An important area of materials accounting is the costing of materials requisitioned from the storeroom for factory use. The unit cost of incoming materials is known at the time of purchase. The date of each purchase is also known, but the materials on hand typically include items purchased on different dates and at different prices. Items that look alike usually are commingled in the storeroom. As a result, it may be difficult or impossible to identify an issue of materials with a specific purchase when determining what unit cost should be assigned to the materials being issued. Several practical methods of solving this problem are available.
In selecting the method to be employed, the accounting policies of the firm and the federal and state income tax regulations must be considered. •First-In, First-Out Method. The first-in, first-out (FIFO) method of costing has the advantage of simplicity. The FIFO method assumes that materials issued are taken from the oldest materials in stock. Therefore, the materials are costed at the prices paid for the oldest materials. In many companies, the flow of costs using FIFO closely parallels the physical flow of materials. For example, if materials have a tendency to deteriorate in storage, the oldest materials would be issued first. Last-In, First-Out Method. The last-in, first-out (LIFO) method of costing materials, as the name implies, assumes that materials issued for manufacturing are the most recently purchased materials. Thus, materials issued are costed at the most recent purchase prices, and inventories on hand at the end of the period are costed at prices paid for the earliest purchases. The LIFO method of costing closely approximates the physical flow of materials in some industries. For example, in the smelting of iron ore, the raw material is stored in mountainous piles.
As ore is needed for production, it is drawn from the pile in such a way that the material being used is the last ore to have been received. •Moving Average Method. The moving average method assumes that the materials issued at any time are simply withdrawn from a mixed group of like materials in the storeroom and that no attempt is made to identify the materials as being from the earliest or the latest purchases. This method has the disadvantage of requiring more frequent computations than the other methods. However, the use of software packages has overcome this disadvantage, and many firms have adopted this method. Analysis of FIFO, LIFO, and Moving Average. FIFO, LIFO, and moving average are the most commonly used methods of inventory costing. Any of these methods may be adopted to maintain the materials ledger. Because no one method best suits all situations, the method chosen should be the one that most accurately reflects the income for the period in terms of the current economic conditions. One factor to consider is the effect the costing method has on reported income for tax purposes. A higher taxable income will subject a firm to higher taxes.