Methods of Pricing Material Issues

1. Actual Cost Method

2. First-In First-Out (FIFO) Method
3. Last-In First-Out (LIFO) Method
4. Highest-in First-Out (HIFO) Method
5. Simple Average Cost Method
6. Weighted Average Cost Method
7. Periodic Average Cost Method
8. Standard Cost Method
9. Replacement Cost Method
10. Next in First Out (NIFO) Method
11. Base Stock Method.
 Methods of Pricing Material Issues
Actual Cost Method:
Where materials are purchased specially
for a specific job, actual cost of materials is
charged to that job. Such materials will
normally be stored separately and issued
only to that particular job.
 Methods of Pricing Material Issues
First-In First-Out (FIFO) Method:
CIMA defines FIFO as “a method of pricing
the issue of material using, the purchase
price of the oldest unit in the
stock”. Under this method materials are
issued out of stock in the order in which
they were first received into stock. It is
assumed that the first material to come
into stores will be the first material to be
used.
 Methods of Pricing Material Issues
First-In First-Out (FIFO) Method:
Advantages:
(a) It is easy to understand and simple to price the issues.
(b) It is a good store keeping practice which ensures that raw material
leave the stores in a chronological order based on their age.
(c) It is a straight forward method which involves less clerical cost than
other methods of pricing.
(d) This method of inventory valuation is acceptable under standard
accounting practice.
(e) It is a consistent and realistic practice in valuation of inventory and
finished stock.
(f) The inventory is valued at the most recent market prices and it is
near to the valuation based on replacement cost.
 Methods of Pricing Material Issues
First-In First-Out (FIFO) Method:
Disadvantages:
(a) There is no certainty that materials which have been in stock longest will be used, if
they are mixed up with other materials purchased at a later date at different price.
(b) If the price of the materials purchased fluctuates considerably, it involves more
clerical work and there is possibility of errors.
(c) In a situation of rising prices, production cost is understated.
(d) In inflationary market, there is a tendency to under-price material issues. In
deflationary market, there is a tendency to overprice such issues.
(e) Usually more than one price has to be adopted for a single issue of materials.
(f) The method makes cost comparison difficult of different jobs when they are
charged with varying prices for the same materials.
This method is more suitable where the size of the raw materials is large and bulky and
its price is high and can be easily identified in the stores separately. This method is
useful when the frequency of material receipts is less and the market price of the
material are stable and steady.
 Methods of Pricing Material Issues
Last-In First-Out (LIFO) Method:
Under this method most recent purchase will be
the first to be issued. The issues are priced out
at the most recent batch received and continue
to be charged until a new batch received is
arrived into stock. It is a method of pricing the
issue of material using the purchase price of the
latest unit in the stock.
 Methods of Pricing Material Issues
Last-In First-Out (LIFO) Method:
Advantages:
(a) Stocks issued at more recent price represent the current
market value based on the replacement cost.
(b) It is simple to understand and easy to apply.
(c) Product cost will tend to be more realistic since material
cost is charged at more recent price.
(d) In times of rising prices, the pricing of issues will be at a
more recent current market price.
(e) It minimizes unrealized inventory gains and tends to show
the conservative profit figure by valuation of inventory at
value before price rise and provides a hedge against inflation.
 Methods of Pricing Material Issues
Last-In First-Out (LIFO) Method:
Disadvantages:
(a) Valuation of inventory under this method is not acceptable in
preparation of financial accounts.
(b) It is an assumption of a cash flow pattern and is not intended
to represent the true physical flow of materials from the stores.
(c) More than one price may have to be adopted for an issue.
(d) It renders cost comparison between jobs difficult.
(e) It involves more clerical work and sometimes valuation may go
wrong.
(f) In times of inflation, valuation of inventory under this method
will not represent the current market prices.
 Methods of Pricing Material Issues
Highest-in First-Out (HIFO) Method:
Under this method, the materials with highest prices
are issued first, irrespective of the date upon which
they were purchased. The basic assumption is that in
fluctuating and inflationary market, the cost of
material are quickly absorbed into product cost to
hedge against risk of inflation. This method is used
when the material is in short supply and in execution
of cost plus contracts. This method is not popular and
not acceptable under standard accounting practices.
