Process Costing: Normal Loss, Abnormal Loss and Abnormal Gain

A cement works, a paint factory and a plant that bottles drinks all make large volumes of identical output without a break. Nobody can cost an individual litre by following it through the factory. Instead, costs are collected for each process and spread over the output.

This is process costing, and its distinctive problem is loss: some input is always lost along the way, and the business has to decide how much of the cost of lost units the good units must carry.

This topic introduces process costing and the process account, then treats the three loss situations: normal loss, abnormal loss and abnormal gain, including the cases where lost units have a scrap value or cost money to dispose of. Work-in-progress is added in the next topic. Process account questions are worth many marks and appear regularly, so each method here is worked through in full.

What process costing is and when it is used

Process costing is used when output is produced continuously, is measured in total quantities such as tonnes or litres or in very large numbers of small items. Individual units cannot easily be separated. Typical examples are chemicals, liquids, and high-volume, low-cost foods such as tins of beans or bottles of sauce.

• Materials may be added all at the start or gradually through the process.
• Costs are usually split into direct materials and conversion costs (direct labour plus production overhead).
• Some input is lost, for instance by evaporation or chemical reaction, so output is less than input. Process costing allows for expected loss.
• Because production never stops, there is normally unfinished work at the end of a period. Process costing provides a way to cost it (next topic).
• More than one product may come out of the same process (joint products and by-products).
• There may be several processes in sequence, with the output of one becoming the input of the next.

The principle is the same as for other costing methods: the cost per unit is the total cost of resources put into the process divided by the units produced.

The process account

A process account is a work-in-progress account for the process. Costs are collected on the debit side. They must then be shared among everything on the credit side: good output, normal loss, abnormal loss and closing work-in-progress. Quantities are shown alongside the money so that the quantity columns balance.

An abnormal loss and an abnormal gain cannot both occur in the same process in the same period. In every question, you need to:

• identify the losses and output
• calculate the cost of good output, losses and work-in-progress
• use those costs to value each item
• complete the process account

It is a good habit to draw the process account before calculating anything.

Normal loss

Normal loss is the loss that is expected in processing. It is inherent in the physical or chemical changes in the process, and it is unavoidable. It is usually stated as a percentage of the input.

If a process takes in 5,000 litres and the normal loss is 10%, normal loss is 500 litres and expected output is 4,500 litres. Think of soup: you buy a litre, and heating evaporates some of it. You paid for a litre and get 0.9 litre. The evaporation is unavoidable, so its cost is part of the cost of getting the good soup.

It follows that the whole cost of the input is charged to the good output, and none to the normal loss, unless the lost units can be sold.

Normal loss with no scrap value

Cost per unit of good output = total process cost ÷ expected units of output.

1. Total cost = ₦45,000.
2. Expected output = 4,500 litres.
3. Cost per litre.
   ₦45,000 ÷ 4,500 = ₦10.
4. If actual output is 4,500 litres, good output is valued at ₦45,000.

Normal loss with a scrap value

Sometimes the lost units can be sold. The normal loss may not truly disappear. It may be a residue that is changed so that it is no longer the good product. The scrap sale recovers part of the input cost, so it reduces the cost of the process.

Cost per unit of good output = (total process cost − scrap value of normal loss) ÷ expected output.

1. Scrap value.
   500 × ₦1.80 = ₦900.
2. Net cost.
   ₦45,000 − ₦900 = ₦44,100.
3. Cost per litre.
   ₦44,100 ÷ 4,500 = ₦9.80.
4. Good output of 4,500 litres is valued at ₦44,100, and the normal loss is shown on the credit side at ₦900.

Normal loss with a disposal cost

If the firm has to pay to dispose of the loss, for example a toxic residue, the disposal cost is an additional process cost. The normal loss is valued at nil, and the expected disposal cost is added to the cost of the process.

Cost per unit = (total process cost + disposal cost of normal loss) ÷ expected output.

1. Disposal cost.
   500 × ₦0.90 = ₦450.
2. Net cost.
   ₦45,000 + ₦450 = ₦45,450.
3. Cost per litre.
   ₦45,450 ÷ 4,500 = ₦10.10.
4. The disposal cost is debited to the process account, and the normal loss is credited at nil.

