FIFO, LIFO, Simple & Weighted Average - Material

Cost
-Shilpa Prakash

Materials issued from stores are debited to the jobs or work orders
which received them and credited to the materials account. These jobs
are debited with the value of materials issued to them. But what is the
value of materials? Theoretically the value includes the invoice price
less trade discount, the freight, cartage and insurance on incoming
materials, expenses of purchase, receiving, storing and record keeping
and carriage from the stores up to the process plant. However, in
practice, it involves minute calculations for including all these expenses
and is a big task compared to the benefit derived from it.
Moreover the price changes according to the market conditions and at
any given time there will be stock of materials purchased at different
times at different prices. Hence the problem as to at what price the
materials should be issued?
There are many methods of pricing material issues. The most important
being: FIFO, LIFO, simple and weighed average methods.

1) First in First Out (FIFO)

Under this method material is first issued from the earliest consignment
on hand and priced at the cost at which that consignment was placed in
the stores. In other words, materials received first are issued first. The
units in the opening stock of materials are treated as if they are issued
first, the units from the first purchase issued next, and so on until the
units left in the closing stock of materials are valued at the latest cost of
purchases. This method is most suitable in times of falling prices
because the issue price of materials to jobs or work order will be high
while the cost of replacement of materials will be low. But in case of
rising prices this method is not suitable because the issue price of
materials to production will be low while the cost of replacement of
materials will be high.
Advantages:
(i) Since materials issued for production are at the original cost, the
inventory reflects the current market price,
(ii) Profit and Loss Account and the Balance Sheet satisfactorily
represent the actual conditions,
(iii) When the price level is declining, the FIFO method shows a lower
profit for income tax implications,
(iv) Next to the Average Cost Method, FIFO is the most commonly
accepted basis of valuation of issue, and
(v) The method simplifies computation of the values of issues.

Demerits:
(i) When there are price-fluctuations FIFO method makes the cost of
production fluctuating from period to period,
ii) At the time of increasing price-level this method shows profit and
inventory at higher figures which have unfavourable income tax
implications.

Illustration 1: The following is a history of the receipts and issue of

motives in a factory during February, 2004:

Issues are to be priced on the principles of FIFO. Stock verifier of

the factory noted on 15th a shortage of 5kgs. Write out the
complete Store ledger account in respect of the above motives for
February, 2004.
Solution.

2) Last in First Out (LIFO)

Under this method, issues are priced in the reverse order of purchase
i.e., the prices of the latest available consignment is taken. This method
is suitable in times of rising prices because material will be issued from
the latest consignment at a price which is closely related to the current
price levels. Valuing material issues at the price of the latest available
consignment will help the management in fixing the competitive selling
prices of the products.

Advantages:
This method claims a few advantages:
(a) The issue will be priced at the market rate prevailing, more or less,
near the date of issue. This has the advantage of ascertaining the cost at
about the prevailing market price and the cost thus ascertained will
enable the prices to be fixed on competitive basis.
(b) The principle of costing the goods at cost has not been given up.
(c) In case of rising prices the method has the advantage of showing a
lower profit which may help in saving tax to some extent. It is not
without reason that this method has come into use only when prices
have been steadily rising.

Disadvantages:
(i) The disadvantages of this method are the same as those of the FIFO
method, namely, excessive clerical labour and differing costs of similar
jobs using similar materials.
(ii) Under this method the inventory is shown at the oldest market price
and so does not reflect the current conditions,
(iii) Since the inventory value at the end of a period is out of date, large
adjustment may be necessary, if the cost or market rule is applied.

Illustration 2: The received side of the Stores Ledger Account shows

the following particulars:
Jan. 1 Opening Balance: 500 units @ Rs.4

Jan. 5 Received from vendor: 200 units @ Rs.4.25

Jan.12 Received from vendor: 150 units @ Rs.4.10

Jan.20 Received from vendor: 300 units @ Rs.4.50

Jan.25 Received from vendor: 400 units @ Rs.4

Issues of material were as follows:
Jan. 4- 200 units;
Jan.10- 400 units;
Jan. 15- 100 units;
Jan 19- 100 units;
Jan.26- 200 units;
Jan.30- 250 units.
Issues are to be priced on the principle of “first in first out”. Write the
Stores Ledger Account in respect of the materials for the month of
January.

Solution:
Stores Ledger Account

Receipts Issues Balance

Partic
Date
ulars Amo
Quant Quan
Total Unit c Total Unit c Quant unt Per
ity tity
Cost ost Cost ost ity ( unit(
(Units (units
(Rs) (Rs) (Rs) (Rs) (units) R Rs)
) )
s)

Jan Balan 20
- - - - - - 500 4
1 ce b/d 00

Requi
Jan sition 12
- - - 200 800 4 300 4
4 slip 00
no.

Goods
receiv
Jan 12
ed 200 850 4.25 - - - 300 4
5 00
note
no.

85
200 4.25
0

Requi
Jan sition
- - - 300 1200 4
10 slip
no.
 42
100 425 4.25 100 4.25
5

Goods
receiv
Jan 42
ed 150 615 4.10 - - - 100 4.25
12 5
note
no.

61
150 4.10
5

Requi
Jan sition 61
- - - 100 425 4.25 150 4.10
15 slip 5
no.

Requi
Jan sition 20
- - - 100 410 4.10 50 4.10
19 slip 5
no.

Goods
receiv
Jan 20
ed 300 1350 4.50 - - - 50 4.10
20 5
note
no.

13
300 4.50
50

Goods
receiv
Jan 20
ed 400 1600 4.00 - - - 50 4.10
25 5
note
no.

