Determining the purchase cost
Stock may be raw materials or components bought from suppliers, finished goods which have been made by the business but not yet sold, or work in the process of production, but only part completed. It will simplify matters however if we think about the historical cost of purchased raw materials and components which ought to be their purchase price.
When the storekeeper issues components to production he will simply pull out from the bin the nearest components to hand, which may have arrived in the latest consignment or in an earlier consignment or in several different consignments. Our concern is to devise a pricing technique, a rule of thumb which we can to attribute a cost to each of the components issued from stores.
There are several techniques which are used in practice,
- First in first out (FIFO)
This assumes that materials are issued out of stock in the order in which they were delivered into stock. The components issued are deemed to have formed part of the oldest consignment still unused and are cost accordingly.
- Last in first out (LIFO)
This involves the opposite first in first out system; the components issued to production originally formed part of the most recent delivered.
- Average cost
As purchase prices change with each new consignment, the average price of components in the bin is constantly changed. Average cost may be simple average cost or weighted average cost.