Normal Loss - Accounting Treatment

Recording Normal Loss

Particulars	Quantity (Units)	Value	Rate (per/Unit)
Gross Input − Normal Loss	1,000 100	1,00,000 100	100 1
Net Output	900	99,900	111

The rate column is always to be obtained as a quotient using the relation $\frac{Value}{Quantity}$ .
Net (Normal) Output Units = Gross Input Units − Normal Loss Units
Normal loss in quantity terms should be deducted from the gross input to obtain Net (Normal) Output.
Normal Cost = Total Cost − Normal Loss Realisation
Net realisable value of normal loss units should be deducted from the total cost to obtain Net (Normal) Cost of Output.

Gross input and total cost are debited to Process a/c. Deducting from gross input and from total cost amounts to deducting from the debit side of the Process a/c. Deducting from the debit side of process account is the same as crediting the Process a/c.

Therefore, Normal Loss both in terms of quantity and value is recorded by

Crediting Process a/c and
Debiting Normal Loss a/c

Units are also shown along with value in the relevant column.

Journal
Particulars		Amount (Dr)	Amount (Cr)
Normal Loss a/c To Process a/c	Dr	100	100
[For the value of normal loss.]		100	100

Ledgers

Process a/c
DrCr
Particulars	Quantity (in Units)	Amount	Particulars	Quantity (in Units)	Amount
			By Normal Loss a/c	100	100

Normal Loss a/c
Dr Cr
Particulars	Quantity (in Units)	Amount	Particulars	Quantity (in Units)	Amount
To Process a/c	100	100

Recovery of Normal Loss - Disposal/Sale

The value attributed to Normal loss is a notional value which is arrived at by taking its net realisable value as the basis. The value may be enhanced by incurring some expenses on it.

Where Normal loss has a physical presence, its value may be recovered or realised by sale or disposal for a consideration.

Having a physical presence is not a guarantee that normal loss units would be capable of being disposed for a consideration. Normally normal loss units which are not capable of being sold are valued at zero.

There may be instances where the normal loss units are attributed some value and are subsequently sold or disposed at a value that is different than the value attributed.

Normal Loss ≡ Asset

Assume that through the journal entry for recording Normal Loss we are creating an asset by name Normal Loss whose value is the notional value attributed to it. The actual value realised by sale or disposal for a consideration of this asset may be more than, less than or equal to its notional value.

Thus, on disposal of normal loss units there may be a Gain or Loss or Neither Gain nor Loss

In most cases of problem solving, no mention is made regarding the value at which the normal loss units are sold or disposed. In such cases we assume that they are disposed off at the same value that is attributed to them, thereby leaving neither profit nor loss.

Expenses on Normal Loss Stock

There may be cases where some expenditure is incurred on the normal loss stock in making it saleable. Such expenses would go into the value of the asset, normal loss and are debited to the Normal Loss a/c.

Journal
Particulars		Amount (Dr)	Amount (Cr)
Normal Loss a/c To Cash a/c	Dr	400	400
[For the expenses on normal loss stock]		400	400

Ledgers

Normal Loss a/c
Dr Cr
Particulars	Quantity (in Units)	Amount	Particulars	Quantity (in Units)	Amount
To Process a/c To Cash a/c	100	100 400

The expenditure incurred would increase the value of the asset, normal loss, after the asset has been created. It should not be added up to the notional value at which the asset is valued at the time of its creation.

The value of normal loss after capitalising such expenses should be considered in assessing the profit or loss on disposal of the normal loss stock.

Insurance Realisation

Consider the following notional data relating to an insurance policy issued by an insurance company for loss on theft.

a) Insurance premium per policy
b) Value Insured per policy
c) Number of policies sold
d) Total premium collected (a) × (c)
e) Claims received
f) Total amount paid on claims
g) Surplus (d) − (f)

200
100,000
50,000
100,00,000
500
80,00,000
20,00,000

Contract of Indemnity

A contract of general insurance (not life insurance) is a contract of indemnity.

Indemnify

Secure against future loss, damage, or liability
Pay compensation for
compensate
insure
repair

The contract amounts to the insurance company saying we will make good the loss you incur on the contingency of a theft subject to a maximum of the policy value. It does not mean that we will pay you the policy value on the occurrence of the event.

