Abnormal loss – what is abnormal loss?
Abnormal loss refers to a situation when a company experiences a loss that exceeds the normal loss allowance.
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When a company experiences an abnormal loss, its total revenue doesn’t cover the total costs that it incurs. If the company experiences repeated abnormal losses, it can threaten the company’s survival.
What causes abnormal losses?
An abnormal loss signifies that there are significant issues with the company’s production that need to be identified and fixed as soon as possible. There are a number of factors that can contribute to a business experiencing an abnormal loss. Examples may include:
- Damage to the business, e.g. from fire, flood, earthquake
- Theft of goods.
At times, the root cause of the abnormal loss is within the company’s control. These causes must be identified and resolved so the company can recover financially and minimise the risk of further losses. Substandard working conditions, negligence or inefficiency may lead to abnormal losses. Problems may arise for example if the company:
- Uses faulty equipment in manufacturing processes
- Uses substandard raw materials
- Relies on unskilled or untrained workers.
The difference between normal loss and abnormal loss
The controllability of the loss is the defining feature that distinguishes an abnormal loss from a normal loss.
Normal loss
Normal losses can’t be controlled by the business as they’re an unavoidable part of the production process. The cost of normal losses should be considered when you’re valuing your closing stock. To work out the cost per unit of your product after the normal losses have been incurred you need to use this calculation:
Cost per unit = Total cost (including expenses incurred) / (Total quantity - Normal loss)
For example, suppose that you run a café that sells fruit smoothies and you take delivery of fruit. It’s likely that a few units of fruit will be destroyed during the delivery or will otherwise be unsuitable for use. Imagine that you take an order of 500 pieces of fruit for £40.00 and the delivery costs £20.00. You also know that on average, in a 500 unit order, 50 units will not be used, due to you not making enough sales of smoothies or other damages, e.g. the fruit goes mouldy.
The calculation you therefore would do to calculate your cost per unit after normal losses is:
(40.00 + 20.00) / (500 - 50) = £0.13
You can then work out the total cost of the unused units of fruit, i.e. the normal loss: 50 x 0.13 = £6.50. In this example, the loss of a certain amount of produce is normal, and little can be done to minimise this loss any further.
Abnormal loss
However, an abnormal loss is an additional loss that is greater than the normal amount the company experiences. It’s a controllable loss because it can be avoided if the company works efficiently. An abnormal loss is essentially an unnecessary loss as it (usually) happens because of carelessness or negligence, e.g. using faulty equipment.
How to calculate an abnormal loss
When you’re using process accounting, you need to record abnormal losses in your books. The difference between the total loss you have incurred and the normal loss that is to be expected is the abnormal loss.
The calculation you need to perform is:
Abnormal loss = (Normal cost at normal production / (total output - normal loss units)) x units of abnormal loss
For example, you may order 500 units of fruit to make your smoothies at a total cost of £60. Of that amount, 50 units of fruit are normally lost, and this loss is expected. However, suppose that your blender breaks and you’re unable to produce your smoothies. You therefore only use 200 units of fruit, meaning that 300 units of fruit are wasted as they go bad before you can use them. This is an abnormal loss.
To determine the cost of this abnormal loss you would therefore calculate:
(£60.00 / (500 - 50)) x 300 = £40.00
Depending on what you are producing, you may calculate the losses based on the cost of the raw materials, or at the end of the production process. Above, the calculation determines the abnormal loss incurred based on the cost of the raw materials.
In some cases however, it may be assumed that the losses occur at the end of production and therefore the units of abnormal loss are costed the same as finished output units. What this means is that the cost per units of abnormal loss is the same as the cost of units of good output.
Accounting for an abnormal loss
An abnormal loss is a cost to your business. It should therefore be treated as an expense and shown on your income statement.
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