The abnormal loss on consignment is credited to

Correct — C, (c) Consignment Account. In the consignor's books the entry for an abnormal loss is Abnormal Loss Account debit, Consignment Account credit. The Consignment Account is therefore the account credited, and that is what the stem asks for.

The reason lies in what the Consignment Account is for. It is a nominal account opened to find the profit or loss on one particular consignment. Its debit side carries the cost of the goods sent, the consignor's expenses and the consignee's expenses and commission; its credit side carries the sale proceeds and the value of the unsold stock left with the consignee. If a part of the goods has been destroyed by fire, stolen or broken in transit, the cost of those goods is sitting on the debit side but no sale proceeds will ever come in against it. Leave it there and the account reports a loss on the consignment that is not a trading loss at all. So the cost of the lost goods is taken out by crediting the Consignment Account, and it is carried to a separate Abnormal Loss Account.

What happens next is the second half of the treatment and the reason option (a) is tempting. The Abnormal Loss Account is closed by debiting the insurance company with whatever it admits, and by debiting the general Profit and Loss Account with the balance the insurer does not meet. So the loss does end up in the Profit and Loss Account — but as a debit, and one step later. The stem asks which account the abnormal loss is credited to, and only the Consignment Account answers that.

The amount taken out is not the bare purchase price. An abnormal loss is valued on the same basis as unsold stock in the consignee's hands: the cost of the goods plus a proportionate share of the non-recurring expenses incurred up to the point where the loss occurred — the consignor's freight, insurance and loading, and any of the consignee's expenses of a non-recurring kind such as unloading and octroi if the loss happened after the goods reached him. Recurring expenses such as godown rent, selling expenses and commission are excluded, because they attach to the goods only as they are sold.

Abnormal loss must also be kept clear of normal loss. A normal loss is the unavoidable wastage inherent in the nature of the goods — evaporation, drying, leakage, ordinary breakage in bulk handling. It gets no entry at all. Its cost is absorbed by the units that survive, so that the cost per unit of the remaining goods rises, and that higher figure is used to value the closing stock.

Why the others are wrong

• (a)Profit and Loss Account — The Profit and Loss Account is where the abnormal loss ends up, but it is debited there, not credited, and only after the Abnormal Loss Account has been relieved of anything the insurer admits. The full sequence is: Abnormal Loss Account debit and Consignment Account credit to lift the loss out of the consignment; then Insurance Company debit for the claim admitted, Profit and Loss Account debit for the balance, and Abnormal Loss Account credit to close it. A candidate who knows that abnormal losses are charged to general profit and loss and stops there will choose this option; the item is testing whether he also knows the direction of the entry and the account it comes out of.
• (b)Consignee’s Account — The Consignee's Account is a personal account recording the dealings between consignor and agent. It is debited with the gross sale proceeds and credited with the expenses the consignee has paid, his commission, and the amounts he remits. An abnormal loss is a loss of the consignor's own goods, and the consignee is not answerable for it merely because the goods were in his custody; charging his account would make him a debtor for a loss he did not cause. He is charged only where the loss is traceable to his own negligence, or where he is a del credere agent and the item in question is a bad debt rather than a loss of goods.
• (d)Income and Expenditure Account — The Income and Expenditure Account belongs to a club, society or other not-for-profit organisation and has no place in the books of a trading concern that consigns goods for sale. A consignor prepares a Consignment Account for each consignment and a general Profit and Loss Account for the business as a whole. This option is a category error rather than a near miss, and it is recognisable as one the moment a candidate asks whose books the entry is being made in.

A consignment is a despatch of goods by a consignor to a consignee who is to sell them on the consignor's behalf for a commission. It is not a sale: ownership and risk stay with the consignor until the goods are sold, which is why the unsold stock appears in the consignor's Balance Sheet and why losses of the goods fall on him. The consignor's books carry three accounts. The Consignment Account is nominal and measures the profit or loss on the venture. The Consignee's Account is personal and measures what the agent owes. The Goods Sent on Consignment Account collects the cost of the goods despatched and is closed by transfer to the Trading Account or to Purchases. Expenses are classified as non-recurring — those incurred to bring the goods to the consignee's godown, such as freight, insurance in transit, packing, loading, unloading and octroi — and recurring, those incurred after arrival, such as godown rent, insurance of the godown, advertisement and selling expenses. Only non-recurring expenses enter the valuation of unsold stock and of an abnormal loss. Commission may be ordinary, del credere — which makes the agent answerable for bad debts — or over-riding, paid for exceeding a stated price.

Key facts

• Abnormal loss on consignment: Abnormal Loss Account debit, Consignment Account credit.
• The Abnormal Loss Account is then closed by debiting the insurance company with the claim admitted and the Profit and Loss Account with the uninsured balance.
• An abnormal loss is valued at cost plus a proportionate share of the non-recurring expenses incurred up to the point of loss, on the same basis as unsold stock.
• Normal loss — evaporation, leakage, drying, unavoidable breakage — gets no entry; it is absorbed by the surviving units and raises the cost per unit used to value closing stock.
• The Consignment Account is a nominal account measuring the profit or loss on one consignment; the Consignee's Account is a personal account.
• Ownership and risk in consigned goods remain with the consignor until sale, so unsold stock appears in the consignor's Balance Sheet.
• Non-recurring expenses are those incurred up to the arrival of the goods at the consignee's godown; recurring expenses are those incurred afterwards.
• A del credere commission makes the consignee answerable for bad debts, but it does not make him answerable for the loss of goods.

Common traps

• Answering with the account that is finally charged rather than the account that is credited. The Profit and Loss Account is debited, one step later.
• Treating an abnormal loss like a normal loss and absorbing it in the cost per unit, which hides a real loss inside the value of the closing stock.
• Valuing the abnormal loss at bare cost and leaving out the proportionate non-recurring expenses.
• Including recurring expenses such as godown rent or selling commission in the valuation of the loss.
• Charging the loss to the consignee because the goods were in his custody, when he is answerable only for his own negligence.

• practice — not a real PYQ

  Normal loss on a consignment is

  • (a)credited to the Consignment Account and debited to the Abnormal Loss Account
  • (b)debited to the Profit and Loss Account
  • (c)not recorded by a separate entry, being absorbed by the surviving units in valuing the unsold stock
  • (d)recovered from the consignee

  Answer(c) not recorded by a separate entry, being absorbed by the surviving units in valuing the unsold stock

• practice — not a real PYQ

  Unsold stock lying with the consignee is valued at

  • (a)the selling price fixed by the consignor
  • (b)cost to the consignor plus a proportionate share of non-recurring expenses
  • (c)cost to the consignor plus all expenses incurred by both parties
  • (d)the market price prevailing on the date of the account sales

  Answer(b) cost to the consignor plus a proportionate share of non-recurring expenses