LIFO, FIFO and average methods

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LIFO, FIFO and average methods

The value of closing inventory and material issues

In management accounting, there are various methods to value closing inventory and issues from stores.

The three main inventory valuation methods are

  1. FIFO

    – materials are issued out of stock in the order in which they were delivered into inventory, i.e. issues are priced at the cost of the earliest delivery remaining in inventory.

  2. LIFO

    – the last items of material received are the first items to be issued. 

    The items remaining in inventory are the first which were produced or purchased.

  3. Cumulative Weighted average cost

    – AVCO calculates a weighted average price for all units in inventory. 

    Issues are priced at this average cost, and the balance of inventory remaining would have the same unit valuation.

    A new weighted average price is calculated whenever a new delivery of materials into store is received.   

    Hence, fluctuations in prices are smoothed out, making it easier to use the data for decision making.

How do we calculate the PERIODIC weighted average cost?

This method is only used if specifically mentioned in the exam question. Otherwise, the cumulative weighted average method should be used.

Periodic weighted average =

cost of opening inventory  + total costs of receipts
-----------------------------------------------------------                                                  
units of opening inventory + total units received

Illustration

What is the value of the closing inventory if the FIFO method of valuation is used below?

Number Cost ($)/unit
Opening bal 01/07 20 4
Receipt 08/07 40 4.4
Issue 12/07 40
Receipt 18/07 100 4.6
Issue 26/07 100

Solution

The issue on 12/07 will first be issued from the opening balance (20 units) and then the receipt on 08/07 (the remaining 20 units).

The issue on 26/07 will first be issued from the remaining 20 units from 08/07 receipt, and then the 80 units will be issued from 18/07 receipt.

Therefore closing inventory will be 20 units from 18/07 receipt (20*4.6 = $92 is the value of the closing inventory).

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