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Overview of Weighted-Average Method
Definition of
Weighted-Average Method
What is the Weighted-Average Method? The Weighted-Average Method, also known as the Average Cost Method, is one of the common inventory valuation methods used to determine the cost of inventory on hand and the Cost of Goods Sold (COGS). This method calculates a weighted average cost for all similar items available for sale during an accounting period. The formula is: Total Cost of Goods Available for Sale / Total Units Available for Sale. This average cost is then applied to both the units sold (COGS) and the units remaining in ending inventory.
Activities Related to
Weighted-Average Method
Here is a list of Weighted-Average Method related activities:Â
Tracking the total cost of beginning inventory and all purchases during the period, Summing the total units in beginning inventory and all units purchased, Calculating the weighted-average cost per unit after each new purchase (in a perpetual system) or at the end of the period (in a periodic system), Assigning the calculated average cost to units sold to determine COGS, Valuing ending inventory using the same average cost, and Maintaining accurate bookkeeping records of purchases and quantities.
These activities ensure inventory costs are smoothed out over the period.
The Importance of
the Weighted-Average Method
The Weighted-Average Method is important because it provides a simple and objective way to value inventory and COGS, especially when individual item costs fluctuate or are difficult to track separately (unlike the Specific Identification method). It tends to smooth out the effects of price changes over time, resulting in COGS and ending inventory values that fall between those calculated by FIFO and LIFO during periods of inflation or deflation. This method is relatively easy to apply, particularly with a periodic inventory system, and is an acceptable method under both GAAP and IFRS.
Key Aspects of
Weighted-Average Method
Averaging of Costs
Uses an average cost for all units available for sale during the period, rather than tracking specific unit costs.
Smooths Price Fluctuations
Less sensitive to extreme price changes in recent purchases compared to LIFO, or old purchases compared to FIFO.
Simplicity (Especially Periodic)
Can be simpler to calculate than FIFO or LIFO, especially if a periodic inventory system is used (one average cost calculated at period end).
Impact on Financials
Produces COGS and ending inventory values that are typically between those of FIFO and LIFO during periods of consistent price changes.
Concepts Related to
Weighted-Average Method
The Weighted-Average Method is a key Inventory Valuation Method, along with FIFO and LIFO. It directly affects the calculation of Cost of Goods Sold (COGS) presented on the Income Statement and the value of ending Inventory on the Balance Sheet. It is a common method used in cost accounting for identical items that are commingled.
Weighted-Average Method
in Action:
The Adventures of Coco and Cami
Coco and Cami buy ingredients at different prices throughout the month. Professor A shows them the Weighted-Average Method to simplify how they figure out the cost of their inventory.
Learn how this method averages out cost fluctuations, giving Coco and Cami a steady way to value their supplies and the cost of the delicious items they sell.