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Average Costing Method

The average costing method calculates the average cost of similar inventory items to assign costs to units sold, applicable in both perpetual and periodic inventory systems. In a periodic system, the weighted average unit cost is computed to determine the cost of goods sold and ending inventory, while in a perpetual system, the average unit cost is updated with each purchase. This method is simple to apply and reduces the risk of income manipulation compared to other inventory valuation methods.

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Mohamad ayoubi
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10 views3 pages

Average Costing Method

The average costing method calculates the average cost of similar inventory items to assign costs to units sold, applicable in both perpetual and periodic inventory systems. In a periodic system, the weighted average unit cost is computed to determine the cost of goods sold and ending inventory, while in a perpetual system, the average unit cost is updated with each purchase. This method is simple to apply and reduces the risk of income manipulation compared to other inventory valuation methods.

Uploaded by

Mohamad ayoubi
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Under average costing method,the average cost of all similar items in the

inventory is computed and used to assign cost to each unit sold. Like FIFO and
LIFO methods, this method can also be used in both perpetual inventory
system and periodic inventory system.

Average costing method in periodic inventory


system:
When average costing method is used in a periodic inventory system, the cost of
goods sold and the cost of ending inventory is computed using weighted average
unit cost. Weighted average unit cost is computed using the following formula:

Weighted average unit cost = Total cost of units available for sale / Number of
units available for sale

Example:

The Meta company is a trading company that purchases and sells a single product –
product X. The company has the following record of sales and purchases of
product X for the month of June 2013.

June 01: Balance on hand at the beginning of the month; 200 units @ $10.15.
June 05: Purchased 800 units @ $10.25.
June 07: Sold 400 units.
June 12: Purchases: 600 units @ $10.40.
June 14: Sales: 500 units
June 20: Purchases: 400 units @ $10.50
June 25: Purchases: 800 units @ $10.70
June 26: Sales: 1,400 units
June 28: Sales: 200 units
June 30: Purchases: 600 units @ $10.85

Required: Compute inventory cost at June 30, 2013 using average cost method
assuming the Meta company uses periodic inventory system.

Solution:

Units available for sale:


Weighted average unit cost = $35,740 / 3,400 units
= $10.51176 per unit

Units in ending inventory = Total units available for sale – Total units sold during the
period
= 3,400 units – (400 units + 500 units + 1,400 units + 200 units)
= 3,400 units – 2,500 units
= 900 units

Cost of goods sold: 2,500 units × $10.51176 = $26,279.40


Cost of ending inventory: 900 units × $10.51176 = $9,460.60

Average costing method in perpetual inventory


system:
When average costing method is used in a perpetual inventory system, an average
unit cost figure is computed each time a purchase is made. This average unit cost
figure is then used to assign cost to each unit sold until a new purchase is made.
This technique is also referred to as moving average method.

Using the data from above example we can compute the cost of goods sold and the
cost of ending inventory as follows:

Solution:
Cost of goods sold: $4,092 + $5,158 + $14722 + $2,103 = $26,075 (Total of sales
column)
Cost of ending inventory: $9,665 (Balance column)

The use of average costing method in perpetual inventory system is not


common among companies.

The main advantage of using average costing method is that it is simple and
easy to apply. Moreover, the chances of income manipulation are less under
this method than under other inventory valuation methods.

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