Accounting cost methods are used to control how a businesses inventory expenses appear on the company books. The weighted average is an accounting cost method used to value a company’s inventory by applying the average cost of on-hand inventory to each item of inventory stock. This means that both the cost of goods sold (COGS) and on-hand inventory are treated comparatively the same when it comes to determining value.
Average costing, however, isn’t always the best accounting cost method or the right approach for all businesses or industries because it can have ramifications for accounting and tax reports. For example, if there are clear upward or downward swings in inventory costs, average costing may understate or overstate the COGS, and consequently, the businesses declares a profit.
One of the main reasons companies choose weighted average costing over other costing methods is because it radically simplifies cost calculations and record keeping. SMEs may utilise the weighted average method for its simplicity or because they lack the knowledge or the right inventory management tools to track FIFO or LIFO inventory layers. So how do you know if the weighted average costing method is right for your business?