BBA Study Material Bookkeeping LIFO FIFO Method
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Straight line method (BBA Study Material)
It is the simplest method of charging depreciation. The original cost of assets is divided by the estimated life period of the assets.
e.g. if the value of assets is ₹ 50,000 and its useful life is estimated to be 10 years, the amount of depreciation to be charged every year will be 5,000, i.e. 50,000/10. It will be fixed at ₹ 5,000 for every year.
In certain case, we are also given the scrap value or residual value of the assets. The term residual or scrap value mean the amount realised from the sale of obsolete asstes.
In these cases, we use the following formula for calculation of depreciation :
Annual depreciation =
Under SLM (straight line method) depreciation may also be determine by applying by applying a fixed rate to the original cost of the assets.
Rate of Depreciation =
Disadvantages of Straight Line Method (BBA Bookkeeping)
Straight line method suffers from the following weakness :
- No provision for replacement : The amount charged are depreciation is retained in the business and used in the routine affairs. The firm has to bother for making arrangement of funds for the replacement of assets although depreciation has been charged every year.
- Loss of interest : The amount of depreciation charged every year is not invested outside the firm, so no interest is received. In certain method of depreciation, the amount of depreciation is invested outside the business in securities and interest is charged.
- Illogical method : It seems illogical to charge depreciation on the original cost of the assets every year when the balance of the assets is declining year after year.
Annunity Method (BBA Notes)
The amount spent on the purchase of an assets has an opportunity cost i.e. if that amount had been invested in some other form, it would have earned interest at a certain rate.
The SLM and DBM method ignore such cost. Generally depreciation does not take such loss of interest into account. But in some case it is considered desirable to included it.
e.g. when some property is taken on lease we have to pay a lumpsum amount at the initial stage and then a nominal amount as rent every year.
The amount paid at the initial stage is a sort of advance payment of rent. It is treated as the cost of lease and written off during the lease period by way of providing depreciation. In such a situation , the loss of interest on advance payment must be treated as a part of the cost of using the assets.
The method by which the interest is also included in the amount of depreciation is know as annuity method.
Merits and Demerits of Annuity Method
This method is to a great extent scientific as it takes care of the fact that business besides losing the original cost of assets, also lose interest which would have earned in case of the same amount had been invested in some other form of investment.
But the main defect is that total charges of depreciation and repaid put together do not remain fairly uniform year to year as in the DBM.
(FIFO) Method First in First Out (BBA Bookkeeping and Accounting)
In this method, it is assumed that the material/goods first received are the first to be issued or sold. After the first lot or batch of goods purchased in exhausted, the next lot is taken up for sale.
Advantages of FIFO Method
- This method is simple to understand and easy to operate.
- It is a logical method because it takes into consideration the normal procedure of utilising first those item of stock which are received first.
- This method is very useful when prices are falling because cost of goods sold will be high on account of using earliest lot which is costly.
- It is simple to operate especially when price level are minimum.
(LIFO) Last in First Out Method (BBA Study Material)
According to this method, current cost of applied to current sales. Material goods issued to production/sold to customer are valued at the costs of latest purchases. The inventory, therefore is valued at cost of the remaining goods of earlier purchases. The actual issue of material/sale of finished goods may not follow the principle of last in first out.
FIFO Method Advantages
- It keeps the value of issues close to the current market prices.
- No unrealised profit and loss is made by using this method.
- Current costs are correlated with current sales and therefore the management gets a more accurate picture of the business profit and loss.
- It helps in reducing taxation liability in times or rising prices. During inflation, higher cost of goods sold in charged against sales on the basis of most recent purchase, while the closing stock is valued at a lower cost on the basis of most recent purchases, while the closing stock is valued at a lower cost on the basis of old purchases. The net result is the reduction in the income for tax purposes.