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Controlling and Costing Materials Inventory
Controlling and Costing Materials Inventory
Costing Problem
To illustrate the problem of costing materials inventory, assume that the materials ledger card shows
unit prices of materials purchases ranged from P100 to P175. Assume further that 150 units of materials
are issued and 25 units are on hand at the end of the month.
If other factors remain the same, the higher the ending inventory valuation, the lower the cost of goods
sold resulting in greater profits or smaller losses. On the other hand, the lower the ending inventory
valuation, the higher the cost of goods sold, resulting in a smaller profit and greater losses.¹
When the inventory items are few and are not ordinarily interchangeable, specific identification
technique may be used. Specific identification of cost means that specific costs are attributed to identify
items of inventory.¹
When there are large numbers of items of inventory that are usually interchangeable, perpetual
inventory system is usually used. Under the system, unit costs and total costs should be computed each
time materials are received or issued. The primary basis of inventory valuation is cost.¹
There are three methods to determine the cost of ending inventory to be reported These methods are
as follows:
a. First in first out (FIFO) method – Under this method, the first materials purchased (the oldest or
earliest) are the first materials to be used. The materials on hand are therefore assumed to be
the last one purchased.¹
b. Last in, first out (LIFO) method – Under this method, the last materials purchased (the most
recent) are the first materials (the most recent) are the first materials to be used. The materials
on hand are assumed to be the first one purchased.¹
c. Moving average method – In this method, all costs are commingled and an average cost is
computed with each new purchase and assigned to materials issued and on hand.¹
¹Pedro P. Guerrero, Cost Accounting – Principles and Procedural Applications, 2018 Edition
Illustration: To illustrate the application of these methods, assume the following transactions relating to
Material IJ-4, ink jet:
May 1: The beginning balance on hand is 150 units, costing P150 each.
10: 180 units are issued for use per Requisition 10.
25: 10 units are returned to the storeroom as noted on Returned Materials Report 3. These units
had been issued on May 10 for use on Requisition 10.
The materials ledger card shows the transactions relating to Materials IJ-4 are recorded under the FIFO
method:
Arguments in favor of the first in, first out method are that that it is easier and less costly to use because
FIFO requires less record keeping.; it reflects the actual physical flow of goods; and that the inventory
shown in the balance sheet is more relevant because it includes the most recent costs.¹
A strong argument against the first in, first out method is that it does not match current costs against
current sales revenue, because under this method, the ending inventory is priced at the most recent
costs, resulting on the cost of goods sold to be priced at the oldest costs. When the net income is
computed, the cost of goods sold that is deducted from sales revenue does not include the most recent
costs.¹
Using the same transactions for Material IJ-4, the Materials Ledger Card under the LIFO method is
shown below:
The argument against the LIFO is that it represents an unrealistic physical flow of goods.¹
Under this method, the units and cost of each new purchase are added to the balances already on hand
when the purchase is received and a new average cost per unit is computed. When materials are issued,
they are charged out at this average cost until another purchase is received or a return is recorded,
when a new average cost per unit is computed.¹
One advantage of the moving average method is that it is relatively simple to apply, especially with
computers. Moreover, the moving average method produces inventory valuation that approximates
current value if there is a rapid turnover of inventory.¹
The main argument against the moving average method is that there may be a considerable lag between
the current cost and inventory valuation since the average unit cost involves early purchases.¹
Philippine Accounting Standards (PAS) No. 2 (Inventories) prescribes the use of FIFO and the Moving
Average Methods to compute the cost of inventories. LIFO is no longer permitted under PAS 2.¹
Pedro P. Guerrero, Cost Accounting – Principles and Procedural Applications, 2018 Edition