MA-1 (MATERIAL COSTING) 1

SUBSEQUENT MEASUREMENT OF INVENTORY

1. Specific Identification Method: (Non-interchangeable Inventory)

The specific identification method, also called specific invoice inventory pricing, is a technique used
to assign cost to identifiable inventory. In other words, this is a way to value inventory by allocating
costs to individual goods when they are purchased and received.

2. First In First Out Method (FIFO): (Interchangeable Inventory)

This method is based on the premise that the first item purchased is the first item sold, that is, all the
inventories are sold in the order in which they are acquired. Since the oldest stock in the inventory is
sold first, the calculation of the inventory is on the basis that the inventories in hand represent the
ones most recently purchased.

FIFO Rs.
Cost of Sales 25,800
Inventory 10,400
STOCK LEDGER CARD
Date Particulars Purchases Issue Stock
Qty PUC Value Qty PUC Value Qty PUC Value
1-Jan Opening 300 22 6,600
Stock
10-Jan Purchases 400 23 9,200 300 22 6,600
400 23 9,200
14-Jan Sales 300 22 6,600
Sales 200 23 4,600 200 23 4,600
20-Jan Purchases 400 25 10,000 200 23 4,600
400 25 10,000
21-Jan Sales 200 23 4,600
Sales 300 25 7,500 100 25 2,500
25-Jan Purchases 400 26 10,400 100 25 2,500
400 26 10,400
28-Jan Sales 100 25 2,500 400 26 10,400
25,800
3.
4. LIFO – Last in, first out (Interchangeable Inventory)

1 September 1,000 at $2.00

8 September 500 at $2.50
15 September 500 at $3.00
22 September 1,000 at $3.50
If on 23 September 1,500 units were issued to production

This method is the opposite of FIFO. Issues will be valued at the prices of the most recent purchases;
hence inventory remaining will be valued at the cost of the oldest items. In the example above it will

From the desk of Syed Munib (Faculty for CA / ACCA / A ‘Levels)

 MA-1 (MATERIAL COSTING) 2

be 1,000 units of issues which will be valued at $3.50, and the other 500 units issued will be valued
at $3.00. 1,000 units of closing inventory will be valued at $2.00, and 500 at $2.50.

5. Weighted Average Method: (Interchangeable Inventory)

Under this method, the cost to be assigned to inventories are ascertained by applying to the closing
inventory an average cost computed by dividing the total cost of units by the total numbers of such
units. The average cost is calculated by applying the following formula:

The value of the closing inventory is ascertained by multiplying the number of units on land (from
the physical count) by the weighted average cost per unit.

Weighted Average Rs.

Costs of sales 25,945
Inventory 10,255
STOCK LEDGER CARD
Date Particulars Purchases Sales Stock
Qty PUC Value Qty PUC Value Qty PUC Value
01- Jan Opening Stock 300 22.000 6,600
10-Jan Purchases 400 23 9,200 700 22.571 15,800
20-Jan Sales 500 22.571 11,286 200 22.571 4,514
21-Jan Purchases 400 25 10,000 600 24.190 14,514
25-Jan Sales 500 24.190 12,095 100 24.190 2,419
25-Jan Purchases 400 26 10,400 500 25.190 12,819
28-Jan Sales 100 25.638 2,564 400 25.638 10,255
25,945

Note: In an inflationary economy the value of closing stock will be higher under FIFO method as
compared to weighted average method.

Question 2.01:

On 1 January 2012, a company held 300 units of an item of finished goods inventory. These were valued
at Rs. 22 each. During January 2012 three batches of finished goods were received into store from the
production department, as follows:
Date Unit Received Production cost per unit
10-Jan 400 Rs. 23
20-Jan 400 Rs. 25
25-Jan 400 Rs. 26
Goods sold out of the inventory during January 2012 were as follows:

Date Unit Received Sales price per unit

14-Jan 500 Rs. 31
21-Jan 500 Rs. 33
28-Jan 100 Rs. 32

From the desk of Syed Munib (Faculty for CA / ACCA / A ‘Levels)

 MA-1 (MATERIAL COSTING) 3

Required:
Compute the cost of sales and inventory at 31 January 2012, applying the following basis of
inventory valuation:
(i) FIFO (Perpetual & Periodic System both)
(ii) LIFO (Perpetual & Periodic System both)
(iii) Weighted Average Cost (Perpetual & Periodic System both)

Question 2.02:

Ahsan company presents the following data for the month of August, 1995.

