Methods Of Pricing Material Issues
The market price of a material doesn’t remain fixed. It fluctuates depending on market conditions. So, the stores department receives the same material at different prices in different types. Now, a problem may arise regarding the valuation of materials when they are issued to the jobs. In order to make a valuation of material issues, different methods of Pricing material issues are there.
Some of the important methods of Pricing material issues are:
1.First in First out (FIFO)
2.Last in First out (LIFO)
3.Average Cost Method
i.Simple Average Price Method
ii.Weighted Average Price Method
4.Base Stock Method
5.Standard Price Method
It stands for “First in First out”. That means materials received first will be issued first. But, physical issues of material in this manner may not be possible. So, under FIFO method the material rate of the easiest lot is taken first for valuation of material issue. That rate will remain valid for pricing material issues till the entire lot is exhausted. Then the rate of the next lot of material received will be taken for the valuation of material issue. That rate will remain valid till the whole material is exhausted. This process continues. So, the main features of FIFO method are:-i. Both issues and stock are valued at actual cost.ii. Production is charged at the oldest material price.iii. Closing stock will be at the latest price.
Advantage of FIFO Method
For the sake of clarification some of the most important advantages of FIFO method are discussed below:-
i. The method is suitable in case of perishable materials if physical movements take place in the manner first in first out.
ii. The method is simple to understand and easy to calculate.
iii. The method is useful at the time of falling market prices.
iv. All issues are priced at cost price. So, the total cost price of the material is recovered from production.
v. The method lowers book-profit, so there will be loss tax liability during falling prices.
vi.The value of the closing stock will be realistic because it reflects the current market price.
vii.It is simple to understand and easy to calculate.
viii.This method is suitable for slow moving material.
Disadvantages/Limitations of FIFO Method
i.This method will not be useful at the time of rising prices, because it will result higher book profit. Therefore, tax liability will be more.
ii. The cost of two similar jobs using the same material can’t be compared because the issue price differs from issue to issue.
iii.For pricing one material requisition, more than one price may be issued.
iv. The method increases the possibility of clerical errors if consignment is received frequently at different prices.
It stands for “Last in First Out”. Literally, it means materials received last will be issued first. But always physical issues of materials in this manner may not be possible. Under this method, we take the material price of the latest consignment first for valuation of material issue till the whole lot of latest consignment is exhausted. After the latest consignment is exhausted we take the material price of the preceding consignment for the valuation of material issue. This process continues.
Features of LIFO Method
i.Both closing stock and issue are priced at actual cost.
ii.Production is charged more or less at the current market price of material.
iii.Closing stock is valued at the oldest price.
Advantages Of LIFO Method
i.The method is simple to understand and easy to calculate.
ii. The issues are priced at cost price. So, the cost of material can be recovered from production.
iii.At the time of rising prices, the method lowers book profit, So, tax liability decreases.
Disadvantages/ Limitations Of LIFO Method
i.During falling prices, LIFO Method will not be useful because it will result in higher book profit hence higher tax liability.
ii.Under this method the closing stock is at the oldest price. So, it does not reflect the current market price.
iii.The valuation of one material requisition more than one price may be used.
iv.The cost of two similar jobs using the same material can’t be compared because, issue price differs from issue to issue.
v.Like FIFO method, it may reflect clerical error.
vi. It is not suitable when prices are falling.
Average Costing Method
This method is used on the assumption that materials purchased in different lots are shown together. So, their identity gets lost. Therefore, we have to charge the material to production at an average price. The average price may be simple or weighted average.
Simple Average Price Method
Under this method, material issued is valued at simple average price. It can be found out in the following way.
Formula of Simple Average Price Method
Total of prices of materials in the stock from which materials are to be issued ÷ Total number of price Used main advantage of simple average price is, it is simple to calculate issue price but its main disadvantage is that it may result in over or under recovery of material cost.
Weighted Average Price Method
Under this method, the issues are valued at weighted average price. The weighted average price can be calculated as follows;
Formula of Weighted Average Price Method
Total cost of material in the stock from which material is to be issued ÷Total quantity of material in the stock
Advantage of weighted Average Method
i.This method is very much suitable at the time of heavy fluctuation in the market price of the material.
ii.The new issue price will be calculated only when a new lot of material is received.
iii. The method recovers the fall material cost from cost of production.
Disadvantages/Limitations of weighted Average Price Method
i. New issue price is to be calculated after every new receipt.
ii. Issue price is different from the actual cost price of material.
iii. The calculation of issue price is a little bit complicated.
Base Stock Method
Base stock method is not an independent method of valuation of inventories, this method is onle useful for the pricing material issue. This method is based on convention that firms in order to able to maintain minimum level of stock which is known as Base Stock.
Standard Price Method
Standard price Method is predetermined rate as a standard is used for determining of sales as well as the closing inventories in the hand. It is otherwise known as standard cost method.