Absorption of Losses

Absorption

Meaning

Take up, as of debts or payments
Assimilate or take in

Absorption of Losses

A credit in a nominal account for ascertaining profits like the Trading and Profit and Loss account which represents a transfer of debit balance to some other nominal account (holding profits kept aside or losses) is said to be an absorption of loss.

Example

Transfer of loss to Contingency Reserve.

Journal in the books of ___ for the period from ___ to ___
Date	R/V No.	Particulars		L/F	Amount
Date	R/V No.	Particulars		L/F	Debit	Credit
—	—	Contingency Reserve a/c To Profit and Loss a/c	Dr.	- -	15,000	15,000
—	—	[For the amount of loss transferred to contingency reserve.]		- -	15,000	15,000

Ledger Show

Dr	Profit and Loss a/c	Cr

Particulars

Amount

Particulars

Amount

...
...

By Contingency Reserve a/c

14,000

Dr	Contingency Reserve a/c	Cr

Particulars

Amount

Particulars

Amount

To Profit & Loss a/c

14,000

Profit and Loss account will have a credit balance when there are profits. Transfer of loss i.e. debit balance from the profit and loss account to the Contingency Reserve account will result in the Contingency Reserve account being debited and the Profit and Loss account being credited.

Transfer of debit balance from one account to a second results in the second being debited, thereby reducing the credit balance (or increasing the debit balance) in the second account.

Effect of absorption on Net Loss

The absorption of loss would increase the available profits or reduce the existing loss.

When there is no absorption to Contingency Reserve

Dr	Profit and Loss a/c	Cr

Particulars

Amount

Particulars

Amount

To Rent
To Salaries
To Interest
To Taxes
To Depreciation
To Net Profit

2,50,000
4,50,000
12,40,000
14,00,000
2,10,000
18,50,000

By Gross Profit

54,00,000

When loss has been absorbed by the contingency reserve

Dr	Profit and Loss a/c	Cr

Particulars

Amount

Particulars

Amount

To Rent
To Salaries
To Interest
To Taxes
To Depreciation
To Net Profit

2,50,000
4,50,000
12,40,000
14,00,000
2,10,000
18,64,000

By Gross Profit
To Contingency Reserve

54,00,000
14,000

54,14,000

But for the absorption of loss by the contingency reserve, the net profit would have been Rs. 18,50,000.

Both accruals to profits and absorptions of losses result in a credit to the profit and loss account resulting in an increase in the available profit or a decrease in the existing loss.

Absorption would result in the loss being transferred to another account whereby we can say that the losses are being absorbed by multiple accounts instead of a single account.

Absorption is transfer from the profit and loss account and Accrual is transfer to the profit and loss account.

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