Abnormal loss

Abnormal loss occurs when the actual loss is more than the normal loss.

Abnormal loss is not expected and should not happen. So it is given a cost. By costing it, management can see how much the problem costs and can look for the cause. If it is assumed that all losses occur at the end of the process, the abnormal loss is costed at the same cost per unit as good output.

The cost of abnormal loss is written off as an expense in the income statement.

1. Total loss.
   5,000 − 4,300 = 700.
2. Normal loss = 500.
3. Abnormal loss = 200 litres.
4. Cost per litre = ₦10.
5. Good output.
   4,300 × ₦10 = ₦43,000.
6. Abnormal loss.
   200 × ₦10 = ₦2,000.
7. Normal loss = nil.
8. Total credits = ₦45,000, which equals the debits. ✓

The double entry: debit abnormal loss account ₦2,000; credit process account ₦2,000. At the period end, the balance of the abnormal loss account goes to the income statement as a cost.

Abnormal loss with a scrap value

Abnormal loss units may also be sold as scrap. The key point is where the scrap proceeds go.

• The scrap value of normal loss is deducted from the process cost, as above.
• The abnormal loss is valued in the process account at the cost per expected unit, as before.
• The scrap value of abnormal loss is credited to the abnormal loss account, not the process account. The balance on the abnormal loss account is the net cost (cost less scrap proceeds), which is written off.

Example. Scrap value ₦1.80 per litre; cost per litre ₦9.80. Actual output 4,300; abnormal loss 200 litres.

• Good output.
  4,300 × ₦9.80 = ₦42,140.
• Abnormal loss.
  200 × ₦9.80 = ₦1,960.
• Normal loss.
  500 × ₦1.80 = ₦900.
• Total credits.
  ₦42,140 + ₦1,960 + ₦900 = ₦45,000 = total debits. ✓

Abnormal gain

Abnormal gain occurs when the actual loss is less than the normal loss.

It is costed on the same basis as abnormal loss: at the cost per expected unit. The differences are that an abnormal gain is a benefit, so it is debited in the process account, with the credit in an abnormal gain account. The balance on that account is transferred to the income statement as an addition to profit.

1. Actual loss = 300.
2. Normal loss = 500.
3. Abnormal gain = 200 litres.
4. Cost per litre = ₦10.
5. Good output.
   4,700 × ₦10 = ₦47,000.
6. Abnormal gain.
   200 × ₦10 = ₦2,000.
7. Debits.
   ₦45,000 + ₦2,000 = ₦47,000 = credits. ✓
8. Double entry: debit process account ₦2,000; credit abnormal gain account ₦2,000, which moves to the income statement as a gain.

Abnormal gain when the loss has a scrap value

With a scrap value, the gain is worth less than the amount in the process account, because there are fewer units to sell as scrap than expected. The process account still shows the gain at the cost per expected unit. The scrap value that is not earned on the units that did not get lost is debited to the abnormal gain account, and the balance is the net gain.

Example. Scrap ₦1.80 per litre, cost per litre ₦9.80, actual output 4,700 litres, abnormal gain 200.

• Good output.
  4,700 × ₦9.80 = ₦46,060.
• Abnormal gain.
  200 × ₦9.80 = ₦1,960 (debit in the process account).
• Normal loss.
  500 × ₦1.80 = ₦900 (credit).
• Debits = ₦45,000 + ₦1,960 = ₦46,960.
  Credits = ₦46,060 + ₦900 = ₦46,960. ✓
• Abnormal gain account: credit ₦1,960 (from the process account) and debit ₦360 (200 × ₦1.80, scrap not earned).
  Net gain to the income statement = ₦1,600.
• Scrap sales.
  only 300 litres (500 − 200) are available to sell, so cash received = 300 × ₦1.80 = ₦540 rather than the 500 × ₦1.80 = ₦900 expected.

