The materials stored in the stock room are issued to various jobs or production departments against the authorized materials requisitions. The issues are recorded in the store ledger and the respective jobs or production departments are debited with the price of the material issued. As the time of purchase and the time of issue are mostly different and the market price of the materials tends to vary, the problem of pricing the materials issued necessitates certain policy formulation. It is an important consideration not only under stores management but also for costing and pricing policies. The fundamental consideration is whether to price the issues at historical price i.e. the original purchase price, at the replacement price i.e. the prevailing market price at the time of issue or at some other price.
The various methods are used for pricing the material issues which are based on different principles. The following are the important methods of pricing the material issues.
First In First Out Method (FIFO Method): FIFO as its name suggests is governed by the principle that the materials which are received first are issued first. The issues are priced at the cost price of the oldest consignments till it gets exhausted. As soon as the oldest lot is exhausted, the issues are priced at the cost price of the next of oldest lot in the sequence, e.g. the following transactions occurred during the first week of April, 1993:
April 1: 200 units purchased @ Rs 5 per unit
April 3: 500 units purchased @ Rs 6 per unit
April 5: 300 units issued to job No. 1001
The issue of 300 units will be priced as under
From the first lot: 200 units @ Rs 5 = 1000
Remaining 100 units from second lot =
100 units @ Rs 6 600
The value of the closing stock of 400 units (i.e. second lot 500 units less 100 units issued) will be costed @ Rs 6 i.e. the value of closing stock would be Rs 2,400.
Last In First Out method (LIFO Method): LIFO method reverses the procedures as followed under FIFO. The cost of the last lot of materials received is used to price the issues until that consignment is exhausted then the next lot of pricing is used and so on through the successive lots. This method is based on the premises that the materials which are issued to the jobs should carry the cost of the most recently purchased materials, and that is why it is also known as the replacement cost method. It should be noted that like FIFO method, the actual physical handling of the material in the bins and shelves in the sequence of purchases is imaginary. It is considered only for pricing the issues made from the stores e.g. the following transactions occurred in the stores department during the first week of April, 1991
April 1: 500 units purchased @ Rs 5
April 3: 300 units purchased @ Rs 6
April 6: 400 units issued to Job Order No. 1086
The issue of 400 units on April 6, will be priced as under:
First 300 units @ Rs 6 = Rs 1,800
Remaining 100 units @ Rs 5 Rs 500
The closing stock of 400 units will be priced @ Rs 5 i.e. Rs 2,000
Average Cost Method: Under this method, the issues are charged at a price ascertained from the common pool made up of the varied prices of a several lots. It is advantages to use this method when the prices are subject to constant changes. In the periods of rise or fall of materials prices, an average cost tends to even out the extreme price changes. The upward and downward trends ar6e moderate as contrasted with the steep rise or fall under the FIFO and LIFO methods. The average price is calculated in different ways as under:
1) Simple average of the stock on and at the price of the issue
2) On the basis of the simple average cost of each kind of material on hand at the close of the month, and to apply it for all, issues made during the following month.
3) On the basis of the simple moving average wherein the earlier price is dropped the moment the new purchases are made and cost of such fresh will be included while arriving at the new average.
It should be noted that instead of the simple average wherein only the unit cost is considered for calculating the average cost to be charged to the issues, weighted average cost can also be used. Under the weighted average cost, along with the unit cost the quantity of the units is also considered e.g. the following two lots were purchased during, 1993:
1) 1,000 units @ Rs 3
2) 5,000 units @ Rs 5
The simple average cost would be Rs 4 only (i.e. Rs 3 + Rs 5 + 2) while the weighted average cost would as under:
Unit cost Weight Weighted Cost
1) 3 1,000 3,000
2) 5 5,000 25,000
Weighted average cost = 28,000