Contents -

1. Meaning and Methods of Pricing of Issues.
2. Advantages, Disadvantages and Example of FIFO Method.
3. Advantages, Disadvantages and Example of LIFO Method.
4. Advantages, Disadvantages and Example of Simple Average Price Method.
5. Advantages, Disadvantages and Example of Weighted Average Price Method.
6. Other Methods

  • Pricing of Issues -
Against authorised requisitions made, materials are assigned to various jobs for production department. The respective production departments are then debited with the amount of the material issued to them. Here, the matter of concern is what should be the price of material issued. As the price of material changes frequently. Starting from the date of their procurement to the date of the issue. So selection of price needs a pricing policy which also facilities in preparation of Costing records.
Historical cost and market price are usually the two criteria for setting up a material pricing policy to record the issue of materials.

  • Methods of Pricing Material Issues -
Following is a list of the various methods of pricing the material issues :

Important Methods -

1. First In First Out (FIFO) Method -
This methods of material pricing is by far more systematic than the methods discussed above. The receipts and the issues follow a sequential pattern. i.e. the materials which are received first are also issued first and when the complete lot is done with them the further receipt is considered for issue. In simple words, the closing inventory simply represent the stock which was procured at the last and thus represents the latest price.
This method is suitable during deflation, when the latest prices are low. The obvious reason being that the material procured at higher rates have already been absorbed and closing inventory thus appearing at a minimum level following the principles of conservatism.

Implications of FIFO Method in the Periods of Rising or Failing Prices :

          Period

   Implications of          FIFO Method 

 1) In Period of.       Rising Prices

 The value of the   closing stock will   increase, resulting   in higher profits.   As  a result tax   liability will also   increase.

 2) In Periods of   Falling Prices

 The value of   closing stock will   decrease,   resulting in lesser   profits. As a result   tax liability will   also decrease.

Advantages of FIFO Method -
Advantages of FIFO method are as follow :

1. Materials are issued on the basis of purchases.
2. It is very simple and  easily understandable.
3. The closing inventory is valued at the current level prices.
4. Mostly used in case of perishable goods.
5. Better to follow in case of deflation than inflation to reduce the tax liability.

Disadvantages of FIFO Method -
Disadvantages of FIFO method are as follows :

1. It is difficult to record the returns and rejected items.
2. Regular purchases and issues can make this cumbersome.
3. As in the warehouse, all the materials are kept together, there is no sure that the one which was purchased earlier is issued first.
4. Due to frequent price changes comparison between similar job become difficult.
5. If followed during inflationary situation, the value of the closing stock will be higher, there by tax liability will increase.

Example of FIFO Method :
From the following particulars relating to material A, show how the value of the issues should be arrived and the FIFO method .

             Date

        Particulars

 1-1-2019


 3-1-2019

 7-1-2019

 11-1-2019


 13-1-2019

 Opening stock 1000 units at Rs.5 each

 Purchases 900   units at Rs.6 each

 Issued 1200 units

 Purchased 800   units at Rs.6.20   each

 Issued 1000 units

 Solution - 

                          FIFO Method

                   Stores Ledger Account

 Date

 Receipts

 Issues

 Balance

 

 Jan

2019

Qty

Rate

Amt

Qty

Rate 

Amt

Qty

Rate

Amt 

 1

 -

 -

 -

 -

 -

 -

1000

 5

5000

 3

900

 6

5400

 -

 -

 -

1000

 5

5000

 

 

 

 

 

 

 

900

 6

5400

 7

 -

 -

 -

1000

200

 5

 6

5000

1200

700

 6

4200

 11

800

 6.20

4960

 -

 -

 -

700

800

 6

 6.20

4200

4960

 13

 -

 -

 -

700

300

 6

 6.2

4200

1860

500

 6.20

3100



2. Last In First Out (LIFO) Method -
Under this method, most recently purchased goods are released first. However, this assumption is made only for the purpose of valuing the issues of an inventory. This method operates in an inverse manner to FIFO method. The actual flow of inventory may differ. This method employs the price of the latest lot until all the units from the lot are exhausted. Afterwards it continuous with previous lots. If a new batch is received then such batch is considered to be the last lot.

Implications of LIFO Method in Different Time Periods :

 Period

Implications of LIFO Method

 1) In period of increasing prices

This method leads to lower profit as it matches old and higher cost with current revenues.

 2) In period of decreasing prices

This method leads to inflated profit as it matches old and lower cost with current revenues.


Advantages of LIFO Method -

Advantages of LIFO method are as follow :

1. This method is suitable for the time period when price is rising.
2. Since material is charged at the latest price level the cost of production is realistic.
3. It is easy to understand.
4. This leads to minimal unrealised gain.

Disadvantages of LIFO Method -
Disadvantages of LIFO method is as follows :

1. It does not conform to the physical flow of the goods.
2. Inventory is not priced at current market price.
3. Price comparison is different, if similar jobs are carried out using material from different lots.
4. This method is not supported by Income Tax Act or Accounting Conventions.
5. This method leads to inflated profit and tax liability in the time of downward prices and vice versa.
6. It can be difficult to calculate if there are frequent price changes.

Example of LIFO Method :
Prepare a store ledger account using LIFO method showing pricing of materials from the following transaction.

 Date

 Particulars

 2019

1 march

3 march

9 march

12 march

15 march

20 march

25 march


30 march

Opening stock 1000 units at Rs.20 each

Purchased 800 units at Rs.21 each

Issued 1200 units

Purchased 1600 units at Rs.24 each

Issued 1000 units

Issued 600 units

Purchased 1,000 units at Rs.25 each

Issued 800 units

 Solution :

                            LIFO Method

                  Stores Ledger Account

 Date

 Receipts

 

Issues

 

 Balance

Qty

Rate

Amt

Qty

Rate

Amt

Qty

Rate

Amt 

2019

Mar.

1

 -

 -

 -

 -

 -

 -

1000

20

20000

 3

800

 21

16800

 -

 -

 -

1000

800

20

21

20000

16800

 9

 -

 -

 -

800

400

 21

 20

16800

8000

600

20

12000

 12

1600

 24

38400

 -

 -

 -

600

1600

20

24

12000

38400

 15

 -

 -

 -

1000

 24

24000

600

600

20

24

12000

14400

 20

 -

 -

 -

600

 24

14400

600

20

12000

 25

1000

 25

25000

 -

 -

 -

600

1000

20

25

12000

25000

 30

 -

 -

 -

800

 25

20000 

600

200

20

25

12000

5000

 

  • Difference Between FIFO and LIFO Method -

 Basis of

 Differences

 FIFO

 LIFO

 1. Basic assumptions

Under this method material purchased first is issued first.

Under this method material purchased last is issued first.

 2. In case of rising prices

Higher income is reported since old cost are matched with current revenue. As a result Income Tax liability is increased.

Lower  income is reported since current cost are matched with current revenue. As result Income Tax liability is reduced.

 3. Cost of goods sold

Cost of goods sold consists of cost of earlier purchases.

Cost of goods sold equales to cost of recent purchases.

 4. Distortion in balance sheet

Balance sheet shows the ending inventory at a value near the current market price.

Balance sheet is distorted because ending inventory is understated at old cost.

 5. ending inventory

Inventory valuation is done using cost of recent purchases.

Ending inventory represents cost of Ariel purchases.

 

3. Simple Average Price Method -

When the material are kept in store and they are homogeneous in nature, they tend to get mixed up with each other in a way that they lost their identity. This makes it rather difficult or almost impossible at times to identify the lot to which the material belongs and when the above was procured. So, for pricing purpose the average price is considered till the time the existing lot is totally consumed. Further, when a new lot is purchased, the price is re-computed again.
The formula for calculation of average price is as follows :
                             Total unit prices of
                             All lots in stores
Average price = -----------------------------------
                            Total no. of unit prices

Note : The price for lot that has been totally issued on FIFO method is not taken into consideration.

Advantages of Simple Average Price Method -
Following are the advantages of simple average price method :

1. The end result are often accurate when identical purchases are made at a similar rate.

2. Even through the purchases are being made at an inflated or deflected rate, the prices are not affected much.

3. Simplicity of the method makes it easily operational.

Disadvantages of Simple Average Price Method -
Disadvantages of simple average price method are as follows :

1. Closing inventory is not easily identifiable.

2. As the material issued carries a different price then the price at which it was procured. There will arise certain profit or loss in this case.

3. The end results may not be accurate where the purchasers are not similar and when there is fluctuation in prices.

4. Number of units at level of price is ignored. Weighted is only given to the prices and not be quantity. This makes this method impractical.

5. Closing inventory may appear to be negative in inflationary situation.

Suitability -
Simple average price method is suitable in the following cases :
1. When prices at which the purchases are made do not very much.

2. It will give accurate outcome only when the material is procured in uniform numbers.

Example :
Prepare a store ledger account by simple average method from the following transaction.

 Date

 Particulars

 2019

1 sept.


5 sept.


7 sept.


13 sept.


18 sept.


21 sept.

26 sept.


29 sept.


