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 costing system?
- 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.
You may also be interested in other useful articles from “process costing system – addition of materials and beginning inventory” chapter:
- Increase in Unit Cost Due to Addition of Materials
- Addition of Materials – Increase in units and Change is Unit Cost
- Beginning Work in Process Inventories – Average Costing Method
- Cost of Production Report FIFO
- Average Costing Method Versus FIFO Costing Method – Process Costing
- Difficulties Encountered in Process Costing Procedure
- Discussion Questions and Answers
Similarities and Differences between Job Order and Process Costing System
Operation Costing /Hybrid Costing System