Normal and abnormal loss in consignment

Normal loss – meaning and treatment

Normal loss occurs majorly due to natural causes like drying, evaporation, leakage, shrinkage or perishing a few items due to handling goods in bulk quantities. It is an unavoidable or inevitable loss and we cannot avoided it by any effort.

Normal losses are mostly related to the nature or type of the goods being handled or moved from one place to another. These losses are highly expected in many industries and generally have a higher degree of acceptance as compared to abnormal losses.

In consignment, the normal loss is ignored which means its value is absorbed by remaining good units in the stock. For example, A consigns 1,000 units of goods costing $9,500 to B. The per unit cost of consignment is $9.5 (= $9,500/1,000 units). Suppose a normal loss of 50 units occurs and consignee receives 950 units. The increased per unit cost after normal loss would be $10 (= $9,500/950 units) and the stock on consignment would be valued using this new unit cost.

The students should remember the following two points while accounting for the normal loss in a consignment problem or assignment:

  • If all the goods have been sold and nothing remains unsold in the stock, the normal loss does not require any treatment.
  • If all the goods have not been sold and there remain some unsold units in the stock, the value of stock should be calculated using the following formula:

Example

On 1st September, 2020, Dravid sent 1,000 kgs of goods costing $30,000 to Sunny on consignment basis. Dravid incurred the following expenses for sending the goods:

  • Loading: $200
  • Insurance: $150
  • Freight: $300

Sunny’s expenses regarding consignment were as follows:

  • freight and insurance: $250
  • Godown rent: $100
  • Selling expenses: $400

Sunny sold 800 kgs for $45,000. His ordinary commission was 10% on gross sale proceeds. No del credere commission was allowed to him.

The consignee observed a loss of 10 kgs which was quite natural and was to be treated as normal.

Required: Prepare a consignment account in the books of Dravid. The detailed calculation of closing stock on consignment should be the part of your answer.

Solution

*Calculation of stock on consignment:
= (Value of goods before normal loss/Quantity received after abnormal loss) × Unsold stock
= [($30,000 + $200 + $150 + $300 + $250)/990] × 190
= $5,930 approx.

Abnormal loss – meaning and treatment

The abnormal loss is avoidable in nature and generally arises due to reasons like fire, theft, accident or flood etc. In consignment, the value of abnormal loss is charged to profit and loss account and not to consignment account. The consignment account, in fact, is given a credit for the value of abnormally lost units so that true profit or loss of consignment can be computed.

In consignment accounting, the abnormal loss is generally handled using one of the two methods discussed below:

Method 1

1. Journal entry if the goods are not insured:

Profit and loss A/C [Dr]
Consignment A/C [Cr]

2. Journal entry if the goods are fully insured:

Insurance claim A/C [Dr]
Consignment A/C [Cr]

3. Journal entry if the loss is more than the compensation given by insurance company:

Profit and Loss A/C [Dr]
Insurance claim A/C [Dr]
Consignment A/C [Cr]

4. Journal entry when the amount of claim is received from insurance company:

Bank A/C [Dr]
Insurance claim [Cr]

Method 2

Under second method, the abnormal loss is dealt through a special account known as “abnormal loss account”. When abnormal loss occurs, its entire value is transferred to abnormal loss account. The journal entries under this method are as follows:

1. Journal entry to transfer the loss to abnormal loss account:

Abnormal loss A/C [Dr]
Consignment A/C [Cr]

2. Journal entry to close the abnormal loss account if goods are not insured:

Profit and loss A/C [Dr]
Abnormal loss A/C [Cr]

3. Journal entry to close the abnormal loss account if goods are fully insured:

Insurance claim A/C [Dr]
Abnormal loss A/C [Cr]

4. Journal entry if the loss is more than the compensation given by insurance company:

Profit and Loss A/C [Dr]
Insurance claim A/C [Dr]
Abnormal loss A/C [Cr]

5. Journal entry when the amount of claim is received from insurance company:

Bank A/C [Dr]
Insurance claim [Cr]

Formula for calculating abnormal loss

For computing the value of abnormal loss in consignment, we first need to compute the total cost of goods just before the occurrence of abnormal loss. It is done as follows:

After the total cost of goods before abnormal loss has been obtained using above procedure, the value of abnormal loss can be calculated by applying the following formula:

Consider the following example:

Example

A consigned 1,000 packets of coffee costing $50,000 to B. A paid $700 for freight and $300 for insurance. While the goods were on their way to consignee, an accident occurred which completely destroyed 100 packets. B received the delivery of remaining 900 packets and transported them to godown. B paid $600 as clearing charges, $400 as freight and insurance, $150 as godown rent and $200 as selling expenses. 800 packets were sold @ $75 per packet and 100 packets were in stock.

Required: Calculate the value of abnormal loss and the value of stock on consignment.

Solution

1. Calculation of abnormal loss:

Value of abnormal loss = ($51,000/1,000) × 100
= $5,100

The cost or value of 100 abnormally lost packets are $5,100.

2. Calculation of stock on consignment:

Value of stock on consignment = (46,900/900) × 100
= $5,289 approx.

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