Question

The controller of a local firm that uses a continuous production process asks you to recommend whether the company use weighted-average or FIFO process costing. What factors would you consider making a recommendation?

Answer 1

The local firm which uses continuous production is recommended to use weighted average process costing method. Reason being, the inventories are used on a continuous basis, hence the old inventories gets mixed up with the new inventories, hence it is difficult to identify the cost variance in the inventories purchased at different rates. Hence under such circumstances the weighted average method is the solution, which takes a weight of the inventories and arrives at an average price of the inventories bought at different dates at different prices. It arrives at one cost, and hence makes it easier to account for the inventories.

Factors kept in mind at the time of the recommendation:

• Consistency: For continuous production process, the inventory is required continuously, it makes a difficult task for the accountant to identify the prices of each inventory, hence using weighted average method, it helps the accountant to use only one price, arrived at by taking weighted average of all the inventories. Hence it reduces the difficulty and burden of the accountant.
• Less Paper work: Since only one cost price is used for accounting, it requires less of paperwork in the recording the cost of the inventories. hence only one cost is taken for all the calculations.
• Simple Calculation: Since only one price is used for all calculations, it makes the job of the accountant very simple and easy. As he doesnt have to account for different costs of inventories separately. he just need to arrive at one price, which will be used for the total inventories.
• When the prices are rising: Weighted average takes the average price of the old inventories and new inventories, Hence it takes into account the mid-price of the inventories. Its cost of goods sold is less as obtained under LIFO and more than as obtained under FIFO. Inventory is not as badly understated as under LIFO, not it is not uptodate as FIFO. Company takes a middle road approach.