Average Costing Method Versus FIFO Costing Method:
Learning Objectives of this Article:
- What is the difference between average
costing method and FIFO costing method when they are used in process
- What are advantages and disadvantages of
Average and FIFO costing method?
Both average costing and FIFO costing have
certain advantages. It would be arbitrary to state that one method is either
simpler or more accurate than the other. The selection of either method depends
entirely upon management's opinion regarding the most appropriate and practical
cost determination procedures.
The basic difference between the average
costing and FIFO costing method concerns the treatment of beginning work in
process inventory. The averaging method adds beginning work in process inventory
costs to the preceding department's materials, labor and factory overhead costs
incurred during a period. Unit costs are determined by dividing these costs by
equivalent production figures. Units and costs are transferred to the next
department as one cumulative figure.
The FIFO method retains the beginning work in
process inventory cost as a separate figure. Costs necessary to complete the
beginning work in process units are added to this total cost. The sum of these
two costs totals is transferred to the next department. Units started and
finished during the period have their own unit cost which is usually different
from the completed unit cost of the units in process at the beginning of the
period. The FIFO method thus separately identifies for management the current
period unit cost originating in a department. Unfortunately, the costs are
averaged out in the next department, resulting in a loss of much of the value
associated with the use of the FIFO method.
If the FIFO method is used, units lost during a
period must be identified as to whether they came from in process at the
beginning or from units received during the period. Also, in computing
equivalent production figures in FIFO costing., the degree of completion of both
the beginning and ending work in process inventories must be considered.
The principle disadvantage of FIFO costing
is that if several unit cost figures are used at the same time, extensive detail
is required within the cost of production report. which can lead to complex
procedures and even inaccuracy. Whether the extra detail yields more
representative unit costs than the average costing method is debatable,
especially in a firm using process costing where production is continuous and
more or less uniform and appreciable fluctuations in unit costs are not expected
to develop. Under such conditions, the average costing method leads to more
satisfactory cost computations.