What is the average cost method?
submitted by raza

hamblin

It's a way to value inventory. You look at the total cost of all inventory bought or produced during a period, and then divide it by the total number of units that were made. This gives you a uniform per-unit cost, which you use to figure out the value of ending inventory and cost of goods sold.

The difference with a standard cost to produce and average cost is that you may have some items that have a different manufacturing cost. If you produce running shoes, for example, and you have the option to add lights. The standard pair of shoes might cost you $15 to produce, and $18 if you add lights to the soles. Those are your actual costs of production. However, you may decide to lump them together, since they're roughly the same product. In that case you'd use the average cost method.

clark

They sometimes call that the weighted average cost method. It calculate inventory value by dividing the total cost of the products by the total units available. It then assigns the average cost to each unit sold or remaining in inventory. It sort of smooths our price fluctuations over the period.

This is good because you might be paying a certain amount to put tires on a car, but then costs go up every summer for some reason. Rather than changing your cost constantly, you can use average cost to see, more or less, what it will take to keep putting tires on cars. Instead of your numbers fluctuating through the year, you just look at the overall average. It helps you estimate the next year's expenses.

ben

The average cost method finds an average price for all your inventory items. Instead of tracking each item's cost separately, you add up all the costs and divide by how many items there are. That will give you the average price.

therush

They gave you a pretty good idea of what it is. Here are some times you may want to use the average cost method:

Your company has a lot of the same item in inventory.
Your company has a lot of really similar stuff in inventory.
Your costs change through the year.

It's easier to do it this way, but you wouldn't want to use this method when you've got a wide variety of items in your inventory. If you had, golf carts, golf bags, and tees in your inventory, you'd have a pretty wide range. It wouldn't make sense to average those all together, because golf tees cost almost nothing and golf carts cost thousands of dollars. It wouldn't give you an accurate picture of your costs. On the other hand, if you sold bluetooth speakers that came in different colors, your costs would vary only slightly. It would make sense to treat them as basically the same costs, even though there's a minor difference.