Normal loss

Normal loss
See also
Purchase price variance Inventory in transit Net purchases Partial delivery Full Ratchet Insurable value Merchandise inventory Cycle stock Non recurring cost

The term of a normal loss determines loss which is passed-down and can not be escaped. It shall also be reflected on during the time of when the closing stock is valued. To estblish the cost per one good after the normal loss, we wil need to use undermentioned formula:

Cost per one good=(Expenses incurred+Total cost)/(Total quantity- Normal loss)

Normal loses during the regular method of production are inevitable. This includes such an example as lost in the weight of timber due to evaporation, scraps remaining after making an armchair as well as gold dust as an outcome of making a ring.No matter how much the sender of goods or receiver try this cannot be prevented. Thus, it is reckoned as a component of production cost.

An example of Normal loss

To understand better the concept of a normal loss here is an example: Hypothetically a vegetable seller buys a box of carrots containing 100 carrots for $95. One carrot costs 95 cents. Let's just say that 5% of the vegetables are damaged, it would not be correct to say that the cost per carrot is 95 cents. In reality, a vegetable seller is buying 95 carrots for 95 $ and that price for one carrot is $1 not 95 cents. In the case when the seller is charged 95 cents per apple and establishes selling price at 98, he will lose money when all carrots are vended at the price of 95 cents. Even though, one would think he earns 3 cents per carrot. That is why price should be established with regard to the $1 cost per carrot.Such an operation is named inflating the cost of the products. It is used to cover the normal loss of the products. Products that were not sold are also treated in the same. In addition to that, the same rule applies when goods on consignment are evaluated .

Abnormal loss

Abnormal loss happens when some unexpected situations occur such as lack of care, usage of inappropriate materials, fire, etc. As this situation shouldn't occur during regular actions of production, as an outcome, the cost is not charged in the product.

Accounting approaches for normal loss

The process of a loss might happen early in a process or while process. The process of a loss might also happen at the closing stages of a process. The time of existence the normal losses (damaged goods) is very important because it effects deciding which of the listed approaches should be considered in a process of accounting :

• First Approach- in this case, the cost of normal loss goods should be incorporated in the cost of all goods calculated as equivalent production.
• Second Approach- in this case, the cost of normal loss goods should be incorporated in the cost of all fine goods which have been completed and consequently the cost of normal loss goods will not be asked payment for closing work in progress.

Advantages of Normal loss

Normal losses are an unavoidable part of any business and can be beneficial when managed properly. The main advantages of normal losses include:

• Improved accuracy of inventory records: Normal loss provides a more accurate reflection of inventory levels, as it takes into account shrinkage, spoilage and expiration of product. This can help businesses to better estimate and prepare for future inventory needs.
• Cost savings: Because normal losses are taken into account when calculating the value of closing stock, businesses can save money by not having to pay for goods that have been lost or spoiled.
• Improved efficiency: By including normal losses in inventory records, businesses can better track and manage their resources, leading to improved efficiency in the long run.

Limitations of Normal loss

Normal losses can be limited in various ways, including:

• The amount of loss is limited by the item's original stock, meaning that the loss can not exceed the amount of the original stock.
• The amount of loss is limited by the actual value of the item at the time of the loss, meaning that the loss can not exceed the actual value of the item at the time of the loss.
• The amount of loss is limited by the amount of time the item has been in storage, meaning that the loss can not exceed the amount of time the item has been in storage.
• The amount of loss is limited by the amount of time the item has been in use, meaning that the loss can not exceed the amount of time the item has been in use.
• The amount of loss is limited by the amount of money spent to acquire the item, meaning that the loss can not exceed the amount of money spent to acquire the item.
• The amount of loss is limited by the amount of money spent to maintain the item, meaning that the loss can not exceed the amount of money spent to maintain the item.

Other approaches related to Normal loss

The following are some other approaches related to Normal Loss:

• Standard Costing: This method of accounting is used to value inventory and cost of goods sold. It is based on predetermined costs based on past experience and uses a normal loss figure to account for wastage and spoilage.
• Absorption Costing: This method of accounting is used to value inventory and cost of goods sold. It allocates overheads to the cost of goods sold, including the normal loss figure.
• Activity-Based Costing: This is a method of accounting which allocates overhead costs to activities and then allocates the costs to individual products. This includes a normal loss figure which is allocated to the products affected by the loss.

In summary, normal loss is a way of accounting for unavoidable wastage and spoilage and is reflected in the closing stock valuation. Other approaches related to normal loss include standard costing, absorption costing and activity-based costing.

References

• Drury C. (2010)., Management and Cost Accounting, Cengage Learning EMEA
• Izhar R. , Hontoir J. (2001)., Accounting, Costing and Management
• Kapoor N.D. (2008)., A Complete Course in ISC Accounting, Pitambar Publishing
• Lal J. (2011)., Cost Accounting 4E, Tata McGraw-Hill Education

Author: Julia Lech