Methods of Pricing materials may be grouped under 3 broad categories. They are 1. At Cost Methods 2. Average Cost Methods 3. Notional Price Methods.
Methods of Pricing Material
- Actual Cost Method: Where materials are purchased specially for a specific job, the actual cost of materials is charged to that job. Such materials will normally be stored separately and issued only to that particular job.
- Fixed Price: Under this method, the issue price is fixed for a whole period. The rate is used for costing the issues irrespective of the purchase price. It is clear that such a method will introduce an element of profit or loss in the value of the material used. For example, if the purchase price is 5 and the issue price has been fixed at 6 per unit, every time an issue is made a profit of RS. 1 per unit will be created. Thus, the Store Ledger will be complicated. Even the advantages of the market price method are not available under this method simply because the fixed price will be different from the market price.
- Standard Price: “Standard Price is a predetermined price fixed on the basis of a specification of all the factors affecting that price.” Firms that follow standard costing will record all the receipts and issues of materials at the standard price which will be fixed in advance. In this case, both the receipts and issues will be costed at a standard rate. In case the purchase price is more or less than the standard price, the difference is charged to an account which is known as the standard price, the difference is charged to an account which is known as “Price Variance Account”. For Ex: If the standard price is 5 per unit and the actual price is Rs. Rs. 5.50, then the Stores Ledger will be debited at the rate of Rs. 5 and Price Variance Account with 50 paise per unit. Issues are all costed at the standard price. It serves to measure efficiency in the use of materials, also it saves clerical labor.
- Inflated Price: Where materials are subject to natural wastage the cost may be inflated to account for the wastage. Thus, if 100 units of materials are bought for Rs. 150 and if, out of this, only 90 units can be normally used (the other ten going to waste), the issues may be costed not at 1.50 per unit but at Rs.1.67 per unit, i.e. 150 h- 90. With the actual issue of 90 units the amount will be exhausted and so will the actual quantity. Both in the store’s ledger, a quantity balance of 10 units will remain; it should be written off.
- Highest in First Out (HIFO) Method: By this method quantities of materials are issued at the highest price of materials on hand. When the quantity having the highest price is exhausted, the next highest price is used in valuing issue. When this method is used, production becomes highest, so that the profit is reduced. During a period of the increasing price level, the method is equivalent to the LIFO method and in a period of decreasing price level, the method is identical to the FIFO method. HIFO method is of theoretical interest only as it has not received wide acceptance.
- Next-in-First out (NIFO) Method: Under the NIFO Method, the price of the material that is to be next received is used in valuing issued materials. It is based on the assumption that the price of the next consignment is known before it is received. If by the time the materials are received, the production is completed, the production cost of materials shows the value of most current purchases. This method is almost similar to the LIFO method but is more forward-looking and under this method, the cost of production reflects the current prices of materials.
- Moving Average Method: By this method, the issue rate for a certain month is established by taking the average of the periodic weighted average cost prevailing during that month and the number of months proceeding it. It may be moving average on the basis of six months, twelve months, etc. For example, if six months moving average is taken for the month of June, the moving average will be a simple average of the rates prevailing for six months from January to June, and for the month of July, it will be a simple average of rates for February to July.
- Base Stock Method: Under this method, a minimum quantity of stock is always to be held in stores as a fixed asset. The minimum stock is known as base stock and it should not be issued unless there is an emergency. The stock in excess of base stock would be issued in accordance with one of the methods of pricing of issue e.g. LIFO, FIFO, Average, etc. Thus it is not an independent method in itself.