Page 45 - Accountancy_F5

Disadvantages of LIFO (iv) Risk of LIFO liquidation: Using LIFO,
(i) Lower reported profits: may be an organisation may find itself selling
tax deductible, investors and other more of its older inventory during
stakeholders who are interested in inventory liquidation periods. This
the success of the company may find would cause expenses to be recorded at
them less enticing. a reduced rate, which would possibly
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(ii) Potential for outdated inventory costs: increase reported profits.
LIFO may cause older inventory (v) Record-keeping and complexity:
items to stay on hand, meaning that Similar to FIFO, LIFO requires
inventory may be devalued and its maintaining detailed records of
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stated value may become out-of-date, inventory purchases and sales.
particularly in inflationary times. However, it can be more complex to
(iii) Mismatch between inventory and implement and maintain due to its
current prices: In strong inflationary reverse nature of inventory flow.
times, closing inventory under LIFO
may be worth substantially less than
the going rate

Weighted Average Cost Method

The Weighted Average Method (WAM) was developed as a way to overcome some of
the disadvantages associated with the use of FIFO and LIFO. In this method, materials
are issued at the average price of purchases. Inventory is valued based on the average
price paid for the goods, weighted by the quantity purchased at each price. The formula
for determining the weighted average cost is given as follows:

Total costof purchase + Value of opening inventories
Weighted Average Cost =
Total number of units available for sale

Where: Total number of units available for sale = opening inventory + purchases

The need for determining the Weighted Average Cost on regular basis
The weighted average cost needs to be recalculated periodically or each time an additional
inventory is received. Why is this important? Regular recalculation of the weighted
average cost is a key aspect of effective inventory management and financial control.
It ensures that the value of inventory reported on the financial statements accurately
reflects the cost of replacing the inventory at current market prices. It also provides
valuable information for decision-making related to purchasing and pricing strategies.

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