Contingency

A possible event, occurrence or result
eventuality

In the above example, the payout if full for the 500 claims would be 500,00,000. The payout being 80,00,000 indicates that not all claims are paid out in full.

Insurance possible only for probable events

General insurance is offered only for events which may probably occur. The insurance company would have to pay up only if the event takes place. If the event does not occur the insurance company would benefit as it need not pay anything.

The insurance company would be making maximum profit when there are no claims. The more the claims the less the profit it makes. If all the insured are going to file a claim, then there is no scope for the insurance company to make a profit. It would be like making a promise that they will repay 1,00,000 within a year if the insured pays 500 now.

The premium charged for insuring is also set by the insurance company based on the probability of the event occurring, an estimate of the number of policies it can sell and number of claims that it anticipates to receive during the insured period.

Normal Loss is a certainity

The event of sustaining normal loss is a certainity and not a probability. If the insurance company insures loss on account of normal loss, then 100% of the insured would be filing a claim.

Thus, we cannot think of insurance for normal loss. when we talk of insurance of loss, we mean abnormal loss and not normal loss.

Profit on Disposal/Sale of Normal Loss Stock

Normal Loss - 100 units of value 100 valued at 1/unit
Sale of 80 units at 1.50/unit

Total sale proceeds

=	units sold × selling price per unit
=	80 units × 1.50/unit
=	120

Cost value of units sold

=	units sold × value per unit
=	80 units × 1/unit
=	80

Profit on sale

=	Sale value − Cost value
=	120 − 80
=	40

Balance

=	Normal Loss Units − Units sold
=	100 − 80
=	20

Value of Balance

=	Balance units × value/unit
=	20 × 1
=	20

Journal
Particulars		Amount (Dr)	Amount (Cr)
Bank a/c To Normal Loss a/c	Dr	120	120
[For the sale of 80 units of normal loss stock]		120	120
Normal Loss a/c To Costing Profit & Loss a/c	Dr	40	40
[For the profit on sale of normal loss stock]		40	40

In recording the transaction for sale,

under integrated accounting
- Cash a/c would be debited if the sale is for cash.
- Debtors a/c would be debited if the sale is on credit.
under cost ledger accounting
- General Ledger Adjustment a/c would be debited, whether the sale is made for cash or for a cheque or on credit.

Ledgers

Normal Loss a/c
Dr Cr
Particulars	Quantity (in Units)	Amount	Particulars	Quantity (in Units)	Amount
To Process I a/c To Costing P&L a/c	100 –	100 40	By Cash/Bank/Drs a/c By balance c/d	80 20	120 20
	100	140		100	140
To balance b/d	20	20

Costing Profit & Loss a/c
Dr Cr
Particulars	Amount	Particulars	Amount
		By Normal Loss a/c	40

Note

Crediting the sale value and balancing the Normal Loss a/c would leave the profit or loss as the balancing figure.
Since only 80 units are sold, the value of the other 20 units would be retained in the Normal Loss a/c, till they are disposed.
At the end of the accounting period, these would be shown in the balance sheet as assets or by making any other appropriate adjustments to stock values.
The two entries for recording the sale and profit can be combined into a single compound entry.
Journal
Particulars Amount
(Dr) Amount
(Cr)
Cash/Bank a/c
To Normal Loss a/c
To Costing Profit & Loss a/c
Dr 120
80
40
[For the sale of normal loss stock and the profit thereon]

Journal
Particulars	Amount (Dr)	Amount (Cr)
Cash/Bank a/c To Normal Loss a/c To Costing Profit & Loss a/c	Dr	120	80 40
[For the sale of normal loss stock and the profit thereon]

Loss on Disposal/Sale of Normal Loss Stock

Normal Loss - 100 units of value 100 valued at 1/unit
Sale of 90 units at 0.80/unit

Total sale proceeds

=	units sold × selling price per unit
=	90 units × 0.80/unit
=	72

Cost value of units sold

=	units sold × value per unit
=	90 units × 1/unit
=	90

Loss on sale

=	Cost value − Sale value
=	72 − 90
=	18

Balance

=	Normal Loss Units − Units sold
=	100 − 90
=	10

Value of Balance

=	Balance units × value/unit
=	10 × 1
=	10

Journal
Particulars		Amount (Dr)	Amount (Cr)
Bank a/c To Normal Loss a/c	Dr	72	72
[For the sale of 90 units of normal loss]		72	72
Costing Profit & Loss a/c To Normal Loss a/c	Dr	18	18
[For the loss on sale of normal loss stock]		18	18

