There are different methods of pricing materials issue. The various methods used fall under the following main categories:
I. Cost Price Methods
(a) First in First out (FIFO)
(b) Last in First out (LIFO)
(c) Base Stock
II. Average Price Methods
(a) Simple Average.
(b) Weighted Average.
III. Notional Price Method
(a) Standard Price.
(b) Inflated Price.
(c) Replacement price.
As per the syllabus only F.I.F.O., L.I.F.O., Average and Base Stock methods are discussed below:
First in First out Method (FIFO)
Under this method materials are used in the order in which they are received. In other words, materials received first are issued first. This process is repeated throughout.
The price of the earliest consignment is taken first and when that is exhausted, the price of the next consignment is adopted and so on. This method is most suitable for use where the material is slow moving and has comparatively high unit cost This method is also useful in times of falling prices because the issue price of material to the job will be high while the replacement cost of material will be below.
Show the Stores Ledger entries for the month of Jan, 2008 as they would appear when using FIFO method:
Jan.1 Purchased 300 units @ Rs.3 per unit
Jan.4 Purchased 600 units @ Rs.4 per unit
Jan.6 Issued 500 units.
Jan. 10 Purchased 700 units @ Rs.4 per unit.
Jan. 15 Issued 800 units.
Jan.20 Purchased 300 units @ Rs.5 per unit.
Jan.23 Issued 100 units.
Ascertain the quantity and value of closing stock as on 31st Jan under FIFO method. Solution:
Stores ledger Account (FIFO Method)
200 units @ Rs.4 = 800 300 units @ Rs.5 = 1,500 Rs. 2,300
The following are the advantages of FIFO method:
(i) It is simple to understand and easy to calculate.
(ii) FIFO method is based on sound principle that materials are issued in order of purchase. Thus materials received first are issued first.
(iii) The value of closing stock will reflect current market price.
(iv) This method is suitable when prices are falling.
(v) This method is also useful if transactions are few and prices of material remain stable.
(vi) Unrealised profit or loss does not arise as materials are issued at actual cost but not on estimate.
(vii) Deterioration and obsolescence can be avoided by exhausting oldest materials at the time of issue.
This method suffers from the following disadvantages:
(i) The calculation becomes difficult and cumbersome when purchases are made very frequently at different prices.
(ii) Issue price does not reflect current market price and so does cost of production.
(iii) For pricing one requisition, more than one price has often to be taken.
(iv) Cost of production tends to be high during the period of falling prices.
(v) Two similar jobs cannot be compared as the issue price of one lot differs from that of other.
Last in First Out Method: (LIFO)
This method is exactly the opposite of FIFO method. Under this me materials received last are issued first. The price of the material to be issued would the cost price of the last lot of materials purchased.
This method is useful during t period of rising prices because materials will be issued from the latest consignment a price which is closely related to the current price levels. Under this method product’ cost is calculated on a basis which approximates to replacement cost.
The followings transactions took place in respect of material in during the month of January, 2008. You are required to write up the Stores Ledger under LIFO meth
The following are the advantages of LIFO method:
(i) This method is very simple to operate and quite useful where transactions are not too many and prices are fairly steady.
(ii) Production is charged at the most recent prices so that it is based on the principle that costing should be related to current price levels.
(iii) During the period of rising prices there is no windfall profit as in case of FIFO method.
(iv) Closing stock will be valued at earlier price and will not, therefore, show unrealised profit.
(v) This method reduces burden of income tax during the period of price rise Disadvantages
This method suffers from the following disadvantages:
(i) Like FIFO system, calculations become complicated and cumbersome when transactions are many with frequent price fluctuations.
(ii) Two similar jobs cannot be compared because of charging different rates of materials to different jobs.
(iii) Under this system, closing stocks are not shown at current market price.
(iv) Sometimes more than one price has to be adopted for pricing a single requisition.
(v) When prices are falling it will lead to low charge to production, whereas materials in the stock purchased at higher rate need adjustment for valuation of closing stock.
(vi) This system of material issue is not accepted by Income Tax Authorities.
Base Stock Price
This is not a distinct method of pricing materials issue. This method is based o^ the principle that a certain minimum quantity of material is always maintained in to ensure continuous production.
This minimum stock is treated as fixed asset and is called as base stock. Since minimum stock is created out of first lot of material purchased, it is always valued at cost price of first lot of materials. The quantity in excess of this base stock is issued at a price similar to FIFO or LIFO method.
This bad stock method operates in conjunction with some other methods like FIFO or LIFO and is called Base Stock – FIFO method or Base Stock – LIFO method. The advantages of FIFO and LIFO are applicable in this method.
Simple Average Price Method
Under this method, materials issued are valued at average price. This is calculated by dividing the total of the price of the materials on the stock from which the material to be priced could be drawn by the number of prices used in that total.
Unit pieces of material in stock Issue Price – Number of purchases.
A new simple average price is to be determined when a fresh receipt is made. The rate is also revised when an earlier consignment is exhausted.
The following example will illustrate this. Suppose, following are three different lots of materials in stock when materials is to be priced:
100 units purchased @ Rs.4.00 200 units purchased @ Rs.5.00 300 units purchased @ Rs.6.00
The simple average price will be =— = Rs.5.00
The following are the advantages of simple average method:
(1) It is easy to calculate and simple to operate.
(2) A particular purchase at higher or lower rate cannot disturb the price to a great extent. .
(3) Issue rate remains the same until a fresh purchase is made. Disadvantages:
(1) It is not a logical method as it takes into account purchase price but not quantity.
(2) The value of closing stock becomes absurd.
(3) The issue price does not relate to the current market price. Illustration – 5
From the following transactions, prepare a Stores Ledger Account under simple average method: