How does the FIFO method differ

Accounting
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How does the FIFO method differ from the average costing method of process costing system? Provide an example of FIFO and explain

Nov 22nd, 2014

The basic difference between the average costing and FIFO costing method is retention of cost when it is transferred to from one warehouse to another or sent for production or for consumption and so on.

1. Average cost would be cost of the [(total cost inventory lying in the location of the production floor or consumption department as on current date) divided by / ((total count of that inventory lying in the location of the production floor or consumption department as on current date)]. This average cost goes on changing whenever you add quantities or adjust cost in that location.

The FIFO method retains the inventory cost as a separate figure i.e. it holds the cost of the inventory as it is moving from 1 location to another, from 1 department to another. Every unit consumed/sold or purchased will retain its costs till you do not add/adjust costs to it Or in case of return of stocks from customer you specify different cost.

2. One should take care that If the FIFO method is used, inventory lost during a period must be identified from which bucket it is lost or else the complete value of FIFO costing would be lost. This would not be a case in Average Costing. Cause for Average costing it does not matter when it was purchased. It is concerned about the current value of the individual stock.

3. FIFO costing would be say there were 10 qty with different costs were sent to production/usage/consuming department with no proper tagging as to what cost is associated with which unit then it would be difficult for the production department to give you the exact cost of the consumed/finished product hence making it complicated for the management to decide the lot cost of the finished good or calculating cost of the consumed quantity. Under such scenarios, average costing method would lead to quite satisfactory cost computations.

4. One thing to note here is be it FIFO or Average cost, any back dated entry done in the system after the data entries have already been done for present would not give you appropriate results. This is where Sage has come up with a solution called Lot (Actual) costing. Using this costing method user will be able to select the lost from which the items have been consumed and the system would pick up the correct cost.

Example:

Bala LTD purchased 10 bikes during January and sold 6 bikes, details of which are as follows:

January 1 Purchased 5 bikes @ $50 each

January 5 Sold 2 bikes

January 10 Sold 1 bike

January 15 Purchased 5 bikes @ 70 each

January 25 Sold 3 bikes

The value of 4 bikes held as inventory at the end of January may be calculated as follows:

The sales made on January 5 and 10 were clearly made from purchases on 1st January. Of the sales made on January 25, it will be assumed that 2 bikes relate to purchases on January 1 whereas the remaining one bike has been issued from the purchases on 15th January. Therefore, the value of inventory under FIFO is as follows:

Solution:
DatePurchaseIssuesInventory
Units$/Units$ TotalUnits$/Units$ TotalUnits$/Units$ Total
Jan 1550250550250
Jan 5250100350150
Jan 1015050250100
Jan 15570350570350
Jan 157450
Jan 25250100
17070470280

As can be seen from above, the inventory cost under FIFO method relates to the cost of the latest purchases, i.e. $70.


Nov 22nd, 2014

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Nov 22nd, 2014
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Nov 22nd, 2014
Dec 8th, 2016
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