Average Cost Method:
As the
name implies, the average cost method prices
items in the inventory on the basis of the average
cost of all similar goods available during the
period.
Example:
Assume
that a company had the following transactions in the
first month of operations.
|
Date |
Purchases |
Sold
or Issued |
Balance |
|
March
2 |
2,000
@ $4.00 |
|
2,000
units |
|
March
15 |
6,000
@ $4.40 |
|
8,000
units |
|
March
19 |
|
4,000
units |
4,000
units |
|
March
30 |
2,000
@ $4.75 |
|
6,000
units |
|
Assume
the company used the periodic inventory method, the
ending inventory and cost of goods sold would be
computed as follows using a weighted average
method.
|
Date
of Invoice |
No. of
Units |
Unit
Cost |
Total
Cost |
|
March
2 |
2,000 |
$4.00 |
$8,000 |
|
March
15 |
6,000 |
4.40 |
26,400 |
|
March
30 |
2,000 |
4.75 |
9,500 |
| |
|
|
|
| |
10,000 |
|
$43,900 |
| |
|
|
|
|
Weighted average cost per unit:
$43,900/10,000 = $4.39 |
|
Inventory in units: 6,000 $4.39 =
$26,340 |
| |
Cost
of goods available for sale |
$43,900 |
|
| |
Deduct: Ending inventory |
26,340 |
|
| |
|
|
|
| |
Cost
of goods sold |
$17,560 |
|
| |
|
|
|
|
If the
company has a beginning inventory, it is included
both in the total units available and in the total
cost of goods available in computing the average
cost per unit.
Another average cost method is moving average
method, which is used with perpetual inventory
records. The application of the average cost method
for perpetual records is shown below:
|
Date |
Purchases |
Sold
or Issued |
Balance |
|
March
2 |
(2,000
@ $4.00) $8,000 |
|
(2,000
@ $4.00) $8,000 |
|
March
15 |
(6,000
@ $4.40) $26,400 |
|
(8,000
@ $4.30) 34,400 |
|
March
19 |
|
(4,000
@ $4.30) 17,200 |
(4,000
@ $4.30) 17,200 |
|
March
30 |
2,000
@ $4.75 $9,500 |
|
(6,000
@ $4.45) 26,700 |
|
In
this method a new average unit cost is computed each
time a purchase is made. On 15 March, after 6,000
units are purchased for $26,400, 8,000 units costing
$34,400 ($8,000 plus $26,400) are on hand. The
average unit cost is $34,400 divided by 8,000, or
$4.30. This unit cost is used in costing withdrawals
until another purchase is made, at which time a new
average unit cost is computed. Accordingly, the cost
of the 4,000 units withdrawn on March 19 is shown at
$4.30, a total cost of goods sold of $17,200. On
March, following the purchase of 2,000 units for
$9,500, a new unit cost of $4.45 is determined,
resulting in an ending inventory of $26,700.
The
use of average cost methods is usually justified on
the basis of practical rather than conceptual
reasons. These methods are simple to apply,
objective and not as subject to income manipulation
as some of the other inventory pricing methods. In
addition, proponents of the average cost methods
argue that it is often impossible to measure a
specific physical flow of inventory, and therefore
it is better to cost items on an average price
basis. This argument is particularly persuasive when
the inventory involved is relatively homogeneous in
nature. Relevant Articles:
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