Opening stock 1200 units at Rs.14 each

Purchased 600 units at Rs.15 each

Issued 1000 units

Purchased 1800 units at Rs.16 each

Issued 1200 units

Issued 400 units

Purchased 800 units at Rs.18 each

Issued 1000 units

Solution :
              Simple Average Method
               Stores Ledger Account

Date

Receipts

Issues

Balance

Qty

Rate

Amt

Qty

Rate

Amt

Qty

Rate

Amt

2019

Sept.

 1

 

-

 

-

 

-

 

-

 

-

 

-


1200


 14


16800

 5

600

 15

9000

 -

 -

 -

1600

 -

25800

 7

 -

 -

 -

1000

14.50

14500

800

 -

11300

 13

1800

 16

28800

 -

 -

 -

2600

 -

40100

 18

 -

 -

 -

1200

15.00

18000

1400

 -

22100

 21

 -

 -

 -

400

16.00

6400

1000

 -

15700

 26

800

 18

14400

 -

 -

 -

1800

 -

30100

 29

 -

 -

 -

1000

17.00

17000

800

 -

13100

Working Note :
1) First issue price on 7th September : Cumulative receipts 1800, cumulative issues : nil.
              14+15
SAP = ---------------- = 14.50
                   2

2) Second issue price on 8 sept. : cumulative receipts 3600, cumulative issues : 1000
           14+15+16
SAP = ---------------- = 15.00
                   3

3) Third issue price on 21 Sept. : cumulative receipts 3600 : cumulative issues : 2200
As 2200 units exceed stock as on 1st September and stock received on 5th September, i.e. 1800 units, the rate Rs.14 and Rs.15 will not be considered for calculating simple average price.
              16
SAP = --------- = 16.00
                1

4) Fourth issue price on 29 sept. : cumulative receipt 4400, cumulative issues : 2600
As 2600 unit exceed stock as on 1st September and stock received on 5th September i.e. 1800 units at Rs.14 and Rs.15 will be ignored.
              16+18
SAP = ---------------- = 17.00
                   2

5) Closing Stock = opening stock + receipts - consumption or issues
= (16800+9000+28800+14400)-(14500+18000+6400+17000)
= 16000+52200-55900
= 13100

4. Weighted Average Price Method -
Weighted average price of the materials procured is considered and the quantity is duly taken into account. This method follows a practical approach as compared with the other methods. The issue price calculated is a realistic one and in ratio of the material procured. Every time a new lot is procured. Weighted average price is recomputed.
The formula for calculating weighted average price is as follows :
             Total cost of materials in stock
WAP = ---------------------------------------------------
           Total quantity of material in stock

This method is not suitable when the quantity in each lot varies.

Advantages of Weighted Average Price Method -
Following are the advantages of weighted average price method :

1. There is not much of critical work as the price of issue is constant till the expiry of the current lot.

2. Which method is simple and easy.

3. The value of closing inventory calculated is quite accurate and can be taken into consideration while preparation the financial statements.

4. When prices fluctuate the debits are set off as against the credits, thus no profit and loss exist on account of issues.

Disadvantages of Weighted Average Price Method -
Following are the disadvantages of weighted average price :

1. In order to minimize clerical error, calculations are made to 4/5 decimal places, which makes the job tedious.

2. Closing inventory is valued at per the calculations and not the current cost.

3. The issues continue to be made at a fixed price even after the previous lot of stock has been totally consumed till the new stock comes in.

Example :
Using the given transactions prepare a store ledger account by weighted average method.

  Date

 Particulars

 2019

1 march


3 march

9 march

12 march


15 march

20 march

25 march


30 march

Opening stock 1000 units at Rs 20 each

Purchased 800 units at Rs.21 each

Issued 1200 units

Purchased 1600 units at Rs.24 each

Issued 1000 units

Issued 600 units

Purchase 1000 units at Rs.25 each

Issued 800 units

Solution :
                        Weighted Average Method
                          Stores Ledger Account

 Date


2019

 Receipts

 Issues

 Balance

Qty

Rate

Amt

Qty

Rate

Amt

Qty

Rate

Amt

Mar.

