Average Cost Method

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Average Cost Method

The average cost method (also called the weighted-average method) values inventory by assigning each unit the same cost: the total cost of goods purchased or produced during a period divided by the total number of units purchased or produced. The resulting average cost is used to calculate both cost of goods sold (COGS) and ending inventory.

Key points

  • One of three common inventory valuation methods (the others are FIFO and LIFO).
  • Calculates a single weighted-average unit cost for a period and applies it to units sold and units on hand.
  • Must be used consistently across accounting periods; changes require disclosure and retrospective application.

Formula

Average cost per unit = Total cost of goods purchased or produced in the period ÷ Total number of units purchased or produced in the period

Apply this average to:
* COGS = Average cost per unit × Units sold
* Ending inventory = Average cost per unit × Units remaining

How it works (step-by-step)

  1. Sum the cost of all inventory purchases or production for the period.
  2. Sum the total units acquired or produced in the period.
  3. Divide total cost by total units to get the average cost per unit.
  4. Multiply the average cost by units sold to determine COGS.
  5. Multiply the average cost by units remaining to determine ending inventory.

Example

Sam’s Electronics purchases inventory during a quarter with a total cost of $113,300 for 100 units. The company sold 72 units during the quarter.

  1. Average cost per unit = $113,300 ÷ 100 = $1,133
  2. COGS = 72 units × $1,133 = $81,576
  3. Ending inventory = 28 units × $1,133 = $31,724

Benefits

  • Simple to compute and administer—saves time and reduces record-keeping labor.
  • Well-suited for businesses with large volumes of similar or interchangeable items.
  • Smooths cost fluctuations, which can make income less volatile and harder to manipulate through purchase timing.

Drawbacks and considerations

  • May not reflect the actual physical flow of goods or recent price changes—can obscure the effect of inflation or deflation on costs and margins.
  • Less precise for businesses with distinct or high-value individual items.
  • U.S. GAAP requires consistent application of the chosen inventory method; changes must be disclosed and applied retrospectively. IFRS permits FIFO and average cost but does not allow LIFO.

When to use it

Choose the average cost method if inventory items are virtually identical, unit-level cost tracking is impractical, or you prefer a simple, stable costing approach that smooths price volatility.

Bottom line

The average cost method provides a straightforward way to value inventory and compute COGS by using a weighted average unit cost for a period. It balances simplicity and consistency, making it appropriate for many businesses with homogeneous, high-volume inventories.