Material Variances when there are opening and closing stocks of materials

Page M12

Material Purchased/Consumed

When it comes to calculating material variances, what is it that is considered for actuals? Is it the material purchased or the material consumed?

When it comes to quantity, there should be no doubt that it is the material consumed that has to be considered in measuring variances.

The problem of choice arises regarding prices. This is on account of the fact that we will come across different prices in the context of stocks, specifically when the prices of opening and closing stocks are not known and are to be assumed.

Quantity
(kgs) 		Price
/kg 		Value
Opening Stock
(+) Current Period Purchases 		1,200
7,600 		?
4.20 		?
31,920
Total Stock
(−) Closing Stock 		8,800
800 		?
? 		?
?
Value of Material Consumed 8,000 ? ?

The prices and values indicated with ? should be either assumed or derived. If we can arrive at the price we can caluclate the value or vice versa.

Valuing Material Consumed

The value of material consumed is obtained as a residual figure after deducting the value of closing stock from the total value of materials. The relevant price is obtained using the value and quantity of material consumed.

Valuing Opening Stock

In the absence of information relating to the price and value of opening stock, i.e. when only the quantity is known, the following options are available regarding its price

  • Valuing at current period prices

    Opening stock is closing stock of the previous period.

    Valuing opening stock at current period prices amounts to assuming that the closing stock of previous period is valued at the same price as the current period purchase.

    If following FIFO method for stock valuation, which generally is the case, we value the closing stock at the current period prices.

    Valuing closing stock of the previous period at current period prices amounts to assuming that the current prices relating to the previous period, based on which the closing stock was valued, and the current prices of the current period are the same. This amounts to assuming that the purchase price of stock of the previous period and the current period are the same.

    In the example given above, if this is adopted, price of opening stock would be 4.2 per kg and accordingly the value of opening stock

    Quantity
    (kgs)     		Price
    /kg     		Value
    Opening Stock
    (+) Current Period Purchases     		1,200
    7,600     		4.2
    4.2     		5,040
    31,920
    Total Stock
    		8,800 4.236,960
    • Opening Stock
      Price = 4.2 (assumed)
      Value = 1,200 × 4.2

      (Quantity × Price)

    • Total Stock
      Value = 5,040 + 31,920

      [Value of opening Stock + Value of current period purchases]

      Price = 36,960 ÷ 8,800

      [Value ÷ Quantity]

    Assumption independent of method for valuation of closing stock

    FIFO, LIFO, and Average methods are the three common methods used in valuing closing stocks.

    Assuming the price relevant to opening stock to be equal to the current period purchase price is not influenced by the method adopted for valuing closing stock. It amounts to valuing the opening stock at some price that is reasonable and rational.

  • Valuing at standard prices

    Where stocks are valued or maintained at standard prices, we consider the standard price to be the price at which the opening stock has to be valued.

    In the example given above, say if the standard price is 3.1 per kg, price of opening stock would be 3.1 per kg and accordingly the value of opening stock

    Quantity
    (kgs)     		Price
    /kg     		Value
    Opening Stock
    (+) Current Period Purchases     		1,200
    7,600     		3.1
    4.2     		3,720
    31,920
    Total Stock
    		8,800 4.0535,640
    • Opening Stock
      Price = 3.1 (assumed)
      Value = 1,200 × 3.1

      (Quantity × Price)

    • Total Stock
      Value = 3,720 + 31,920

      [Value of opening Stock + Value of current period purchases]

      Price = 35,640 ÷ 8,800

      [Value ÷ Quantity]

Methods for valuation of Closing Stock

The information relating to the opening stocks and current period purchases in an organisation is as follows.

Quantity
(kgs) 		Price
/kg 		Value
Opening Stock
(+) Current Period Purchases 		1,200
7,600 		4.31
4.2 		5,172
31,920
Total Stock
(−) Closing Stock 		8,800
800 		4.215
? 		37,092
?

Following are some of the common methods available for valuation of closing stock.

