Determining the Cost of Materials
DETERMINING THE COST OF MATERIALS
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
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