Definition:
The average cost method is an inventory valuation method that assigns the same cost to all units of inventory in a specific period. It calculates the average cost per unit by dividing the total cost of goods available for sale by the total number of units available for sale.
Key points about the average cost method:
- Cost calculation: The average cost per unit is calculated by dividing the total cost of goods available for sale by the total number of units available for sale.
- Cost of goods sold: The cost of goods sold is calculated by multiplying the average cost per unit by the number of units sold.
- Ending inventory: The ending inventory is valued at the average cost per unit.
- Simplicity: The average cost method is relatively simple to apply.
Why is the average cost method used?
- Simplicity: The average cost method is a relatively simple method to apply, making it suitable for businesses with a large number of inventory items.
- Smoothing: The average cost method can help to smooth out fluctuations in inventory costs over time.
- Compliance: The average cost method is often allowed by accounting standards.
However, the average cost method may not provide the most accurate valuation of inventory in all cases, especially when inventory costs fluctuate significantly.
In essence, the average cost method is an inventory valuation method that assigns the same cost to all units of inventory in a specific period. Sources and related content