  • FIFO (First in First Out)

    Under this method closing stock is valued at the current period purchase price.

    Quantity
    (kgs)     		Price
    /kg     		Value
    Opening Stock
    (+) Current Period Purchases     		1,200
    7,600     		4.31
    4.2     		5,172
    31,920
    Total Stock
    (−) Closing Stock     		8,800
    800     		4.215
    4.2    		 37,092
    3,360
    Price = 4.2 (assumed)
    Value = 800 × 4.2

    (Quantity × Price)

    This method aims to correlate pricing with physical usage of stock. It is a general practice in physical consumption of stock, to use up older stock first. This is to avoid the risk of stock getting obsolete.

    Thus, the stock that is left in stock is always the one that is acquired the last or the latest stock. By this rationale, the closing stock would be out of the stock that has been acquired during the current period.

    Closing Stock > Purchases

    This method might result in a value that is not in synchrony with the assumption that the stock that is left at the end pertains to the current period purchase where

    • quantity of closing stock is greater than current period purchased quantity and
    • price at which opening stock is valued is not the same as the current period purchase price
    Quantity
    (kgs)     		Price
    /kg     		Value
    Opening Stock
    (+) Current Period Purchases     		1,200
    7,600     		4.31
    4.2     		5,172
    31,920
    Total Stock
    (−) Closing Stock     		8,800
    8,000     		4.215
    4.2055    		 37,092
    33,644

    In such a case,
    Value of Closing Stock

    = Value of current period purchases + Value of stock in excess of current period purchases (valued at opening stock prices)

    = Value of current period purchases + (Quantity of Closing Stock − Quantity of Purchases) × Price at which opening stock is valued

    = 31,920 + (8,000 − 7,600) × 4.31

    = 31,920 + 400 × 4.31

    Price = Value ÷ Quantity
    = 33,644 ÷ 8,000
    = 4.2055

  • LIFO (Last in First Out)

    Under this method closing stock is valued at the rate at which opening stock is valued.

    Quantity
    (kgs)     		Price
    /kg     		Value
    Opening Stock
    (+) Current Period Purchases     		1,200
    7,600     		4.31
    4.2     		5,172
    31,920
    Total Stock
    (−) Closing Stock     		8,800
    800     		4.215
    4.31    		 37,092
    3,448
    Price = 4.31 (assumed)
    Value = 800 × 4.31

    (Quantity × Price)

  • (Weighted) Average Method

    Under this method closing stock is valued at the weighted average rate of the price of opening stock and the current period purchases taking the quantity of purchases as weights.

    Quantity
    (kgs)     		Price
    /kg     		Value
    Opening Stock
    (+) Current Period Purchases     		1,200
    7,600     		4.31
    4.2     		5,172
    31,920
    Total Stock
    (−) Closing Stock     		8,800
    800     		4.215
    4.215    		 37,092
    3,372
    Price = 4.215 (assumed)
    Value = 800 × 4.215

    (Quantity × Price)

    Weighted average of prices taking quantities are weights

    =
    Sum of products of Prices and respective Quantities
    Sum of Quantities
    =
    p1 × q1 + p2 × q2 + ...
    q1 + q2 + ...
    or
    Σpq
    Σq
    =
    po × qo + pc × qc
    qo + qc
    ['o' opening, 'c' current period]
    =
    1,200 × 4.31 + 7,600 × 4.2
    1,200 + 7,600
    =
    37,092
    8,800

    That would be the data pertaining to the Total Stock and average price would be the price relevant to total stock.

  • Simple Average Method

    Under this method closing stock is valued at the simple average of the prices of opening stock and the current period purchases.

    Quantity
    (kgs)     		Price
    /kg     		Value
    Opening Stock
    (+) Current Period Purchases     		1,200
    7,600     		4.31
    4.2     		5,172
    31,920
    Total Stock
    (−) Closing Stock     		8,800
    800     		4.215
    4.255    		 37,092
    3,404
    Price = 4.255 (assumed)
    Value = 800 × 4.255

    (Quantity × Price)

    Simple Average of prices

    =
    Sum of Prices
    Number of Prices
    =
    p1 + p2 + ...
    np
    or
    Σp
    n(p)
    =
    4.31 + 4.2
    2
    =
    8.51
    2
    = 4.255

    It would be the same as weighted average of prices, where the variable (prices) values are all the same, i.e. p1 = p2 = ...

