Average cost method is an inventory valuation method in accounting that assigns a cost to inventory based on the average cost of goods available for sale during a period. Instead of tracking individual purchase prices, the method applies an average unit cost to both cost of goods sold (COGS) and ending inventory.
The average unit cost is computed by dividing the total cost of goods available for sale by the total number of units available for sale. The resulting weighted-average cost per unit is then used to value inventory and cost of goods sold.
Two principal variations of the average cost method are commonly used: the weighted-average cost method, applied in a periodic inventory system, and the moving-average cost method, applied in a perpetual inventory system.
The weighted-average cost (WAC) method is used in a periodic inventory system. Under this approach, the average cost per unit is calculated at the end of the accounting period.
The calculation follows these steps:
Ending inventory is valued by multiplying the weighted-average unit cost by the number of units remaining at period end. Cost of goods sold is calculated using the same average unit cost.
This method smooths the effect of price fluctuations over the accounting period.
The moving-average cost (MAC) method is used in a perpetual inventory system. Under this approach, the average unit cost is recalculated after each purchase.
When additional inventory is acquired:
When a sale occurs, inventory is reduced by the quantity sold and cost of goods sold is computed using the most recently determined moving-average unit cost.
The moving-average method continuously updates inventory values and is commonly used in computerized accounting systems.