13
300 4.50
50

16
400 4.00
00
 Requi
Jan sition 67
- - - 50 205 4.10 150 4.50
26 slip 5
no.

16
150 675 4.50 400 4.00
00

Requi
Jan sition 12
- - - 150 675 4.50 300 4.00
30 slip 00
no.

100 400 4.00

Illustration 3: Prepare Stores Account on Last in First Out method

assuming the same particulars as in Illustration 2:

Solution: LIFO Method

Receipts Issues Balance

Dat Particul Quanti Tot Quanti Tot Quanti Amou

e ars Unit Unit Per
ty al ty al ty nt
cost( cost( unit(
(Uni Cost( (uni Cost( (uni (R
Rs) Rs) Rs)
ts) Rs) ts) Rs) ts) s)

Jan Balance 20
- - - - - - 500 4
1 b/d 00

Requisiti
Jan 12
on slip - - - 200 800 4 300 4
4 00
no.

Goods
Jan 12
received 200 850 4.25 - - - 300 4
5 00
note no.

85
200 4.25
0
 Requisiti
Jan
on slip - - - 200 850 4.25
10
no.

4.0 40 4.0
200 850 100
0 0 0

Goods
Jan 40 4.0
received 150 615 4.10 - - - 100
12 0 0
note no.

61 4.1
150
5 0

Requisiti
Jan 4.1 40 4.0
on slip - - - 100 410 100
15 0 0 0
no.

20 4.1
50
5 0

Requisiti
Jan 4.1
on slip - - - 50 205
19 0
no.

4.0 20 4.0
50 200 50
0 0 0

Goods
Jan 135 20 4.0
received 300 4.50 - - - 50
20 0 0 0
note no.

13 4.5
300
50 0

Goods
Jan 160 20 4.0
received 400 4.00 - - - 50
25 0 0 0
note no.

13 4.5
300
50 0

16 4.0
400
00 0

Requisiti
Jan 4.0 20 4.0
on slip - - - 200 800 50
26 0 0 0
no.
 13 4.5
300
50 0

80 4.0
200
0 0

Requisiti
Jan 4.0 20 4.0
on slip - - - 200 800 50
30 0 0 0
no.

4.5 11 4.5
50 225 250
0 25 0

3) Simple Average Method

In this method, price is calculated by dividing the total of the prices of
the materials in the stock from which the material to be priced could be
drawn by the number of the prices used in that total. This method may
lead to over-recovery or under-recovery of cost of materials from
production because quantity purchased in each lot is ignored.

Advantages:
(a) It is simple to work out & apply.
(b) Issue price cannot be affected considerably by the fluctuations in
prices of purchase.
(c) Average cost method is suitable for the condition when different
lots of purchases get mixed up so that the identification is not possible.
(d) Where the quantity of each purchase is stable but the prices
fluctuate, average cost method suits the condition.

Disadvantages:
(a) Profit or loss in material arises as total cost incurred usually does
not become equal to the total charges.
(b) Frequent calculations of rates will be necessary in case of frequent
purchases, thereby involving much clerical work. Average rate may
have to be revised due to exhaustion of an existing stock even if no new
purchase comes.
(c) Too much profit or loss on materials may be resulted from the
method, when lots of purchases vary much in quantities.
(d) Due to fact that the identity of the materials disappeared in the
store, the verification of closing stock figures becomes difficult.
(e) Absurd figures may be shown by the closing stock. The closing
stock account may even show credit balance, in times of inflationary
spiraling.
The simple average method can work well where:
(a) in each lot, there is standard quantity of purchase
(b) there is very mild fluctuation in prices.

Illustration 4:
From the details prepare stores ledger under simple average
method.

Shortage of 40 kg on 16.12.2010 & another shortage of 40 kg on

26.12.2010 is found by the stock verifier.
Workings: Calculation of simple average price:-
For Issue on 8th Dec = (1.25+1.30)/2 = $ 1.275
For Issue on 10th Dec = $ 1.30
For Shortage on 16th Dec = (1.30+1.35)/2 = $ 1.325
For Issue on 18th Dec = $ 1.325
For Issue on 25th Dec = (1.35+1.40)/2 = $ 1.375
For Shortage on 26th Dec = $ 1.40
For Issue on 28th Dec = $ 1.40

Eg:-
1000 units purchased @ Rs.10
2000 units purchased @ Rs.11
3000 units purchased @ Rs.12
In this example, simple average price will be Rs.11 calculated as
below:
4) Weighted Average Methods
In this method, price is calculated by dividing the total cost of materials
in the stock from which the materials to be priced could be drawn by
the total quantity of materials in that stock.
In the above example, the weighted average price is Rs.11.33 per unit
calculated as follows:

In the periods of heavy fluctuations in the prices of materials, the

average cost method gives better results because it tends to smooth out
the fluctuations in prices by taking the average of prices of various lots
in stock.

Advantages:
(a) The effect of price fluctuations on issue rates are smoothened
effectively by the method.
(b) The rate continues in its application unless a new purchase arrives.
(c) Only if, in the calculation of the rates, mathematical approximation
is made then profit or loss on materials arises.
(d) Simple & not too much clerical work is involved unless purchases
are made frequently.
(e) Where both the price & quantity ordered fluctuate, this method suits
the condition.

Disadvantages:
(a) The work of calculation of rates becomes considerable in case
where a frequent purchase is made.
(b) The cost price (nor the market price) of the materials actually issued
are not represented by the charges made to issues.
(c) Unless the rates are calculated correcting up to 4 or 5 places of
decimal whenever necessary, profit or loss on materials may be created
by the method.