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