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1. The First-In-First-Out Method (FIFO)

This method assumes that the first inventories bought are
the first ones to be sold, and that inventories bought later
are sold later.

This method is based on the assumption that materials, which are

purchase, first are issued first. It uses the price of the first batch of
materials purchased for all issues unit all units from this batch have
been issued. After the first batch is fully issued. The price of the
next batch received becomes the issue price. Upon this batch also
fully used, the price of the still next batch is used for pricing and so
on. In other words, the materials are issued at the oldest cost price
listed in the stores ledger account and these materials in stock are
valued at the price of the latest purchases.
Three important effects of using Fifo method are;
(a) Materials are priced at the actual cost.
(b)Charge to production for material cost is at the oldest prices
materials in stock.
(c) Closing stock is valued at the latest price paid.

Advantage,
The following advantages are claimed for FIFO method;

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1 it is base on a realistic assumption that materials are issued in

the order of their receipt.
2 materials are issued at actual cost and thus no unrealized
profit/loss arises from the operation of this method.
3 Valuation of closing inventory is at coast as well as that the latest
prices paid.
4 This method is easy to understand and simple to operate.

Disadvantage,
The main disadvantages of this method are;
1 as materials are charged to production at the old prices, the cost
of production may lag behind the current economic values.
2 This method does not permit comparison of the costs of similar
jobs or cost units because simultaneously started may be charged
materials at different prices.
3 when prices are subject of frequent changes this method involves
cumbersome records and calculations.
In periods of rising prices, the FIFO method produces their profits
and results in higher tax liability because lower cost is charged to
production. Conversely, in periods of falling prices, the FIFO method
produces lower profits and results in lower taxes because they are
derived from a higher cost of goods sold.

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The value of our closing inventories in this example would be

calculated as follows:

2. The Last-In-First-Out Method (LIFO)

This method assumes that the last inventories bought are
the first ones to be sold, and that inventories bought first
are sold last.
This method operates in just reverse of other of FIFO method. It is
based on the assumption that the last materials purchased are the
first materials issued. Thus the price of the last batch of the
materials purchased is used first for all issued until all units form
this batch have been issued after which the price of the previous

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batch of materials purchased is used. It should be noted that

physical flow of materials may not conform to LIFO assumption.
Three points should be noted regarding this method;
(a) Material issues are priced at actual cost.
(b)Charge to production for material cost is at latest prices paid.
(c) Closing stock valuation is at the olds prices paid and is completely
out of line with the current prices.

Advantages
The main advantages of this method are
1 material is charged to production at the latest prices paid. In time
of rising prices, quotation of price for company product will be sage
and profitable.
2 this method, like FIFO, does not result in any unrealized profit or
loss.
3 this method is also quite simple to operate particularly when
prices are fairly steady.

Disadvantages.
This method suffers from the following disadvantages:
1 this method is not realistic, as it does not conform to the physical
flow of materials.
2 the closing stock is valued at the old prices and does not
represent the current economic values.
3 like FIFO method in this method as well, the material cost of
similar jobs may differ because materials were issued from different

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lots and this at different prices, and this renders comparisons

difficult.
4 this method is cumbersome when price are subject to frequent
fluctuations, in periods of rising prices, profit and tax liability under
Lifo would be lower than under Fifo method because cost will be
charged at current prices which are at higher level. Conversely, in
periods of falling prices, closing stock is valued at old prices, which
are tat higher level, and thus profit would also be higher resulting in
higher tax liability.

The value of our closing inventories in this example would be

calculated as follows:

Using the Last-In-First-Out method, our closing inventory comes to

$1,000. This equates to a cost of $1.00 per lollypop ($1,000/1,000
lollypops).
The LIFO method is commonly used in the U.S.A.

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3. The Weighted Average Cost Method

This

method

assumes

that we

sell

all

our

inventories

simultaneously.

The weighted average cost method is most commonly used in

manufacturing businesses where inventories are piled or mixed
together and cannot be differentiated, such as chemicals, oils, etc.
Chemicals bought two months ago cannot be differentiated from
those bought yesterday, as they are all mixed together.

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So we work out an average cost for all chemicals that we have in

our possession. The method specifically involves working out an
average cost per unit at each point in time after a purchase.
In our example above (assuming the weighted average cost
method was allowed for valuing the lollypops), the value of our
closing inventories would be calculated as follows:

Using the weighted average cost method, our closing inventory

amounts to $1,059. This equates to a cost of $1.06 per lollypop
($1,059/1,000 lollypops).
Oddly enough, the LIFO method is the preferred inventory
valuation method in the United States but is disallowed in non-US
countries. The FIFO method and the weighted average cost method
are used in non-US countries. In recent years there have been calls
for the standardization of accounting rules throughout the world,
and talk specifically about disallowing LIFO in the US (or making
the rest of the world follow the LIFO system). As of this writing the
matter has not been resolved and the differences in inventory
valuation still exist.