    Quantity
    (kgs)     		Price
    /kg     		Value
    Opening Stock
    (+) Current Period Purchases     		1,200
    7,600     		4.4
    4.4     		5,280
    33,440
    Total Stock
    (−) Closing Stock     		8,800
    800     		4.4
    4.4    		 38,720
    3,520

    Weighted Average of prices

    =
    p1 × q1 + p2 × q2 + ...
    q1 + q2 + ...
    =
    p1 × q1 + p1 × q2 + ...
    q1 + q2 + ...
    =
    p1 × (q1 + q2 + ...)
    q1 + q2 + ...
    = p1

    Simple Average of prices

    =
    p1 + p2 + ...
    n(p)
    =
    p1 + p1 + ...
    n(p)
    =
    n(p) × p1
    n(p)
    = p1

Which method to use

The decision as to which method has to be adopted for valuing closing stock is taken by the organisation in resonance with the organisational policies.

In problem solving, in the absence of information to the contrary, we adopt FIFO method for valuation of stocks. This is more of a convention rather than a rule. It would be appropriate to state the method being used as a part of the working note to the solution.

Valuing Closing Stock

The method adopted for valuation of closing stock would be consistent with the one adopted for the valuation of opening stock. It is a matter of policy of the organisation and the same policy would be adopted in valuing both the opening stock as well as closing stock.

In the absence of information relating to the price and value of closing stock, i.e. when only the quantity is known, the following options are available regarding its price

  • Valuing at current period prices (FIFO Method)

    This amounts to assuming that all the stock at the end pertains to stock that has been purchased/acquired during the current period.

    In the example given above, if this is adopted, price of closing stock would be 4.2 per kg and accordingly the value of closing stock.

    Quantity
    (kgs)     		Price
    /kg     		Value
    Opening Stock
    (+) Current Period Purchases     		1,200
    7,600     		4.2
    4.2     		5,040
    31,920
    Total Stock
    (−) Closing Stock     		8,800
    800     		4.2
    4.2    		 36,960
    3,360
    Material Consumed 8,000 4.233,600
    • Closing Stock
      Price = 4.2 (assumed)
      Value = 800 × 4.2

      (Quantity × Price)

    • Material Consumed
      Value = 36,960 − 3,360

      [Value of Total Stock − Value of Closing Stock]

      Price = 33,600 ÷ 8,000

      [Value ÷ Quantity]

  • Valuing at standard prices

    Where stocks are valued or maintained at standard prices, we consider the standard price to be the price at which both the opening and closing stocks have to be valued.

    In the example given above, say if the standard price is 3.1 per kg, price of closing stock would be 3.1 per kg and accordingly the value of closing stock

    Quantity
    (kgs)     		Price
    /kg     		Value
    Opening Stock
    (+) Current Period Purchases     		1,200
    7,600     		3.1
    4.2     		3,720
    31,920
    Total Stock
    (−) Closing Stock     		8,800
    800     		4.05
    3.1    		 35,640
    2,480
    Material Consumed 8,000 4.14533,160
    • Closing Stock
      Price = 3.1 (assumed)
      Value = 1,200 × 3.1

      (Quantity × Price)

    • Material Consumed
      Value = 3,720 + 31,920

      [Value of opening Stock + Value of current period purchases]

      Price = 35,640 ÷ 8,800

      [Value ÷ Quantity]

Value independent of method adopted

Where stocks are valued or maintained at standard prices, we consider the standard price to be the price at which both the opening and closing stocks have to be valued.