 1

 -

 -

 -

 -

 -

 -

1000

20.00

20000

 3

800

 21

16800

 -

 -

 -

1800

20.44

36800

 9

 -

 -

 -

1200

20.44

24528

600

20.44

12272

 12

1600

 24

38400

 -

 -

 -

2200

23.03

50672

 15

 -

 -

 -

1000

23.03

23030

1200

23.03

27642

 20

 -

 -

 -

600

23.03

13818

600

23.03

13824 

 25

1000

 25

25000

 -

 -

 -

1600

24.26

38824

 30

 -

 -

 -

800

24.26

19408

800

24.26

19416

Working Notes :

1) First issue price on 3rd March -
              20000+16800
WAP = ------------------------- = 20.44
                1000+800

2) Secound issue price on 12 March -
              50672
WAP = ------------- = 23.03
               2200

3) Third issue price material not purchased -
WAP = 23.030

4) Fourth issue price on 25 march -
               13824+25000
WAP = -------------------------- = 24.26
                  600+1000

The fresh issue rate is determined after each purchase and not at the time of his issue. Thus, as soon as fresh supply is received, a new price is calculated and all issues are then valued at that price until the next reply is received when a new issue price will be calculated.

  • Other Methods -

1. Standard price method -
All the materials are then issued at this price only for the entire period. Standard price should remain fixed for short period in case, the prices fluctuate heavily and should be constantly reviewed and revised.
After taking into consideration various factors like :
a) Current Prices
b) Anticipated Market Trends
c) Discount Available
d) Transport Charges etc.
A standard price is fixed for a certain period.

2. Specific price method -
When materials are procured for a specific job or a work order, then the actual cost of purchase is allocated to that material supply. The materials procured for a specific purpose are separately market out for the purpose of issue.
For example : a second hand car dealer has various models of car to resale. In this cost, the cost of each and every car is separately earmarked.

3. Base stock method -
This base stock is always kept at the historical price irrespective of the changes in the price level thus it is just like a fixed asset. Under this method, a minimum stock known as the base stock is held to meet the emergencies and the shortage. The stock in excess of this base stock is valued as per the different methods like, FIFO, LIFO, Weighted Average etc. as per the policy and practice of the company.

4. Highest in first out method -
This method assume the principle of conservatism. The materials with highest purchase price are issued is usually followed by materials at the low prices, irrespective of their date of purchase. It presume that, under inflectional situation product can absorb the extra burden of increased prices and thus be allocated leaving low priced materials for deflation.

5. Periodic simple average price method -
Just like simple average price method , issue price is calculated the only difference being that the price calculated is fixed for a particular period and not for a particular issue.
             Total of purchase prices.                                   during the period
PSA = -------------------------------------------------
            No. of prices during the period

In other words, the total amount paid during a period for various purchases is added up and is divided by the quantity of the material purchased to arrive at a rate for valuing the closing inventory.

6. Moving simple average price method -
This method calculated the value of material issued by using periodic simple average price of the material during the given period. This amount is divided by the number of periods.
               Periodic simple average price
MSAP = --------------------------------------------------
                Numbers of periods

For this purpose it is necessary to first determine the number of periods to be employed. The business may decide to use two months simple average or three months simple average to suit its requirement.

7. Moving weighted average method -
This method divides the total of periodic weighted average prices for a given period of time with the given number of period to obtain moving weighted average price.
               Periodic weighted average price
MWAP = -----------------------------------------
                 Number of periods

This method is widely known to be more precious at it take both the prices and quantities for the purpose of calculations.

8. Replacement price method -
Every time the materials are issued their market prices checked. This market price is taken as the replacement price and the issues are recorded at this price.

9. Next in first out method -
In this method the price quoted in the large purchase forms a base to record the material issues. But a problem may occure when the price on the date of the delivery is different from that of the purchase order price.

10. Re use price method -
When the finished products are used alternatively instead of the original use, then it is priced altogether differently to what it would have been originally priced. There is no certain procedure to values such issues.

11. Inflated price method -
In order to cover natural losses like, pilferage, evaporation etc .the price of the issues are instructed to the extent to absorb the amount of losses. This is known as the infected price method.

12. Periodic weighted average price method -
Under this method, a new weighted average price is used at the end of a defined period such as a month or a fortnight. Following formula is used for this purpose :
                 Total cost of materials                 
                 purchased during the period
PWAP = ---------------------------------------
                Total quantity purchased
                      during the period

Conclusion :

1. Weighted average method is preferred where prices do not change frequently as it spreads the input more frequently.

2. In case of rising prices of purchase if production cost are lower and stock value are higher in the FIFO method, revised by LIFO method. Weighted and simple average methods both spread the rising purchase cost between production and closing stock, weighted average method equitably, simple average erratically.

3. Complete cost of receipts will be covered while the issue of closing stock when FIFO. LIFO weighted average method is used, whereas while use of simple average method gain or loss will be created.

4. Given that prices change frequently weighted average method involves more calculations and may not produce an exact unit price. FIFO and LIFO methods would be preferable since no calculations are necessary to establish the issue prices throughout the year.