by Cost Price Method is a material issue pricing technique used in inventory and cost accounting, where materials are issued from inventory at the original purchase cost, regardless of current market prices or subsequent purchases. This method assumes that the inventory is homogeneous and stable in price, so every unit issued is recorded at the same price at which it was originally purchased.
This approach is especially useful in organizations where materials are purchased in large quantities at fixed rates or where consistency in costing is more important than market fluctuations. The Cost Price Method ensures uniformity in valuing materials issued, which simplifies inventory tracking and budgeting.
However, the method does not reflect price variations, which can lead to inaccurate profit measurement if there are significant differences between purchase cost and current market value. It is a practical method for industries with low price volatility or when price stability is required for internal reporting.
Features of Cost Price Method:
- Uniform Valuation of Issues
The Cost Price Method ensures that every issue of material is valued at the original purchase cost, regardless of when it is issued. This feature provides a uniform and consistent basis for calculating the cost of materials consumed in production. As a result, it simplifies accounting records and eliminates the need to adjust material costs based on market price changes or the timing of different purchases.
- Simplicity in Application
One of the major features of the Cost Price Method is its simplicity. Since all issues are made at the same cost price, it eliminates the complexity associated with methods like FIFO, LIFO, or Weighted Average. Businesses can easily maintain inventory records without recalculating material costs for each issue. This feature makes the method highly suitable for small businesses and industries with straightforward inventory systems.
- Consistency in Cost Reporting
Under the Cost Price Method, cost data remains consistent throughout a financial period unless a new purchase changes the cost price. This consistency helps in accurate comparison and budgeting. It also enhances the reliability of financial records, which is useful for internal reporting and managerial decision-making. The method maintains the same valuation until new stock is purchased at a different rate.
- Does Not Reflect Market Fluctuations
A key feature of the Cost Price Method is that it does not account for changes in the market price of materials. Whether the market price increases or decreases, the materials continue to be issued at their original cost. This can lead to a mismatch between actual market value and recorded cost, making the method unsuitable in industries with frequent price volatility.
- Useful in Stable Price Conditions
The Cost Price Method is most effective when the price of raw materials remains stable over time. It helps maintain straightforward and efficient inventory records in such conditions. Since there are no frequent changes in material prices, issuing stock at cost price closely reflects the actual expense. This makes the method reliable in industries with steady supply costs and minimal price fluctuations.
- Facilitates Budget Control
Because the cost of materials is fixed under this method, it becomes easier for managers to prepare and control budgets. The use of a consistent cost figure supports better planning of production costs and allows for accurate variance analysis. Budgeting becomes more predictable, and management can evaluate performance based on standardized costs rather than fluctuating price data.
- Limited Accuracy in Profit Measurement
A significant feature of the Cost Price Method is its limited accuracy in calculating actual profits. If current market prices are significantly higher or lower than the recorded cost price, it may result in misleading profit margins. This limitation is particularly important in industries where material costs form a substantial portion of total production expenses.
- Simple Documentation and Recording
Inventory documentation becomes easier under the Cost Price Method. Since all issues are recorded at the same cost, it reduces the burden on accounting staff and minimizes the possibility of clerical errors. Stock cards, ledger entries, and reports can be prepared quickly and with less effort, which streamlines the inventory management process and enhances operational efficiency.
Method of Cost Price:
Cost Price Method refers broadly to methods used to price material issues based on their recorded or calculated cost. The following are major techniques under this category:
1. FIFO (First-In, First-Out) Method
Concept: The oldest (first) inventory purchased is assumed to be issued first.
How it works: Materials are issued in the order they were acquired. So, the cost of earliest purchases is charged to production first.
Use Case: Industries dealing with perishable goods or where stock rotation is essential (e.g., food, medicine).
Example:
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Jan: 100 units @ ₹10
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Feb: 100 units @ ₹12
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Issue 150 units → 100 @ ₹10 + 50 @ ₹12
2. LIFO (Last-In, First-Out) Method
Concept: The most recently purchased inventory is issued first.
How it works: Materials from the latest lot are issued before earlier ones.
Use Case: Inflationary environments where businesses want to match recent costs to current revenues (though not allowed under IFRS/Ind AS).
Example:
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Jan: 100 units @ ₹10
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Feb: 100 units @ ₹12
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Issue 150 units → 100 @ ₹12 + 50 @ ₹10
3. HIFO (Highest-In, First-Out) Method
Concept: Materials purchased at the highest cost are issued first.
How it works: Inventory is issued from the lot with the maximum purchase price, regardless of date.
Use Case: Used when companies want to maximize COGS to show lower profits, especially for tax minimization.
Example:
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Jan: 100 units @ ₹10
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Feb: 100 units @ ₹15
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Mar: 100 units @ ₹12
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Issue 100 units → from Feb @ ₹15
4. Average Cost Method (Weighted Average)
Concept: Issues are priced at the average cost of all units available, recalculated after each purchase.
How it works: All costs are pooled together and averaged out. Every issue is valued at this uniform average rate.
Use Case: For homogeneous products where tracking individual batch prices is not feasible.
Formula: Average Cost=Total Cost of Inventory / Total Quantity
Example:
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100 units @ ₹10 = ₹1,000
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100 units @ ₹12 = ₹1,200
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Average Cost = ₹2,200 / 200 = ₹11/unit
5. Inflated Price Method
Concept: Materials are issued at a cost slightly higher than the actual purchase price, to cover hidden costs such as losses, wastage, or overheads.
How it works: An artificial markup (inflation) is added to cost price before issuing. The difference may be transferred to a reserve account.
Use Case: In companies where losses in transit or storage are common and need to be internally adjusted.
Example:
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Purchase price: ₹100/unit
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Inflated issue price: ₹105/unit (5% markup)
Comparison Table:
| Method | Issued From | Reflects Market Value? | Key Benefit |
|---|---|---|---|
| FIFO | Oldest stock | Partially | Realistic closing inventory value |
| LIFO | Newest stock | Yes | Higher COGS in inflation |
| HIFO | Highest-cost stock | Yes | Minimum profit (for tax savings) |
| Average Cost | Pooled average cost | Yes | Smooth cost variation |
| Inflated | Cost + % markup | No | Covers internal losses |
6. Replacement Cost Method (Modified Cost Price Approach)
Materials are issued at the cost it would take to replace them today, not at the historical purchase cost. Although this isn’t strictly the Cost Price Method, it’s a modern adaptation where cost accounting uses market-based cost for issue pricing.
Use Case:
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Industries with rapidly changing prices
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To reflect current economic conditions
Example:
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Purchase price: ₹90, Current market price: ₹100
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Issue at ₹100 (replacement cost)
7. Actual Cost Price Method
In this method, materials are issued at their exact purchase price, taken directly from the invoice of the specific lot purchased. Each item issued is matched with its actual cost recorded at the time of purchase.
Best Used When:
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Small number of high-value items
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Easy to track individual purchases
Example:
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Material purchased @ ₹110 per unit
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Issue recorded at ₹110 (actual cost)
8. Standard Price Method
In this method, materials are issued at a pre-determined standard cost, which is estimated based on historical data, forecasts, or budgets. The difference between the standard cost and actual purchase cost is recorded as a variance.
Best Used When:
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Budgeting and cost control are priorities
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Companies use standard costing systems
Example:
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Standard cost: ₹100/unit
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Actual purchase price: ₹110 → ₹10 recorded as variance
