Question

Describe the allocation of inventoriable costs may be made under any of the following assumptions as to the flow of costs (a) first-in, first-out (FIFO), (b) last-in, first-out (LIFO), or (c) average cost.

Answer 1

Inventory costs may allocated under any of the following assumptions:

(a) first-in, first-out (FIFO)

Under this method, for the purpose of pricing the issues, it is assumed that materials received first are issued first and charges are made at the corresponding costs. In other words, issues take place in the order of receipts. Here the identity of materials is not required. In fact, the material received last may be issued first (i.e., in case of materials placed in heaps it cannot be expected that materials from the bottom shall be issued). In FIFO the earlier purchases shall be exhausted earlier (as per assumption) and the stock will represent later purchases. Thus, in condition of falling prices, higher costs shall be consumed by production and there will be lower replacement cost. The opposite shall happen in the condition of rising prices

(b) last-in, first-out (LIFO)

This method is similar to FIFO with the exception that, here, for the purpose of pricing the issues, it is assumed that latest receipts are issued first. The identity of the material is immaterial. In fact, the earliest purchases may be issued first in some cases and in other cases latest purchases can be conveniently issued first. For the purpose of pricing it is always assumed that latest purchases are issued first. However, in conditions of rising prices the charge to production, under this method, will be more or less at current price while the stock will represent earlier low prices.

(c) average cost.

This method is based on the principle that materials received in different lots are mixed up in stores. As such, an issue cannot be made from any particular lot. So, materials are to be issued at the average cost of materials in stores. It does not recognise the particular identity of any particular lot.