COST FLOW METHODS:-
The methods of pricing values under the cost flow method (cost
price method) are classified as follows:-
- Specified Price
- First-in-first-out(FIFO)
- Last-in-last-out(LIFO)
- Highest-in first-out(HIFO)
- Base stock
ABOVE COST PRICE METHODS IN DETAIL:-
1. Specified price (identifiable) method:-
- Sometimes materials are purchased to be utilised in a
particular job or issues can be identified with a particular
receipt.
- In these cases, the actual purchase price can be charged.
- This method can be adopted when prices are stable or when the
materials are covered by price control orders.
- This method has limited application only.
2. First-in-first-out(FIFO):-
- This is the method which is based on the assumption that
materials which are purchased first are issued first.
- It uses the price of the first batch of materials purchased for
all the issues until all units from this batch have been
issued.
- In other words,the materials are issued at the oldest cost
price listed in the stores ledger account and thus,the materials in
stock are valued at the price of the latest purchases.
- It should be noted that the assumption of the flow of
cost,though normally materials would be expected to move out of
stock on approximately a FIFO basis because oldest stocks are
usually used up first.
Example of FIFO:-
Receipts:
20th oct. 500kgs. @$5.00per kg.
23rd oct. 250kgs.@ $5.50per kg.
Issues
25th oct.Issue of 600kgs.will be valued as follows:
500kgs.@$5 per kg.
100kgs.@$5.50 per kg.
3.Last-in-First-out(LIFO):-
- In this method,the principle adopted is that the materials used
in production is from the latest purchase.
- The inventory is priced at the oldest costs.
- As the method applies the current cost of materials to the cost
of units,it is also known as the replacement cost method.
- It is the most significant method in matching cost with revenue
in the income determination procedure.
Example of LIFO:-
Receipts
20th oct. 500kgs.@ $5.00 per kg.
23rd oct. 250kgs.@ $5.50 per kg.
Issues
25th oct. Issue of 600kgs. will be valued as follows:
250kgs @ $5.50 per kg.
350kgs @ $5.00 per kg
4.Highest-in-first-out(HIFO)method:-
- The principle adopted is that costliest materials are issued
first.
- Inventory is valued at the lowest possible price.
- This method requires detailed records.
- It is mainly used for monopoly products or cost plus
contracts.When stocks are undervalued, a secret reserve is
created.
5.Base Stock Method:-
- A certain minimum stock of a material is always carried and is
priced at the original cost (usually at the lowest purchase
price).
- The portion of stock above this level is issued and priced
under any one of the methods.
- The disadvantages of this method is that the stock may be under
valued and hence the computation of return on capotal will not be
reliable.