Question

Distinguish between normal loss and abnormal loss with examples.what procedure is followed for valuation of closing stock when the abnormal and normal losses occur simultaneously?

Answer 1

Normal Loss:

Loss of quantity of goods in the normal course of business and inherent and thus inevitable or unavoidable, such as loss because of loading and unloading of goods, leakage, evaporation or shrinkage is known as normal loss.

The treatment of normal loss is to charge it to consignment account. The total cost of goods sent is charged to the units remaining. Value of stock is inflated to cover the normal loss. In other words such loss is absorbed by the remaining units.

Example:

2000 radio sets are consigned @ $300 per radio set. Freight being $1000. Due to a normal loss only 1960 radio sets  are received by the consignee. If 500 radio sets are in stock (i.e unsold sets), the value of closing stock would be calculates as follows:

No separate entry is made in the books of consignor in case of normal. such loss is considered while calculating the cost of stock left unsold with the consignee. The value of unsold stock on consignment is increased because the value of stock is the proportion of the cost of the goods consigned and direct expenses that the quantity of stock bears to the total quantity of goods consigned as diminished by the normal loss of goods. In brief, valuation of stock will be made:

Abnormal Loss:

This type of loss is an avoidable loss because it does not arise due to the nature of the goods. Such loss may arise due to hard luck of consignor (i.e. destruction of goods by fire, an accident or theft). Such losses are more or less abnormal and, in any case, do not occur frequently. This type of loss does not effect the value of goods and if part of the consignment has been lost in such a manner, one should debit the value of the goods lost to abnormal loss account/profit and loss account. and credit the consignment account so that one may judge the profitability of the consignment properly. In case, if this loss is ignored like normal loss, the the profit shown by the consignment account will be lower than what it would have been, had the loss not occurred. So, we let the consignment account show the same result as the loss had not been taken place. On the preparation of the final accounts of the business (trading and profit and loss account), this loss is finally shown on the debit side of the profit and loss account being a loss of the business as a whole.