Aston Components: FIFO versus AVCO with Rising Steel Prices
Aston Components holds a single type of steel rod. April records show: opening stock 1 April, 200 units at £5.00; receipt 8 April, 300 units at £5.40; issue to production 12 April, 350 units; receipt 20 April, 400 units at £5.75; issue to production 26 April, 250 units. There was no closing work in progress. The buyer reports that steel prices have risen all year and further increases are expected. The managing director wants the highest possible profit reported for April to support a loan application, and tells the accountant to 'use whichever method gives the best number'. A May quotation for a fixed-price one-year contract also needs a steel cost estimate.
1. Value both issues and the closing stock for April using FIFO, showing your workings.
Read the worked answer
FIFO - oldest units issued first
Issue 12 April (350 units)
- 200 units from opening stock at £5.00 = £1,000.00
- 150 units from the 8 April receipt at £5.40 = £810.00
- Cost of issue = £1,810.00
- Stock left after issue: 150 units at £5.40 = £810.00
Issue 26 April (250 units)
- 150 units at £5.40 = £810.00
- 100 units from the 20 April receipt at £5.75 = £575.00
- Cost of issue = £1,385.00
Closing stock: 400 − 100 = 300 units × £5.75 = £1,725.00
Check
- Units: 200 + 300 + 400 − 350 − 250 = 300 ✓
- Value: purchases and opening 1,000 + 1,620 + 2,300 = £4,920; less issues £3,195 = £1,725 ✓
- Total issue cost FIFO = 1,810 + 1,385 = £3,195.00
2. Value the same issues and closing stock using AVCO, recalculating the average after each receipt.
Read the worked answer
AVCO - new average after each receipt
8 April receipt 200 + 300 = 500 units; £1,000 + £1,620 = £2,620; average = £2,620 ÷ 500 = £5.24
12 April issue (350 units) 350 × £5.24 = £1,834.00 Balance: 150 units, £2,620 − £1,834 = £786.00
20 April receipt 150 + 400 = 550 units; £786 + £2,300 = £3,086; average = £3,086 ÷ 550 = £5.6109 (say £5.61)
26 April issue (250 units) 250 × £5.6109 = £1,402.73 Balance: 300 units, £3,086.00 − £1,402.73 = £1,683.27
Summary
| FIFO | AVCO | |
|---|---|---|
| Issue 12 April | 1,810.00 | 1,834.00 |
| Issue 26 April | 1,385.00 | 1,402.73 |
| Total issues | 3,195.00 | 3,236.73 |
| Closing stock | 1,725.00 | 1,683.27 |
Both methods total £4,920, so all stock is accounted for; only the split between cost of sales and closing stock differs.
3. Quantify the effect on April profit of choosing FIFO rather than AVCO, respond to the managing director's instruction, and state which steel cost should be used in the fixed-price quotation.
Read the worked answer
Effect on profit FIFO issues £3,195.00 to production versus £3,236.73 under AVCO - a difference of £41.73. Under FIFO, cost of sales is lower, so gross profit is £41.73 higher and closing stock is £41.73 higher. The effect on a loan application is trivial.
Response to the MD
- A stock valuation method is an accounting policy, not a lever for a desired profit figure. It must be chosen because it reflects the business's actual stock flow, then applied consistently from period to period; a change would need disclosure and a valid reason.
- Steel rods are physically interchangeable, so AVCO is usually the more defensible choice, and it smooths out price swings; FIFO is defensible where stock is genuinely used in date order (perishables or serialised items).
- Deliberately selecting a method to inflate profit for a lender is misleading presentation. It also backfires: the same method must be used next month, and the £41.73 gain is trivial against the risk to credibility.
- Recommend: choose on principle, disclose the policy, and explain the price-increase pressure to the bank honestly.
Fixed-price quotation Do not use the historical FIFO or AVCO figure. A one-year fixed price will be met from future purchases at rising prices, so estimate using current replacement cost (£5.75) plus a sensible allowance for expected further increases; otherwise the contract will lock in a loss.