 Methods of Pricing Material Issues
Simple Average Cost Method:
Under this method all the materials received are
merged into existing stock of materials, their identity
being lost. The simple average price is calculated
without any regard to the quantities involved. The
simple average cost is arrived at by adding the
different prices paid during the period for the batches
purchased by dividing the number of batches. For
example, three batches of materials received at Rs.
10, Rs. 12 and Rs. 14 per unit respectively.
 Methods of Pricing Material Issues
Simple Average Cost Method:
The simple average price is calculated as follows:
Rs. 10 + Rs. 12 + Rs. 14/3 batches = Rs. 36/3 batches =
Rs 12 per unit
This method is not popular because it takes into
consideration the prices of different batches but not
the quantities purchased in different batches. This
method is used when prices do not fluctuate very
much and the stock values are small in value.
 Methods of Pricing Material Issues
Weighted Average Cost Method:
It is a perpetual weighted average system where the
issue price is recalculated every time after each
receipt taking into consideration both the total
quantities and total cost while calculating weighted
average price. For example, three batches of material
received in quantities of 1,000 units @ Rs. 15, 1,300
units @ Rs. 16 and 800 units @ Rs. 14.
 Methods of Pricing Material Issues
Weighted Average Cost Method:
The weighted average price is calculated as follows:
(1,000 units x Rs. 15) + (1,300 units x Rs. 16) + (800
units x Rs. 14)/1,000 units + 1,300 units + 800 units
= Rs. 15,000 + Rs. 20,800 + Rs. 11,200/3,100 units =
Rs. 47,000/3,100 units = Rs. 15.16 per unit
This method tends to smooth out the fluctuations in
price and reduces the number of calculations to be
made, as each issue is charged at the same price until
a fresh batch of material is received.
 Methods of Pricing Material Issues
Weighted Average Cost Method:
This method is easier as compared to FIFO and LIFO,
as there is no necessity to identify each batch
separately. But this method increases the clerical
work in calculation of new average price every time a
new batch is received. The issue price calculated
rarely represents the actual purchase price.
 Methods of Pricing Material Issues
Periodic Average Cost Method:
Under this method, instead or recalculating the
simple or weighted average cost every time there is a
receipt, an average for the accounting period as a
whole is computed.
 Methods of Pricing Material Issues
Standard Cost Method:
Under this method, material issues are priced at a predetermined
standard issue price. Any variance between the actual purchase
price and standard issue price is written off to the Profit and Loss
Account. Standard cost is a predetermined cost set by the
management prior to the actual material costs being known and
the standard issue price is used for all issues to production and for
valuation of closing stock.
If initially the standard price is set carefully then it reduces all the
clerical work and errors tremendously and the stock recording
procedure is simplified. The realistic production cost comparisons
can be made easier by eliminating fluctuations in cost due to
material price variance. In a situation of fluctuating prices, this
method is not suitable.
 Methods of Pricing Material Issues
Replacement Cost Method:
This method is also called as ‘market price method’. The
replacement cost is a cost at which material identical to that
can be replaced by purchasing at the date of pricing material
issues; as distinct from the actual cost price at the date of
purchase. The replacement price is the price of replacing the
material at the time of issue of materials or on the date of
valuation of closing stock.
This method is not acceptable for standard accounting
practice, since it reflects a cost which has not really been paid.
If stocks are held at replacement cost, for balance sheet
purposes when they have been bought at a lower price, an
element of profit which has not yet been realized will be built
into the Profit and Loss Account.
 Methods of Pricing Material Issues
Replacement Cost Method:
This method is advocated by charging the market price of
material to the job or process, make it easier to determine
the profitability of the job or process. This method is suitable
particularly in the inflationary tendency of market prices of
materials. Where there is no precise market for particular
materials, it would be difficult in ascertainments of
replacement prices for the material issues.
 Methods of Pricing Material Issues
Next in First Out (NIFO) Method:
This method is a variant of replacement cost method. Under
this method the price quoted on the latest purchase order or
contract is used for all issues until a new order is placed.
 Methods of Pricing Material Issues
Base Stock Method:
Under this method, a specified quantity of material is always
held in stock and is priced at its original cost as buffer or base
stock; and any issue of materials above the base stock
quantity is priced under any one of the methods discussed
above.
This method indicates how prices are moving over a longer
period of time. But this method is not popular and also not
accepted under standard accounting practice since it would
result in stock valuation totally unrealistic.
STORES LEDGER ACCOUNT (FIFO METHOD)