When the variance between purchase prices is very little, this method is the most suitable one. Here the total of the prices of materials in the stock (from which the material to be priced could have been drawn) is divided by the number of prices used to ascertain “Simple Average Price”. Irrespective of the quantities, the average of the prices is found. One lot may be 5kgs and another lot may 5000kgs. But the prices per kg of both lots are taken for average purpose.
It should be noted that for the purpose of physical movement of materials, FIFO method is assumed which forms the basis of simple average method. Thus, the prices of earlier lots are left out of simple average calculation, as and when materials are issued and older lots are exhausted.
- It is simple and easy to calculate the issue price
- This method reduces the effect of fluctuation of prices by averaging the price.
- This method does not take into account the quantity purchased at each price. This may lead to absurd results.
- As the actual price is not used, PROFIT or LOSS on material will usually arise.
- The value of closing stocks under this method is absurd. When price fluctuates sharply, the closing stock shows credit balance, that is negative figure!