Methods of Pricing Materials Issued from Stores

When materials are purchased at different times, they are very often bought at different rates. Once these differently-priced lots are mixed together in the store, a question arises: when material is issued to production, at which rate should that issue be priced? Several methods are followed, and this chapter covers four of them — First-in-First-out (FIFO), Last-in-First-out (LIFO), Simple Average, and Weighted Average — each illustrated in this chapter through a Stores Ledger Account, the proforma used to record every receipt, issue, and running balance of a material, both in quantity and in value.

1. First-in-First-out (FIFO) Method Under FIFO, it is assumed that the material received FIRST is issued FIRST — so issues are priced at the rate of the oldest lot still in stock, working through progressively newer lots as older ones are used up. The balance of stock remaining at any time is therefore valued at the cost of the most recently purchased lots. Advantages of FIFO: It is simple and logical, following the natural physical flow of most materials; closing stock is valued very close to current/replacement cost since it consists of the latest purchases; and it is widely accepted for both costing and financial-statement purposes. Limitations of FIFO: When prices are rising, FIFO charges production with the cost of older, cheaper material, which can show an inflated profit that does not reflect the higher cost of replacing that material; and comparing the cost of two identical jobs done at different times becomes harder, since each is charged at whatever rate happened to be oldest at the time.
2. Last-in-First-out (LIFO) Method Under LIFO, it is assumed that the material received LAST is issued FIRST — so issues are priced at the rate of the most recently purchased lot still in stock. The balance of stock remaining at any time is therefore valued at the cost of the oldest purchases (in a rising-price situation, this can mean stock is carried at old, low rates). Advantages of LIFO: When prices are rising, LIFO charges production with the cost of the most recent, current material, which better matches current cost against current revenue for decision-making purposes; and it tends to reduce paper/notional profit in a period of rising prices (though this also has tax implications that vary by jurisdiction and are outside this chapter's scope). Limitations of LIFO: Closing stock can end up valued at very old rates, far from current replacement cost, which can distort the balance sheet in a period of steadily rising or falling prices; it is more complex to operate than FIFO, since old, unused layers of cost can persist in the records for a long time; and it is not accepted under some accounting/tax frameworks for external reporting.
3. Simple Average Method Under the Simple Average method, the issue rate is calculated as a plain (unweighted) average of the rates of all the different batches of material currently in stock, WITHOUT regard to how many units are in each batch. This average rate is recalculated every time a fresh purchase is received, and applies to every issue made until the next receipt. Advantages of Simple Average: It is easy to calculate and understand, since quantities of each batch are ignored and only the rates are averaged. Limitations of Simple Average: Because quantities are ignored, a small batch and a large batch influence the average equally, which can distort the issue price away from the actual cost of material used; and, as a direct consequence, the value of closing stock computed under this method very often does NOT exactly agree with the true value of material actually left in stock — this mismatch is one of the best-known drawbacks of the method, and students should expect a small balancing difference rather than an exact tie-out when solving Simple Average problems.
4. Weighted Average Method Under the Weighted Average method, the issue rate is calculated by dividing the TOTAL VALUE of all material currently in stock by the TOTAL QUANTITY currently in stock — so, unlike the Simple Average method, larger batches correctly carry more weight in the average. This weighted rate is recalculated every time a fresh purchase is received, and applies to every issue made until the next receipt. …