Consignment Accounting: Normal vs Abnormal Loss and Valuation

Consignment: Normal and Abnormal Loss

The concepts of Normal and Abnormal Loss are crucial in consignment accounting, as they directly impact the valuation of unsold stock and the calculation of the correct profit or loss on the consignment.

Differences Between Normal and Abnormal Loss

The distinction between the two types of losses is based on their avoidability and nature:

Normal Loss (Unavoidable)

Abnormal Loss (Avoidable)

Valuation of Unsold Stock

Unsold stock (closing stock) on consignment must be valued for inclusion in the Balance Sheet and for calculating the true profit/loss in the Consignment Account. The general principle is Cost or Net Realizable Value (Market Value), whichever is lower.

Components of Cost

The cost of the unsold stock is calculated by including the following:

1. Cost of Goods
   This is the original cost of the goods retained by the consignee.
2. Proportionate Non-Recurring Expenses
   These are expenses incurred to bring the goods to the consignee's godown (warehouse) and must be included in the stock valuation. Recurring expenses (like godown rent, selling expenses) incurred after the goods reach the godown are excluded.

• Consignor's Non-Recurring Expenses: Freight, carriage, insurance, loading, customs duty.
• Consignee's Non-Recurring Expenses: Octroi, unloading charges, duty charges (up to the godown/warehouse).

Effect of Normal Loss on Valuation

If Normal Loss occurs, the total cost and expenses (numerator) are divided by the number of units remaining after the Normal Loss (denominator). This ensures the cost of the lost units is effectively spread over the remaining good units, thus inflating their per-unit cost.

Branch Accounts: Accounting for Dependent Branches

Branch accounting involves maintaining records for different branches of an organization to ascertain their individual financial performance and position. A dependent branch does not maintain its own complete set of books; the Head Office (HO) handles all major accounting records, financial reporting, and controls.

Primary Systems for Dependent Branches

For dependent branches, the Head Office primarily uses two main systems:

1. Debtor's System (Single Account System)

This is the simplest method, typically used for small branches where the primary objective is quick and easy determination of profit or loss.

Key Features:

• Single Account: The HO opens only one account for the branch, called the "Branch Account".
• Nature of Account: The Branch Account is treated as a nominal account to find out profit or loss, but its entries are recorded as if the branch were a personal account (a debtor) of the HO.
• Pricing: Goods are usually sent to the branch at cost price, though the invoice price (cost plus profit) method can also be used.
• Profit Ascertainment: The balance in the Branch Account (after transferring all opening/closing balances and transactions) directly represents the Net Profit (if credit side > debit side) or Net Loss (if debit side > credit side), which is then transferred to the Head Office's General Profit and Loss Account.

Entries:

• Debited with opening balances of assets, goods sent to the branch, and expenses paid by the HO.
• Credited with remittances (cash sales and collections from debtors), goods returned to the HO, and closing balances of assets.

2. Stock and Debtor System (Analytical System)

This system is more elaborate and is adopted for larger branches or when the Head Office requires tighter control over the branch's inventory and transactions. It is generally used when goods are sent at Invoice Price (a price higher than cost).

Key Features:

• Multiple Accounts: Instead of a single account, the HO opens several interconnected ledger accounts to separately control different aspects of the branch's operations.
• Key Accounts Maintained:
  • Branch Stock Account: Records all transactions related to the physical flow of goods (received, sold, returned) at the Invoice Price. It helps control stock by revealing any shortage or surplus.
  • Branch Debtors Account: Maintained to record credit sales and collections from branch customers.
  • Goods Sent to Branch Account: Tracks the total value of goods supplied to the branch.
  • Branch Expenses Account: Accumulates all cash/non-cash expenses incurred by or for the branch.
  • Branch Adjustment Account: Used to eliminate the 'loading' (the difference between Invoice Price and Cost Price) on opening stock, goods sent, and closing stock. The balance of this account represents the Gross Profit.

The Branch Profit & Loss Account receives the balance of the Branch Adjustment Account (Gross Profit) and branch expenses to determine the Net Profit or Loss. By using the Invoice Price and maintaining a separate Branch Adjustment Account, the HO can ascertain the gross profit margin built into the sales price, offering better control over profitability.

This video provides a format and solved problem for the Stock and Debtor System, which is essential for understanding the multiple accounts involved. Stock and Debtor system in Branch accounting | Simple format with Solved Problem | kauserwise

Wholesale Branch: Final Accounts System

The Wholesale Branch System is a method of branch accounting where the Head Office (HO) invoices goods to its retail branch(es) at a price higher than cost, specifically the wholesale price. This allows the HO to:

• Conceal the true profit margin from the branch staff (as the branch only sees profit calculated on the wholesale price).
• Maintain tight centralized control over inventory and pricing.
• Segregate the Wholesale Profit (HO's margin) from the Retail Profit (Branch's margin).

Accounting Treatment (Final Accounts Method)

Under the final accounts system for a wholesale branch, the branch prepares its own Trading and Profit & Loss Account and Balance Sheet based on the wholesale price. The HO then makes adjustments to consolidate the final results.

The key adjustment happens in the Head Office's books via a Stock Reserve entry to neutralize the wholesale profit included in the branch's opening and closing stock figures.

• For Profit in Opening Stock: The loading element is credited to the HO's P&L A/c, effectively adding back the HO's profit on the goods that were unsold last year.
• For Profit in Closing Stock: The loading element is debited to the HO's P&L A/c (or shown as a deduction from Closing Stock in the HO's final Balance Sheet), to reduce the closing stock from wholesale price to its true cost.

This mechanism ensures the final consolidated profit figure reflects both the HO's wholesale profit and the branch's retail profit.

Hire Purchase vs Installment Payment System

Both the Hire Purchase System (HPS) and the Installment Payment System (IPS) allow a buyer to acquire an asset by paying in periodic installments. However, they are fundamentally different in their legal nature, ownership transfer, and accounting treatment.

Basic Concepts and Differences

Accounting Treatment

1. Hire Purchase System (HPS)

In the books of the hirer (buyer), the transaction is treated as a conditional acquisition of an asset.

• Asset Accrual Method: The hirer records the asset and the liability at its cash price (excluding interest) on the date of delivery.

  Dr. Asset A/c (Cash Price)
  Cr. Hire Vendor A/c (Cash Price)

• Interest: Interest for the period is charged to the Profit and Loss A/c and added to the vendor's liability only when it becomes due.

  Dr. Interest A/c
  Cr. Hire Vendor A/c

• Depreciation: The hirer, being in possession and bearing the risk, charges depreciation on the cash price of the asset immediately, debiting the Profit and Loss A/c.

2. Installment Payment System (IPS)

In the books of the buyer, the transaction is treated as a normal credit purchase since ownership is transferred immediately.

• The asset is recorded at its full cash price, and the vendor is credited for the cash price.

  Dr. Asset A/c (Cash Price)
  Cr. Vendor A/c (Cash Price)

• The total interest for the entire period is often credited to an Interest Suspense A/c and transferred to the Profit and Loss A/c over the installment period.

  Dr. Interest Suspense A/c (Total Interest)
  Cr. Vendor A/c (Total Interest)

• Depreciation is charged immediately on the full cash price of the asset, similar to any other owned asset.