Average-Cost Method – Inventory Methods in Financial Accounting

The average-cost method calculates the weighted-average cost of an inventory item on hand during the period and applies this cost to the units sold and to the ending inventory. The average cost is calculated by dividing the cost of goods available for sale by the number of units available for sale. The cost of goods available for sale equals the cost of the beginning inventory plus the cost of all purchases during a period. It reflects the total cost of goods that were on hand at any time during the period and that were available for sale:

Average cost = Cost of goods available for sale / Number of units available for sale

= $450 / 80

= $5.625

To calculate the cost of the 48 units that have been sold, multiply the average cost of $5.625 by 48:

Cost of goods sold = $5.625 * 48 = $270

To calculate the cost of the 32 units in ending inventory, multiply the average cost of $5.625 by 32:

Ending inventory = $5.625 * 32 = $180

Alternatively, once either cost of goods sold or ending inventory has been calculated, the following equation can be used to compute the other.

CGS = Beginning inventory + Purchases – Ending inventory

Adding beginning inventory and purchases yields the cost of goods available for sale. Subtracting the cost of goods that have not been sold (the ending inventory) from the cost of all goods available for sale results in CGS (the cost of the goods that have been sold). If ending inventory is calculated first, the cost of goods sold can be computed as follows:

CGS = Beginning inventory + Purchases – Ending inventory
$270 = $120 + $330 – $180

On the other hand, assuming that cost of goods sold is computed first, the equation can be rearranged and ending inventory can be calculated as follows.

Ending inventory = Beginning inventory + Purchases – CGS
$180 = $120 + $330 – $270

This general equation can be used with all the inventory methods described in this section.

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