Weighted Average Cost

Definition

Weighted average cost is a method used to determine the cost of goods sold and ending inventory in a perpetual inventory system. It involves calculating the average cost of all units available for sale, with the cost of each unit weighted by the quantity of that unit.

5 Must Know Facts For Your Next Test

1. The weighted average cost method calculates the average cost per unit by dividing the total cost of units available for sale by the total number of units available.
2. This method is used to value the cost of goods sold and ending inventory in a perpetual inventory system, where inventory records are continuously updated.
3. The weighted average cost is calculated after each purchase, and the new average cost is used to value the cost of goods sold and ending inventory.
4. The weighted average cost method smooths out fluctuations in the cost of inventory, as the average cost changes gradually with each purchase.
5. The weighted average cost method is often preferred over other inventory costing methods, such as FIFO or LIFO, as it provides a more realistic representation of the cost of inventory.

Review Questions

• Explain how the weighted average cost method is used to calculate the cost of goods sold and ending inventory in a perpetual inventory system.
  • In a perpetual inventory system, the weighted average cost method is used to determine the cost of goods sold and ending inventory. After each purchase, the total cost of units available for sale is divided by the total number of units available to calculate the new weighted average cost per unit. This average cost is then used to value the cost of goods sold as units are sold, as well as the ending inventory at the end of the accounting period. The weighted average cost method provides a more stable and realistic representation of inventory costs compared to other methods like FIFO or LIFO.
• Describe how the weighted average cost method differs from the FIFO (First-In, First-Out) and LIFO (Last-In, First-Out) inventory costing methods.
  • The key difference between the weighted average cost method and FIFO or LIFO is the way the cost of inventory is assigned to cost of goods sold and ending inventory. With FIFO, the cost of the earliest units purchased is assigned to cost of goods sold, while with LIFO, the cost of the most recently purchased units is assigned. In contrast, the weighted average cost method calculates an average cost per unit based on all units available for sale, and applies this average cost to both cost of goods sold and ending inventory. This results in a more stable and less volatile cost of inventory compared to the FIFO and LIFO methods, which can be impacted more by fluctuations in purchase prices.
• Analyze the advantages and disadvantages of using the weighted average cost method in a perpetual inventory system compared to other inventory costing methods.
  • The primary advantage of the weighted average cost method is that it provides a more realistic and stable representation of inventory costs. By averaging the costs of all units available for sale, the method smooths out fluctuations in purchase prices, which can be beneficial for financial reporting and decision-making. Additionally, the weighted average cost method is relatively simple to calculate and apply in a perpetual inventory system. However, a potential disadvantage is that the average cost may not accurately reflect the current market value of the inventory, as it does not distinguish between older and more recent purchases. This can be a concern in periods of significant price changes. Overall, the weighted average cost method is often preferred for its simplicity and consistency, though the choice of inventory costing method should consider the specific needs and circumstances of the business.

Related terms

Perpetual Inventory System: A system that continuously tracks inventory levels and the cost of goods sold, updating the records with each purchase and sale.

Cost of Goods Sold (COGS): The cost of the inventory that has been sold during a particular period, calculated as the beginning inventory plus purchases, less the ending inventory.

Ending Inventory: The cost of the goods that remain in the inventory at the end of an accounting period.