Accurate Costing: It prevents the cost of inventory from being distorted by accidents or inefficiencies.
- Performance Measurement: It helps management identify and control operational problems that lead to abnormal losses.
- Correct Profit Calculation: It ensures that only operational costs are part of the cost of goods sold, providing a true picture of gross profit.
- Insurance Claims: Abnormal losses can often be covered by insurance, whereas normal losses cannot.