In the example given above, say if the standard price is 3.1 per kg, price of closing stock would be 3.1 per kg and accordingly the value of closing stock

Effect on Variances

The method adopted for valuation of opening and closing stocks would influence the value of material consumed. To be more precise, it affects the price at which the actual quantity of material consumed is valued.

Actual Price and Actual Cost are the figures that would vary. Actual Quantity is a figure that is independent of the method adopted for valuation of stocks.

Therefore, those variances which have Actual Cost (AC) in the formula for calculations would vary. Alternatively we can also say that those variances which when written in price and quantity terms have Actual Price (AP) in the formula for calcuations would vary.

Material
MCV
MPV
MQV/MUV
MMV
MYV/MSUV 		=
=
=
=
= 		SC(AO)
SC(AQ)
SC(AO)
SC(AI)
SC(AO) 		−
−
−
−
− 		AC ✔
AC ✔
SC(AQ)
SC(AQ)
SC(AI) 		Cost Variance
Price Variance
Quantity/Usage Variance
Mix Variance
Yield/Sub-Usage Variance

AC = AQ × AP

Thus, Material Cost Variance and Material Price Variance are the two values that would be influenced by the option chosen.

In effect it is the price variance that varies and since cost variance is the sum of price and quantity variances, it is also affected.

Material Price Variance

The variation in the method adopted for valuation will affect the material price variance.

  • Valuing at Standard price

    Valuing stocks at standard prices will result in the material price variance on all material purchased during the current period being taken into account in the current period itself.

    Actual Standard Variance
    [SC − AC]
    Quantity
    (kgs)     		Price
    /kg     		Cost Price
    /kg     		Cost
    AQ AP AC SP SC
    Opening Stock
    (+) Current Period Purchases     		1,200
    7,600     		3.1
    4.2     		3,720
    31,920     		3.1
    3.1     		3,720
    23,560     		0
    −8,360
    Total Stock
    (−) Closing Stock     		8,800
    800     		4.05
    3.1     		35,640
    2,480     		3.1
    3.1     		27,280
    2,480     		−8,360
    0
    Material Consumed 8,000 4.145 33,160 3.1 24,800 −8,360

    There is no variation in the value of opening stock as it is valued at standard prices. Only the value of materials pertaining to the current period purchases have a variation included in its value. All the variation is taken into account in the current period itself, thereby leaving all stock at standard value. Thus the closing stock is also left at standard price.

    MPV = AQ(SP − AP)
    = 8,800 (3.1 − 4.145)
    = 8,000 × (− 1.045)
    = − 8,360 [Adv]

  • Valuing at Current Period price

    Valuing stocks at current period prices will result in the material price variance related to only the material consumed during the current period is taken into account in the current period.

    Actual Standard Variance
    [SC − AC]
    Quantity
    (kgs)     		Price
    /kg     		Cost Price
    /kg     		Cost
    AQ AP AC SP SC
    Opening Stock
    (+) Current Period Purchases     		1,200
    7,600     		4.2
    4.2     		5,040
    31,920     		3.1
    3.1     		3,720
    23,560     		−1,320
    −8,360
    Total Stock
    (−) Closing Stock     		8,800
    800     		4.2
    4.2     		36,960
    3,360     		3.1
    3.1     		27,280
    2,480     		−9,680
    −880
    Material Consumed 8,000 4.2 33,600 3.1 24,800 −8,800

    On account of the opening and closing stocks being valued at a price other than the standard price, there would be some amount of price variance when compared to the standard price in their value. This value will be carried over along with them and will be taken into account as the variance in the period in which the material is consumed.

    As such the variance relating to material consumed only is taken in as Material Price Variance in the current period.

    MPV = AQ(SP − AP)
    = 8,800 (3.1 − 4.2)
    = 8,000 × (− 1.1)
    = − 8,800 [Adv]

Calculation of Variances

The presence of opening and/or closing stocks would thus influence the numerical value of actual price (AP), thereby affecting actual cost (AC).

But for the difference in the AP figure that is to be considered in calculating variances, there is no difference in calculating variances compared to a case where there are no stocks.

Author : The Edifier
Page M14