Posted By Sudhakar to Finance and Cost Management!!! at 5/01/2008 09:23:00 AM

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One of the problems that arise in costing is the pricing of the issues. This is due to the fact that generally the goods are purchased at different lots at different points of time. When issues are made it is difficult to keep track of the issue lot and link with the purchases. Hence a method of pricing the issue has to be selected.
Let us now examine different methods of pricing the issues and see one problem in this regard.

A..FIFO-First –in – First- Out Method

1. It is based on the assumption that the materials which are purchased first are issued first.
2. Accordingly the Stock will be valued at the latest purchases.

Advantages:
1. Closing stock is valued at the latest price.
2. Materials are priced at actual cost and hence no unrealized profit arises.
3. Charge to production is at the oldest price of materials.
4. Easy and Simple.

Disadvantages:
1. Since the materials issued are valued at old prices the cost of production may not reflect the latest prices.
2. Comparisons become tough.
3. Complex calculation.
4. In period of rising prices the FIFO produces higher profit and increases tax liability.

B.LIFO-Last in First out Method.

1. It is based on the assumption that the materials which are purchased last are issued first.
2. Accordingly the Stock will be valued at the oldest purchases unissued.

Advantages:
1. Materials charged to production are at latest cost. Hence in times of rising prices the company’s product quotation will be competitive.
2. This method does not result in unrealized profit or loss like FIFO
3. Simple to operate at the time of steady prices.
4. In period of rising prices the profit and tax liability under LIFO will be lower than under FIFO as the cost of production will be valued at the lower cost (old cost).

Disadvantages:
1. The physical flow is different from logical flow.
2. Closing stock will not represent the current economic value and be valued at old prices.
3. Comparison of different jobs becomes difficult.
4. Complex to operate.
.
C .Average cost Method:
It is based on the assumption that the materials kept together lose their identity and has to be valued at average price.

C1. Simple Average Method.
Simple average represents the average of prices. The average prices of all the materials in stock is calculated .It does not take into account the quantities.For example if there are three different rate of products in stock say 21 , 23 , 25 then the simple average is (21+23+25)/3 =23
The simple average method operated with FIFO method. The prices of stocks issued fully as per FIFO method is not taken into account for computation.

Advantages.
1. Simple

Disadvantages:
1. Unscientific.
2. Results in unrealized profit and loss.

D. Weighted average Method.
This method takes into account the quantities. The price is calculated by dividing the total cost of material in stock calculated at actual purchase price for each lot (present in stock) by the total quantity of materials in stock.

Advantages:
1. Smoothens out the effect of fluctuations and hence useful at the time of fluctuating prices.
2. The work load is reduced as it does not necessitate the calculation of issue price at the time of each issue.
3. No unrealized profit or loss arises in this method.

Disadvantages :
1. Issue price may not be at the current market price.
2. When there are several lots of purchases the work load increases.
3. Excessive high or low prices are reflected in the average even after their total consumption.

E.Replacement Price Method.
The issues are valued at the price at which the materials would be replaced.

Advantages:
1. Simple to operate
2. Production reflects the current market price.
3. When the company has bought the goods at a cheap prices earlier in a large stock and the benefit need not be passed on to the customer ,then this method will reflect profit as the production will reflect the current prices .

Disadvantages:
1. The stock valuation is not at the current prices.
2. Unrealised profit or loss will arise.
3. It involves finding the replacement price at each issue and hence a little difficult to operate.

F.Standard Price Method.
Under this method the prices are issued at standard prices. Standard prices are fixed for a definite period. In the time of fluctuating prices the standard prices has to be fixed for short term period and changed constantly. Receipts will be at actual cost of purchase only. The difference between the standard and actual prices is transferred to Material Price variance account.
Standard price is a notional price and not actual price .It is fixed taking into several factors liked Market condition, fluctuation in prices, trends, discounts etc.
This method can be used in connection with standard costing system or without standard costing system.
Advantages:
1 .No cumbersome calculations at the time of each issue.
2. When standards are fixed correctly it makes the task simple.

Disadvantages.
1. It results variance in profit.
2. If not fixed correctly it can affect the valuation of stock and cost of production.

G.Highest –in –First _Out (HIFO) Method.
The materials are issued at the highest price of material in stores. Once the highest price material in stock is exhausted the next highest price will be used.

Advantages :
1. Production is at the high cost of production and during fluctuating prices the highest cost is recovered first .
2. Inventory value is kept low and results in secret reserve.
3. Used in cost plus contracts.
Disadvantage
1. Results in secret reserve.
2. Unrealised profit or loss arises.
3. Production is not valued at current prices.

H.Next –in-First-out (NIFO) method.

This is more similar to replacement price method except that the issues are priced at the price at which an order (purchase order) has been placed and will be received next in store.
Advantages :
1. Production reflects the current market trend.

Disadvantages :
1. It results in unrealized profit or loss.

I .Specific price or Identifiable cost method.
When materials are purchased and set aside for a specific job order then issue of that material should be at the price at which (the specific price) it has been purchased. Other issues can be at FIFO, LIFO or other methods.

Advantages :
1. The job is costed at the actual material puchase cost.
2. Useful for Job costing .

Disadvantages :
1. The material should be carried separately till it is issued fully.

J. Base Stock Method. 
This method assumes that a minimum base stock is always held in stock and is not issued. This is considered as a fixed cost and carried at original cost. The quantities in excess of base stock are valued by using FIFO or LIFO etc.

Advantages
1. Simplification of valuation of inventory as the base stock values is fixed.
2. Merits of other methods (FIFO, LIFO Etc) of valuation which is used along with this will be reflected here.
Disadvantages
1. It is not an independent method.
2. This is rarely used.
3. Demerits of other valuing methods that is used along with this method will be reflected here. 

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