Average Cost Method
Average cost method assigns a cost to inventory items based on the total cost of goods purchased or produced in a period divided by the total number of items purchased or produced. Average cost method is also known as weighted-average method.
Definition: The average cost method allocates the cost of inventory items by dividing the total cost of goods purchased or produced in a given period by the total quantity of goods purchased or produced. The average cost method is also known as the weighted average method.
Origin: The origin of the average cost method can be traced back to early accounting practices when businesses needed a simple and effective way to calculate inventory costs. With the development of the Industrial Revolution and the popularization of mass production, the average cost method gradually became a standard inventory valuation method.
Categories and Characteristics: The average cost method mainly includes two types: moving weighted average and periodic weighted average.
- Moving Weighted Average: Recalculates the average cost each time new inventory is purchased. This method is suitable for businesses with frequent inventory turnover.
- Periodic Weighted Average: Calculates the average cost at the end of a specific accounting period, suitable for businesses with less frequent inventory turnover.
Specific Cases:
- Case 1: A company purchases three batches of raw materials in a month: 100 units costing 1,000 yuan; 200 units costing 2,200 yuan; and 300 units costing 3,300 yuan. By the end of the month, the company sells 400 units of raw materials. According to the average cost method, the average cost is (1,000+2,200+3,300)/(100+200+300)=11 yuan/unit. Therefore, the cost of goods sold is 400*11=4,400 yuan.
- Case 2: A retailer purchases three batches of goods in a quarter: 50 items costing 500 yuan; 100 items costing 1,200 yuan; and 150 items costing 1,800 yuan. By the end of the quarter, the retailer sells 200 items. According to the average cost method, the average cost is (500+1,200+1,800)/(50+100+150)=10 yuan/item. Therefore, the cost of goods sold is 200*10=2,000 yuan.
Common Questions:
- Question 1: Is the average cost method suitable for all types of businesses?
Answer: The average cost method is suitable for most businesses, but for industries with significant price fluctuations, such as high-tech products or raw materials, it may need to be used in conjunction with other methods. - Question 2: What is the difference between the average cost method and the first-in, first-out (FIFO) method?
Answer: The average cost method allocates inventory costs by calculating the average cost, while the FIFO method allocates costs based on the order of inventory purchases. They may differ in cost calculation and tax implications.
