Explanation of Cost Price Method
Under cost price method, materials issued to production, are charged out on the basis of actual cost i.e., the cost at which these have been purchased. As we already know, the actual cost of materials consists of purchase price or invoice price (less trade discount and quantity discount), import duty, sales tax, commission on purchase, freight, carriage, cartage, transit insurance and octroi duty.
Basis of Cost Price Method
This method is considered to be the simplest and most scientific as it helps in recovering the actual cost of materials paid, from production. As such, it adheres to the costing principles. Under the actual cost method, the materials issued can be priced out on any of the following basis:
- First-In-First-Out Method (or FIFO Method)
- Last-In-First-Out Method (or LIFO Method)
- Highest-In-First-Out Method (or HIFO Method)
- Next-In-First-Out Method (or NIFO Method)
Under this method, materials purchased or received first are deemed to be issued first. As such, the price paid for the earliest lot of materials in hand is taken as the basis for charging out the materials issued. Under this method, the various items on the debit side of the Stores Ledger (Receipts Column) are exhausted in chronological order.
The stock in hand, under this method, is valued at cost of the current or latest purchases. This requires the maintenance of the record of quantity and value of every receipt of material.
The operation of this method can be understood by the following example: