Average Cost Valuation

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  The average cost method is an inventory valuation method used in accounting to calculate the value of inventory.  Put very simply it is the cost of all inventory items summed and averaged.

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How is Average Cost Calculated?

• The figure is calculated by dividing the total cost of goods by the total number of goods over a specific accounting cycle.  While you should speak with a professional accountant or a CPA to decide the best method of inventory valuation, the average cost method is easy to calculate and has many benefits. 

Benefits of Average Cost Valuation

• One benefit is that the average cost method assigns a value to both the cost of goods sold and the cost of goods still available over a defined period.  The period is usually defined as monthly, quarterly or yearly. 
• The average-cost method is one of the most straightforward ways to determine COGS over a specific period. 

Example

• While this may not be critical to inventory management it will help you understand how inventory is valued when using the average cost.  In the Video you will see a company that sells goods.  This sales ledger shows our data for the first quarter of the year.  As you can see we first add up the total number of items and then we add up the total cost of all the items.  Next you would divide the total cost by the total number of items and this would give you the weighted average cost per item.  Now let’s imagine that this same company sells 50 units during this same accounting period.  You would then calculate the cost of goods sold by multiplying the number of units sold by the average cost.  Likewise you could calculate the cost of goods still available by multiplying the number of items remaining by the average cost per item. 

The main benefit of the average-cost method is its simplicity, especially for companies that deal with large volumes of very similar items.  On the downside, results can vary greatly from actual costs if your inventory costs are not stable. And that’s it, the average cost method of inventory valuation.  Remember, you should always consult an attorney, professional accountant or a reputable CPA before selecting your valuation method.