Question

Choose one of the way (LIFO, FIFO, or weighted average) and discuss the advantages and disadvantages of using that costing method. Give detailed information about the cost assigning process.

Answer 1

FIFO Method: FIFO method is one of the traditional ways to determine the cost. it simply means first in first out. as the name suggest we issue the goods which come first in my inventory and record accordingly. In this goods is issued in chronological order. it is best suited for perishable goods where goods have a limited life after that it will destroy itself like milk, curd etc.

Advantage:

1) Old goods are removed first so remaining inventory is always new ones.

2) it gives the inventory value to the nearest point of the current market price.

3) It gives the cost of goods sold to profit & loss to the historical cost which will match the cost with that time of revenue.

4) it provides same result as under periodic method and perpetual inventory system.

5) Easy to understand and operate.

Disadvantages:

1) It's hard to maintain FIFO method with huge no of lots purchase with different prices.

2) in case of price rising, it gives current production cost understated.

3) It overstates profit in the time of inflation.

4) lots of time spent on clerical working and it needs continuous updating of books.

Cost assigning process:

We will issue the goods we received first and assign the cost respectively. leftover of that lot will be my inventory and will be used first for next issue till it completely exhausted than we will issue next lot. In the time when we issue form two lot that we use the remaining cost of the first lot and then the use that rate per unit of 2nd lot to find the cost of the unit issued from the 2nd lot.

eg. lot 1 has 500 unit @ 2 per unit total purchase price 1000. Lot 2 has 400 Unit @ 2.5 per unit having total purchase price 1000. we issue 300 unit each time as per our batch size.

so when we issue first 300 unit it will be transferred at $600 and remaining unit in this lot will be 200

at next issue, we issue 200 unit form lot one and 100 @ 2 amounted $ 400 and remaining 100 unit from lot 2 @ 2.5 amounting $ 250. hence total issue amount will be 400+250 = $ 650 and first lot exhausted and closing inventory will be 300 unit @ 2.5 = $ 750.