August 1 Balance 100 units @ Rs.25 per unit

August 4 Purchase 200 units @ Rs.26 per unit
August 6 Sales 160 units @ Rs.35 per unit
August 7 Sales 80 units @ Rs.38 per unit
August 10 Purchases 380 units @ Rs.28 per unit
August 13 Sales 100 units @ Rs.33 per unit
August 15 Sales 110 units @ Rs.30 per unit
August 20 Purchases 220 units @ Rs.26 per unit
August 27 Sales 130 units @ Rs.33 per unit

Required:
Determine the cost of ending inventory. The cost of goods sold and the gross profit under perpetual and
periodic system both systems by FIFO, LIFO and WACO method.

Question 2.03:

From the desk of Syed Munib (Faculty for CA / ACCA / A ‘Levels)

 MA-1 (MATERIAL COSTING) 4

Which method is correct?

This is a trick question, because there is no one correct method. Each method has advantages and
disadvantages.

The advantages and disadvantages of the FIFO method are as follows.

(a) Advantages

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 MA-1 (MATERIAL COSTING) 5

 It is a logical pricing method which probably represents what is physically happening: in practice
the oldest inventory is likely to be used first.
 It is easy to understand and explain to managers.
 The closing inventory value can be near to a valuation based on the cost of replacing the
inventory.

(b) Disadvantages

 FIFO can be cumbersome to operate because of the need to identify each batch of material
separately.
 Managers may find it difficult to compare costs and make decisions when they are charged with
varying prices for the same materials.
 Prices may diverge widely from market price when there is a high rate of inflation, thereby
understating the cost of sales.

The advantages and disadvantages of the LIFO method are as follows.

(a) Advantages

 Inventories are issued at a price which is close to current market value.

 Managers are continually aware of recent costs when making decisions, because the costs being
charged to their department or products will be current costs.

(b) Disadvantages

 The method can be cumbersome to operate because it sometimes results in several batches
being only part-used in the inventory records before another batch is received.
 LIFO is often the opposite to what is physically happening and can therefore be difficult to
explain to managers.
 As with FIFO, decision making can be difficult because of the variations in prices.

The advantages and disadvantages of weighted average pricing are as follows.

(a) Advantages

 Fluctuations in prices are smoothed out, making it easier to use the data for decision making.
 It is easier to administer than FIFO and LIFO, because there is no need to identify each batch
separately.

(b) Disadvantages

 The resulting issue price is rarely an actual price that has been paid, and can run to several
decimal places.
 Prices tend to lag a little behind current market values when there is gradual inflation.

From the desk of Syed Munib (Faculty for CA / ACCA / A ‘Levels)

 MA-1 (MATERIAL COSTING) 6

Points to remember for the exam:

In a period of rising raw material prices (inflation) , the following points are true:

a) Closing inventory values will be higher using cumulative weighted average pricing rather than
periodic weighted average.

b) Closing inventory values will be higher using FIFO rather than LIFO.

c) Under FIFO, production costs would be lower than under LIFO. In a period of falling raw material
prices (deflation), the opposite will occur.

Free Inventory: Those inventories which can be issued for further production is called free
inventory.

Free inventory = Stock in hand (already possessed) + stock at order (upcoming stock) – stock for
scheduled use (committed stock)

Question 1:

An entity had 30 units in hand when an order for further 80 units was placed. Department A was
promised to get issued 35 units. Find the free inventory available.

Question 2:

An entity had placed an order for further 120 units. Department X was committed for 75 units. The free
inventory available was 180 units. Find stock in hand

Safety stock / Buffer Stock:

Stock which is kept for safety measures and for emergencies is called buffer stock which if remained
unutilized will become closing stock.

Stock out cost:

 Loss of goodwill
 Loss of market shares
 Loss of customers (existing and potential)
 Competitors will get strong
 Entity might be subject to penalties and fines
 Extra cost of buying materials (i.e. additional transportation)

From the desk of Syed Munib (Faculty for CA / ACCA / A ‘Levels)