Ledgers

Normal Loss a/c
Dr Cr
Particulars	Quantity (in Units)	Amount	Particulars	Quantity (in Units)	Amount
To Process I a/c	100	100	By Bank a/c By Costing P&L a/c By balance c/d	90 10	72 18 10
	100	100		100	100
To balance b/d	10	10

Costing Profit & Loss a/c
Dr Cr
Particulars	Amount	Particulars	Amount
To Normal Loss a/c	18

Note

Crediting the sale value and balancing the Normal Loss a/c would leave the profit or loss as the balancing figure.
Since only 90 units are sold, the value of the other 10 units would be retained in the Normal Loss a/c, till they are disposed.
At the end of the accounting period, these would be shown in the balance sheet as assets or by making any other appropriate adjustments to stock values.
The two entries for recording the sale and loss can be combined into a single compound entry.
Journal
Particulars Amount
(Dr) Amount
(Cr)
Cash/Bank a/c
Costing Profit & Loss a/c
To Normal Loss a/c
Dr
Dr 72
18

90
[For the sale of normal loss stock and the loss thereon]

Journal
Particulars	Amount (Dr)	Amount (Cr)
Cash/Bank a/c Costing Profit & Loss a/c To Normal Loss a/c	Dr Dr	72 18	90
[For the sale of normal loss stock and the loss thereon]

No Gain/Loss on disposal/sale of Normal Loss Stock

Normal Loss - 100 units of value 100 valued at 1/unit
Sale of 60 units at 1/unit

Total sale proceeds

=	units sold × selling price per unit
=	60 units × 1/unit
=	60

Cost value of units sold

=	units sold × value per unit
=	60 units × 1/unit
=	60

Balance

=	Normal Loss Units − Units sold
=	100 − 60
=	40

Value of Balance

=	Balance units × value/unit
=	40 × 1
=	40

Journal
Particulars		Amount (Dr)	Amount (Cr)
Bank a/c To Normal Loss a/c	Dr	60	60
[For the sale of 90 units of normal loss]		60	60

Ledgers

Normal Loss a/c
Dr Cr
Particulars	Quantity (in Units)	Amount	Particulars	Quantity (in Units)	Amount
To Process I a/c	100	100	By Bank a/c By balance c/d	60 40	60 40
	100	100		100	100
To balance b/d	40	40

Note

Crediting the sale value and balancing the Normal Loss a/c would leave the profit or loss as the balancing figure.
Since only 60 units are sold, the value of the other 40 units would be retained in the Normal Loss a/c, till they are disposed.
At the end of the accounting period, these would be shown in the balance sheet as assets or by making any other appropriate adjustments to stock values.

Absorbing Value loss of Normal Loss units

In arriving at the cost of manufacturing a product or service, only normal costs are to be considered as being part of cost. Costs should not be influenced by abnormal natured losses and costs.

Value of losses should be eliminated from the total costs to ensure that costs include only normal costs.

All expenses/costs are debited to the process account. Eliminating a value/cost implies either deducting from the debit side or crediting the process account with the value.

Process I a/c
Dr Cr
Particulars	Quantity (in Units)	Amount	Particulars	Quantity (in Units)	Amount
To Input	1,000	1,00,000	By Normal Loss a/c By Balance c/d	100 900	100 99,900
	1,000	1,00,000		1,000	1,00,000
To balance b/d	900	99,900

Assume the Process a/c is being balanced after crediting Normal Loss. The value left in the Process a/c is the cost of 900 good units inflated by the value loss relating to normal loss units.

100 being the realisable value of normal loss is eliminated from the process account and the rest of the value of normal loss units i.e. 9,900 is absorbed by the good units in the process account.

The value loss (difference between cost value and realisable value) of normal loss units is considered to be a normal cost and as such has to be borne by the good output. Thus we eliminate only the realisable value of normal loss units from the total cost by crediting it to the process a/c.

Author : The Edifier

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