Average Price Methods:

(e) Simple average price method. (f) Weighted average price method. (g) Periodic simple average price method. (h) Periodic weighted average price method. (i) Moving simple average price method. (j) Moving weighted average price method. 3. Market Price Methods:

(k) Replacement price method. (l) Realizable price method. 4. Notional Price Methods:

(m) Standard price method.

We may now briefly discuss all the above methods:

(a) Specific Price Method- This method is useful, specially when material are purchased for a specific job or work order, and as such these material are issued subsequently to that specific job or work order at the price at which they are purchased to use this method, It is necessary to store each lot of material separately and maintain its separate account. The advantages and disadvantage of this method are :

Advantages:

1- The cost of material issued for production purposes to specific job represent actual and correct cost.

2- This method is best suited for non-standard and specific products.

Disadvantage: This method is difficult to operate, specially when purchases and issues are numerous. (b) First –in – First Out Method (FIFO): It is a method of pricing the issues of materials. Under this method, the materials first received in the store are the first issued. In other words, the order in which the materials are received in the store are first issued at their cost price in the same order or the items longest in stock are issued first. Thus each issue of material only recovers the purchase price which does not reflect the current market price.

This method is considered suitable in times of failing price because the material cost charged to production will be high while the replacement cost of materials will be low. But in the case of rising prices, if this method is adopted, the charge to production will be low as compared to the replacement cost of materials (as in the current period) in future without having additional capital resources.

The advantages and disadvantages of the method may be stated as follows: Advantages:

2. Material cost charged to production represents actual cost with which the cost of production should have been charged.

3. In the case of falling prices, the use of this method gives better results.

4. Closing stock of material will be represented very closely at current market price.

5. The old material is issued first. Thus, there remains no possibility of loss of material due to spoilage or obsolescence.

Disadvantages:

1. If the price fluctuates frequently, this method may lead to clerical error.

2. Since each issues of material to production is related to a specific purchase price, the cost charged to the same job are likely to show a variation from period to period.

3. In the case of rising prices, the real profits of the concern being low, they may be inadequate to meet the concern’s demand to purchase raw materials at the ruling price.

Illustration - 3:

Prepare store ledger account as per FIFO method from the following data: Receipt of Materials Rate Materials Issued

Date Units per unit Date Units Rs.

April 1, 2008 opening balance 1,000 5 April 4,2008 3,000 April 3, 2008 5,000 6 April 6,2008 2,000 April12, 2008 3,000 5 April 15,2008 1,500 The weekly stock taking on April 7, 2008 showed on shortage of 150 units.

Solution:

(c) Last – in – First Out Method (LIFO): It is a method of pricing the issues of materials. This method is based on the assumption that the items of the last batch (lot) purchased are the first to be issued. Therefore, under this method the price of the last batch (lot) is used for pricing the issues, until it is exhausted, and so on. If however, the quantity of issue is more than the quantity of the latest lot than earlier (lot) and its price will also be taken into consideration.

Store Ledger Account

Date

Receipts Issues Balance +

Units Rate Amount Units Rate Amount Units Rate Amount

2007 Apr.1 Apr.3 Apr.4 Apr.6 Apr.7 Apr.12 Apr.15 ― 5,000 ― 3,000 Rs. ― 6 ― 5 Rs. ― 30,000 ― 15,000 ― ― 1,000 2,000 2,000 150 ― 850 650 Rs. ― ― 5 6 6 6 ― 6 5 Rs. ― ― 17,000 12,000 900 ― 8,350 1,000 1,000 5,000 3,000 1,000 850 850 3,000 2,350 Rs. 5 5 6 6 6 6 6 5 5 Rs. 5,000 35,000 18,000 6,000 5,100 20,100 11,750  Wastage is treated as abnormal.

During inflationary period or period of rising prices, the use of LIFO would help to ensure that the cost of production determined on the above basis is approximately the current one. This method is also useful specially when there is a feeling that due to the use of FIFO or average methods, the profits shown and tax paid are too high.

The advantages and disadvantages of LIFO method are as follows: Advantages:

1- The cost of materials issued will be either nearer to and or will reflect the current market price. Thus, the cost of goods produced will be related to the trend of the market price of materials. Such a trend in price of materials enables the matching of cost of production with current sales revenues. 2- The use of the method during the period of rising prices does not reflect undue high profit in the income statement as it was under the FIFO or average method. In fact, the profit shown here is relatively lower because the cost of production taken into account the rising trend of material prices. 3- In the case of falling prices profit tends to raise due to lower material cost, yet the finished products

appear to be more competitive and are at market price.

4- Over a period, the use of LIFO helps to level out the fluctuations in profits.

5- In the period of inflation LIFO will tend to show the correct profit and thus avoid paying undue taxes to some extent.

Disadvantages:

1. Calculation under LIFO system becomes complicated and burdensome when frequent purchases are made at highly fluctuating rates.

2. Costs of different similar batches of production carried on at the same time may differ a great deal. 3. In time of falling prices, there will be need for writing off stock value considerably to stick to the

principle of stock valuation, i.e., the cost or the market price whichever is lower. 4. This method of valuation of material is not acceptable to the income tax authorities.

5. The closing stock is priced at a very old price which does not show the correct position of the business.

Illustration - 4:

With the help of the following particulars, prepare stores account showing issue of materials on the basis of Last in, First out:

Purchases Issues August 3,2008 750 kg @ Rs. 2.00 August 19,2008 850 kg August 18,2008 350 kg @ Rs. 2.10 August 26,2008 450 kg August 25,2008 600 kg @ Rs. 2.20 August 29,2008 510 kg August 28,2008 500 kg @ Rs. 2.30 August 30,2008 150 kg

(d) Base Stock Method: A minimum quantity of stock under this method is always held at a fixed price as reserve in the stock, to meet a state of emergency, if it arises. This minimum stock is known as base stock and is valued at a price at which the first lot of materials is received and remains unaffected by subsequent price fluctuations.

Thus, this is more a method of valuing inventory than a method of valuing issued because, with the base of stock valued at the original cost some other method of valuing issues should be adopted. The quantity in excess of the base stock may be valued either on the FIFO or LIFO basis. This method is not an independent method as it uses FIFO or LIFO. Its advantages and disadvantages therefore will depend upon the use of the other method viz., FIFO or LIFO.

(e) Simple Average Price Method: Under this method, materials issued are valued at average price, which is calculated by dividing the total of all units rate by the number of unit rate.

Total of unit prices of each purchase Material issue price

Total number of purchase

 

This method is useful under the following circumstances:

1. When the materials are received in uniform lots of similar quantity, otherwise, it will give wrong