Problems of Cost Accounting and Fifo Versus Lifo Methods


The Sanghar Manufacturing Co. Ltd. reports purchases and issues of material no: Special – C as under:
                        Purchases                                 Issued
Date                 Units                Unit Price         Units
                                                      Rs.
July 2, 1967                                                     1,000
       3, 1967     2,000                  42/00
       5, 1967                                                     1,500
       7, 1967     1,000                  43/50
      10, 1967                                                    2,000
      15, 1967    2,000               44/00
      31, 1967                                                    1,000
The opening inventory on July 1, 1967 consisted of 3000 units valued at Rs. 1,21,500
Required: Calculate the cost of the material issued under the following assumptions:
(1) The Lifo, costs calculated at the time of issuance of the material.
(2) The Lifo, costs calculated at the end of the month.
Solution:
(1) Lifo method: Costs calculated at the time of issuance of the material.
Cost of the material issued:
July 2, 1967                                                                 Rs.
(to be issued from
opening balance).          1,000 units at 40/50                  40,500
July 5, 1967                 1,500 units at 42/00                  63,000
                                                                        Rs.
July 10, 1967               1,000 units at 43/50      43,500
                                    500 units at 42/00         21000
                                    500 units at 40/50         20,250
                                    (issued out of opening               84,750
                                       balance)
July 31, 1967               1,000 units at 44/00                  44,000
Cost of the                                                                              
material issued.              5,500 units                             2,32,250
Cost of the ending inventory:                                         Rs.
Material at hand July 1, 1967    1500 units 40/50          60,750
Purchase of July 15, 1967         1000 units at 44/00       44,000
                                                2500 units                  1,04,750
(2) Lifo method: Cost calculated at the end of the month.
Cost of the material issued:                                            Rs.
Purchase of July 15, 1967 – 2,000 units at 44/- 88,000
Purchase of July 7, 1967 – 1,000 units at 43/50            43,500
Purchase of July 3, 1967 – 2,000 units at 42/00            84,000
Material on hand, July 1,1967 -    
                                     500 units at 40 / 50       20,250
Cost of the material issued: 5,500 units  2, 35,750
Cost of the ending inventory:
Comprising of 2,500 units at Rs. 40 / 50           Rs
that were on hand on July 1, 1967…..   1, 01, 250


Fifo and Lifo method
Looked at from the long term point of view both fifo and lifo methods yield the same cost of production. In the periods of rising prices, the fifo method results in increased net income because the oldest costs are matched against the income. As against fifo method, the lifo results in reduced net income in periods of rising prices because the altest costs are charged against the income. Lifo is being widely used because these are the years of rising prices.

The use of lifo method may result in losses if the manufacturer is forced to sell away a substantial part of his stock of materials at a price different from the one shown against the stock. The application of lifo may stimulate profit manipulation. The manufacturer may purchase unduly large quantities of materials at the close of the period to show high profits or the purchases may be postponed so that the costs of prior periods may be matched against income.

Weighted Average Cost Method
The average cost of various units of materials in stock is used when it becomes impractical to identify cost with the materials as these move forward. Average costs carry the effects of high as well as low prices of raw materials and thereby these costs render the cost estimates somewhat more reliable and stable. By average cost is meant the ‘weighted’ average cost and not the ‘simple’ average cost. The weighted average cost is a more dependable concept as compared to simple average cost because these costs are more realistic and dependable.

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