What is abnormal loss

Definition – Abnormal loss

When the actual loss is more than the expected loss or when the actual output is less than the expected output, it is called abnormal loss. It is also called unexpected loss.

Explanation

For example, a company sets a normal loss percentage as 10% of input. In a particular month, 1,000 kg of material was input into the process and 850 kg came out of the process as output. There is no opening and closing work in progress. That means 150 kg (1,000 kg – 850 kg) of material was wasted during the process. Well, the company expected to have a loss of 100 kg, but the actual loss is 50 kg more than the expected loss. So, this 50kg is an abnormal loss for the company.

Example – What is abnormal loss

Albert & Co. manufactures only one product, Zeta, a food chemical. One litre of Zeta requires one litre of Alpha as raw material. The company has estimated the normal loss percentage to be 15% of input (Alpha). In the previous quarter, 8,000 litres of Alpha were input into the manufacturing process and 6,500 litres of Zeta were produced as output. What is the abnormal loss (if any)?

Solution

Normal loss is 15% of input, So:

Normal Loss (units) = Input (units) x normal loss %
Normal Loss (litres) = 8,000 litres x 15%
Normal Loss (litres) = 1,200 litres

Expected Output (units) = Input (units) – normal loss (units)
Expected Output (litres) = 8,000 litres – 1,200 litres
Expected Output (litres) = 6,800 litres

Abnormal Loss (units) = Actual Output (units) – Expected Output (units)Abnormal Loss (units) = 6,500 litres – 6,800 litres
Abnormal Loss (units)           = (300 litres)

Accounting treatment of abnormal loss

We have already discussed in the previous article of process costing that businesses do not assign value to the normal loss, instead the value of the normal loss is distributed among the remaining good units. This means the burden of normal loss is ultimately transferred to the customer. However, a business has to set a maximum acceptable level of loss value that will be incorporated into the cost of inventory. If the actual loss is more than the normal loss i.e., the abnormal loss, a business would not charge that loss to the cost of inventory. Instead, the loss is charged as an expense in the income statement. This is a normal practice.

Businesses calculate the value of abnormal loss separately and debit the value of abnormal loss in the income statement as an expense. However, the value of the abnormal loss is credited to the process account. The value of the abnormal loss is calculated in the same way as we calculate the value of output. Simply, take the cost per unit and multiply it by abnormal units to get the value of the abnormal loss.

Suppose in the above example, the cost per unit was calculated as $10 per litre. So, the value of abnormal loss would be $3,000 (300 litres x $10 per litre).

Scrap value of an abnormal loss

Losses can or cannot have a scrap value. Sometimes, units are wasted due to evaporation or shrinkage for which no scrap proceeds can be taken. But there are instances, where the lost units are scrapped as defective, but they can be sold in the market at a cheap value.

Keeping the above example of 1,000 kg in view, if the company has 150 kg of output as defective and they can sell them in the market, the total scrap proceeds can be divided into two parts i.e., into scrap proceeds from normal loss units and proceeds from abnormal loss units.

The scrap proceeds from the abnormal loss units are deducted from the total value of the abnormal loss before transferring the total value into the income statement. Let’s say, in the above example, each loss unit can be sold for $2 per unit. The scrap proceeds from abnormal loss will be $100 (50 kg x $2 per kg). The value of the abnormal loss is reduced by this amount.

Example – Normal loss and abnormal loss

Consider the example of Paragon Manufacturing Limited, a toy manufacturing company. For one of the products on its production line, dolls, management had estimated that a normal loss of 10% of input would occur. Each doll requires 1kg of plastic. In the previous month, management input 20,000 kg of the material into the manufacturing process but only 17,500 dolls were made. The total process costs incurred were $58,000 to produce 17,500 dolls (including labour cost and overheads). Loss units could be sold as scrap for $2 per unit.

What is cost per unit and total value of output, total value of normal loss and total value of abnormal loss (if any)?

Solution

First, we need to see if there is any abnormal loss:

There is a shortcut to calculate the expected output using the following formula:

Expected Output = Input units x (100% – Normal Loss %)

Expected Output = 20,000 kg x (100% – 10%)
Expected Output = 18,000 kg OR, 18,000 dolls (as 1 kg produces 1 doll)

Abnormal Loss = Actual Output Units – Expected Output Units
Abnormal Loss = 17,500 kg – 18,000 kg
Abnormal Loss = (500 kg)

The normal loss is 2,000 kg (20,000 kg x 10%) which has a total scrap value of $4,000 (2,000 kg x $2 per kg). Now we can calculate the cost per unit as follows:

Cost per unit = [Total cost ($) – Scrap proceeds of normal loss units ($)] / Expected output (units)

Cost per unit = [$58,000-$4,000] / 18,000 units

Cost per unit = $3 per unit

If you remember, the same cost per unit is assigned to each unit of output and abnormal loss.

Therefore:

Cost of Output ($) = 17,500 units x $3 per unit
Cost of Output ($) = $52,500

Abnormal Loss units ($) = 500 units x $3 per units
Abnormal Loss units ($) = $1,500

There is one final adjustment that needs to be made in case of abnormal loss having Scrap Value i.e., the scrap proceeds from abnormal loss units needs to be deducted from the total value assigned to abnormal loss units. The scrap value of abnormal loss units is $1,000 (500 kg abnormal loss units x $2 per kg). Thus, the total value of abnormal loss that will be charged as expense in the income statement is:

Debit to income statement = Total value assigned – Scrap Value of abnormal loss
Debit to income statement = $1,500 – $1,000
Debit to income statement = $500

Example of normal loss and abnormal loss