Stores Ledger and Fire Loss at a Hardware Distributor
On 1 April, a hardware distributor had 500 kg of galvanised sheets at ₹20 per kg. Purchases during April were: 5 April, 800 kg at ₹22; 12 April, 600 kg at ₹25; and 20 April, 400 kg at ₹28. Issues to production were: 8 April, 700 kg; 15 April, 900 kg; and 25 April, 500 kg. On 22 April a fire destroyed 150 kg. The physical stock at 30 April was 50 kg. The insurer has asked for the value of the fire loss. The accountant normally uses FIFO, but the insurer is willing to accept a weighted-average valuation. Rising prices during the month have made the choice material. The production manager wants the fire loss charged to factory overhead so that product cost is not disturbed.
1. Prepare the stores ledger under FIFO and determine the value of closing stock and the abnormal loss.
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FIFO issues and balances
| Date | Particulars | Calculation | ₹ |
|---|---|---|---|
| 8 Apr | Issue 700 kg | 500 kg × ₹20 + 200 kg × ₹22 | 14,400 |
| 15 Apr | Issue 900 kg | 600 kg × ₹22 + 300 kg × ₹25 | 20,700 |
| 22 Apr | Fire loss 150 kg | 150 kg × ₹25 | 3,750 |
| 25 Apr | Issue 500 kg | 150 kg × ₹25 + 350 kg × ₹28 | 13,550 |
| 30 Apr | Closing stock | 50 kg × ₹28 | 1,400 |
Total purchase cost = ₹10,000 + ₹17,600 + ₹15,000 + ₹11,200 = ₹53,800. Check: issues ₹48,650 + fire loss ₹3,750 + closing stock ₹1,400 = ₹53,800.
Abnormal loss under FIFO = ₹3,750; closing stock = ₹1,400.
2. The insurer asks for the fire loss on a weighted-average basis. Compute the loss and explain why it differs from FIFO.
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Using moving weighted average:
| Stage | Average cost per kg | Value |
|---|---|---|
| After 5 Apr purchase | (₹10,000 + ₹17,600) ÷ 1,300 = ₹21.2308 | - |
| 8 Apr issue 700 kg | 700 × ₹21.2308 = ₹14,861.54 | Balance 600 kg, ₹12,738.46 |
| After 12 Apr purchase | (₹12,738.46 + ₹15,000) ÷ 1,200 = ₹23.1154 | - |
| 15 Apr issue 900 kg | 900 × ₹23.1154 = ₹20,803.85 | Balance 300 kg, ₹6,934.62 |
| After 20 Apr purchase | (₹6,934.62 + ₹11,200) ÷ 700 = ₹25.9066 | - |
| 22 Apr fire loss 150 kg | 150 × ₹25.9066 = ₹3,885.99 | Balance 550 kg, ₹14,248.63 |
| 25 Apr issue 500 kg | 500 × ₹25.9066 = ₹12,953.30 | Closing 50 kg, ₹1,295.33 |
FIFO values the fire loss at the oldest available cost, ₹25 per kg, because the earlier cheaper layers were already issued. The weighted average pools all costs, so the loss absorbs some of the later ₹28 purchase. In rising prices, FIFO therefore gives a lower loss and higher closing stock than weighted average.
The insurer should apply the accounting policy actually followed. The company should not switch methods merely to increase the claim; if FIFO is the normal basis, ₹3,750 is the defensible figure.
3. Should the fire loss be charged to factory overhead? Advise the production manager.
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No. The fire loss is an abnormal loss, not a normal cost of production. Charging it to factory overhead spreads it over good output, overstates product cost and inventory, and hides the loss from management control.
The correct treatment is to transfer ₹3,750 to a Costing Profit and Loss Account or to an insurance claim account. Any amount recovered from the insurer is credited against the loss; any unrecovered balance is written off. Normal losses arising in the ordinary course are absorbed by good units, but an abnormal event such as fire should be separately disclosed. This keeps product cost comparable and makes the recovery action visible.