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Average Cost Method.

These methods are based on the assumption that when materials
purchased in different lots are stored together, their identity is lost
and therefore, these should be charged at an average price,
Basically, average prices are of two type simple average and
weighted average.

3Simple average Method,

Simple average price is calculated by adding all the different prices
of materials in stock, from which the materials to be prices could be
drawn, by the number of prices used in that total. This method
does not take into account the quantities of materials in stock while
calculation the average. Suppose, the following three lots of
materials are in stock when material is to be issued
500 units purchased @ Rs. 20
200 units purchased @ Rs 21
700 units purchased @ Rs 22
Simple average price=20+21+22/3=21

Advantages and Disadvantages of Simple Average Method:

The only advantage that this method enjoys is its simplicity, No
more can be said in favor of this method as it pays no consideration
to the relative quantities held at each price. For this method is

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considered unscientific and it usually produces unsatisfactory

results. The value of closing stock may be negative which is quite
absurd. For instance if 100 units at Rs 10 each and 1000 unit at Rs2
each are held in stock at a total value if Rs. 3,000, when 600 units
are issued at a simple average price of Rs6 each. The closing stock
of 400 units will be valued at a negative value of Rs600 which is
absurd. These figures have been exaggerated to illustrate the
point. Another disadvantage of these methods is that this method
does not charge materials at cost and thus may result in unrealized
profit or loss.

4 Weighted average Method.

This method gives due weight to the quantities held at each price
when price when calculating the average price. The weighted
average price is calculated by dividing the total cost of material in
stock, from which the material to be priced could have been drawn,
by the total quantity of material in that stock. The simple formula is
that weighted average price at any

time is the blance value figure

divided by the balance units figure.

Advantage.
This method has be following advantages;
1 this method smoothes out the effect of fluctuations in purchase
price, it is thus particularly advantage where price variations are
wide so that extreme prices are ironed out.
2 The new issue price is calculated at the time of each new
purchase and not at the time of each issue, Since receipts are
much less frequent than issues, the work of making calculations is
reduced.

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3 No unrealized profit or loss arises by the use of this method.

Disadvantages.
1 Issue prices may not be at the current market prices.
2 The method calls for many calculations where purchases are
made frequently.
3 To avoid errors, the average price must be calculated to a
sufficient number of decimal points. This makes the operation of
the method somewhat tedious.
4 Excessively high 9or low prices paid in the past are reflected in
the average for a considerable time after the expensive (or
inexpensive) material has been consumed.

5 Specific price or Identifiable Cost Methods.

Special materials purchased exclusively for specific jobs or work
orders should be charged to those specific jobs at the specific
(actual) price. This method can always be sued where materials are
purchase and set aside for a particular job or work. Order until
required for production. Those materials which have not been
purchased for specific jobs, are issued according to FIFO. LIFO or
any other method.
Of course, this method has only a limited application. But it enjoys
the advantages of pricing the materials at actual cost and thus is
desirable form costing point of view. This method has a special
application in job order industries where non-standard materials
may be purchased for specific jobs.

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Pricing of materials Returned:

Sometimes materials may be returned by production department to
stores for some reason or other. Such return of materials may be
treated baby one of the following two methods:
1 The returned materials may be entered in Receipts Column of
Stores Ledger Account at the price at which these were originally
issued at if it were a new purchase. These materials are re-issued
for production at a price according to the method of pricing in
vogue.
2 The returned materials are recorded in the Receipts Column of
the stores Ledger account at the price at which these were
originally issued and issued at the immediately next stores
requisition at the same price.

CHOICE OF METHOD OF PRICING:

The several methods of pricing discussed above represent different
views of the cost concept. Undoubtedly, there is no one best
method applicable to all situations. The cost accountant mush
weighs the fact carefully and by the exercise of the sound judgment
and common sense. Arrive at the most satisfactory method in a
particular situation. More than one method may be sued within the
same company and the method is adopted, it should be
consistently followed from period to period.
The various factors affecting choice of a method are:
1 The extent of price fluctuations.
2 Frequency of receipts and issues of materials.
3 Type of costing system in use; i.e. job or process costing.

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4 The proportion of material cost in total cost.

5 Degree of accuracy required.
6 Whether issues can be identified with purchased lots.
7 Whether standard costing system is in use.
8 The need for maintaining uniformity in costs within the industry.
9 The nature of material; i.e. whether it is subject to some losses
like evaporation, breaking the bulk, etc.
10 Managerial policy regarding valuation of closing stock.

Note:
1 When material is returned to store from jobs, it may be treated as
follows:
a. Write in brackets in issue column or
b. write in received purchased column.
2 When material is returned to supplier or vendor, it may be
treated as follows:
a. Write in brackets in received purchased column or
b. Write in issue column.
3. Any excess found may be treated as received.
4. Any deterioration of material may be treated as issue.
5. If returned material is at oldest issue then first issue rate will be
considered.