Page 203 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes First-In First-Out (FIFO) Inventory Method

Under FIFO method, cost is computed on the assumption that goods sold or consumed are those
which have been longest on hand and that those remaining the stock present the least purchases
or production.
Items received first are assumed to be used first and therefore prices charged are those paid for
the early purchases. Prices charged are actual prices and therefore there is no question of having
to recalculate a new price each time a new purchase in received. Care has to be taken to ensure
that each quantity is issued at the correct prices.

If prices are rising, costs of products will be understood and therefore profit will tend to over
stand. On the other hand, stock valuations should approximate current replacement values.

Example: 1. Working on the same example as discussed in the average cost method,
if one item is sold for ` 250 using the FIFO method, the cost of goods
sold would be ` 100, profit would be ` 150 (`250 – ` 100), and ending
inventory balance would be ` 390 (`120 + ` 130 + ` 140)

2. Now let us assume that a textile company created 500 tablecloths at a
cost of $1.00 per unit and then created another 1000 with a unit cost of
$1.25. The revenue from the sale of the first 500 table clothes will be
matched up with the tablecloths which have a cost basis of $1.00.

Base Stock Method

Under the base stock method the minimum quantity of raw materials or other goods without
which management considers the operations cannot be continued, except for limited periods. It
is treated as being a fixed asset subject to constant renewal. The base quantity is carried forward
at the cost of the original stock. If a quantity of goods larger than the base stock owned at the end
of any period, the excess will be carried at its identified cost or at the cost determined under FIFO
method. This is considered a temporary condition.
If a quantity of goods less than the base stock is owned at the end of any period, this condition
is similarly considered temporary. In order not inflate the income of the period during which
the base stock was deflected a reserve is set up equal to the excess of the replacement cost over
the amount at which the goods would have been includes in the base stock inventory. Even if
there serve for replacement is not provided for out of income of the year in which the base stock

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