The ideas in more depth

Why abnormal loss is valued but normal loss is not

Normal loss is part of the price of getting good output, so the cost belongs to the good units. Abnormal loss is a failure to achieve the expected yield. If it were buried in the cost of good output, management would never see it. Costing it separately gives a measure of the waste and writes it off against profit, where it belongs.

The assumption that losses occur at the end

This topic assumes that all losses happen at the end of the process, so that every lost unit has absorbed the full cost per unit. That is why abnormal loss and gain are valued at the same cost per unit as good output. (If losses occurred part-way, a lost unit would carry only the cost incurred up to that point.

The next topic shows how work-in-progress and equivalent units handle partial completion.)

Normal loss is based on input, not output

The percentage is applied to the quantity put in, unless a question states otherwise. A common slip is to apply it to the output. When a question says “normal loss is 10% of input”, multiply the input by 10%.

A process following another

In a series of processes, the output of one is transferred at its cost to the next as “transfer from previous process”. That is a cost like materials, and it is subject to loss in the next process.

1. Total cost.
   ₦45,000 + ₦9,000 + ₦11,700 = ₦65,700.
2. Less scrap of normal loss (450 × ₦2 = ₦900) = ₦64,800.
3. Expected output = 4,050 litres.
4. Cost per litre.
   ₦64,800 ÷ 4,050 = ₦16.
5. Abnormal loss.
   4,050 − 4,000 = 50 litres.
6. Good output.
   4,000 × ₦16 = ₦64,000.
7. Abnormal loss.
   50 × ₦16 = ₦800.
8. Normal loss = ₦900.
9. Total = ₦65,700. ✓

Checking your process account

The quantity column must balance (input = good output + normal loss + abnormal loss, or with an abnormal gain on the debit side). The value column must balance too. If it does not, the cost per unit or the scrap value is wrong.

Worked example: a full process account with abnormal loss

1. Quantities.
   Normal loss = 10% × 6,000 = 600 kg.
   Expected output = 5,400 kg.
   Actual output 5,200 kg.
   Abnormal loss = 5,400 − 5,200 = 200 kg.
2. Costs.
   Total = ₦54,000 + ₦18,000 + ₦10,200 = ₦82,200.
   Less scrap of normal loss (600 × ₦2 = ₦1,200) = ₦81,000.
3. Cost per kg.
   ₦81,000 ÷ 5,400 = ₦15.
4. Credit side.
   Good output 5,200 × ₦15 = ₦78,000.
   Abnormal loss 200 × ₦15 = ₦3,000.
   Normal loss ₦1,200.
   Total = ₦82,200. ✓
5. Abnormal loss account. Debit ₦3,000. Credit scrap (200 × ₦2) ₦400. Net ₦2,600 written off to the income statement.
6. Scrap account. Debit from the process account ₦1,200 and from the abnormal loss account ₦400. Credit cash from the sale of 800 kg = ₦1,600.

Common mistakes in the exam

• Applying the normal loss percentage to the output instead of the input.
• Dividing total cost by actual output instead of expected output when finding cost per unit.
• Giving normal loss a cost when it has no scrap value, or forgetting to deduct its scrap value from the process cost.
• Not costing abnormal loss at the cost per expected unit.
• Putting the scrap value of abnormal loss or abnormal gain in the process account instead of the abnormal loss or gain account.
• Showing abnormal gain on the credit side of the process account. It is a debit.
• Treating abnormal loss as a cost of the good units. It is written off to the income statement.
• Quantity columns that do not balance.

Quick revision

• Process costing: continuous, identical output. Costs collected per process, shared over output and losses.
• Normal loss = expected, unavoidable, based on input. Nil value, or scrap value (reduces cost), or disposal cost (adds to cost).
• Cost per unit = (total cost − scrap of normal loss + disposal cost) ÷ expected output.
• Abnormal loss = actual loss − normal loss. Costed like good output. Expense in the income statement.
• Abnormal gain = normal loss − actual loss. Costed like good output. Debit in process account. Adds to profit.
• Scrap of abnormal loss or gain goes through the abnormal loss or gain account.

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer.

Section A style: multiple choice

Section B style: written questions

A further written question

Model answers

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