Uncovering the Implications Behind the Weighted Average Cost Method

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The weighted average cost method helps determine inventory valuation based on an average price per unit. The inventory is calculated by taking the average cost of all like-goods. The average cost is determined by dividing the cost of goods sold in the inventory stock, by the total number of goods that are on the market for sale.

This method can be used in a variety of settings and businesses. When your business has inventory, it’s important to decide which cost accounting method works best for your product. It is important to note that Unleashed Software uses the weighted average cost method.

Let’s uncover a few of the implications behind the weighted average cost method so we can understand what we’re getting into.

Rising prices

If your business is using the weighted average cost method and prices of products are rising, the costs of goods sold will be decreased in comparison to the last-in-first-out (LIFO) method. However, it will look better than what’s obtained from the first-in-first-out (FIFO) method.

The weighted average cost method does a good job of representing the whole period, despite rising prices. It provides a relatively level, middle of the road approach to the unit cost. It takes into account swings in prices and finds the average. If the prices are high, a business can influence income with the weighted average cost method by electing to buy or not buy goods at the end of the year. Although this can be one way to change or manipulate the bottom line, the averages approach reduces the impact of buying or not buying.

Physical flow of goods

Each inventory costing method looks at how cost flows through a business slightly differently. The weighted average cost method would be more applicable to goods that have an average physical flow, such as petrol. With petrol, when a tank gets topped up, the new petrol is mixed with old petrol. Therefore, any amount of petrol used is a combination of old petrol and new petrol. So if you want your cost inventory method to align with physical flows, then you’ll need to apply it to a product with an average flow in order to use the weighted average cost method.

Stick with your accounting decision

Regardless of which accounting method you chose, you need to keep is consistent for several years. You could flip between methods every year, in order to avoid some of the implications of one method and to reap the advantages of another. However, this inconsistency is disruptive to accounting. Accountants need to have the same system from period to period, so be sure to choose your method wisely and stick with it.

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Melanie - Unleashed Software

Article by Melanie Chan in collaboration with our team of Unleashed Software inventory and business specialists. Melanie has been writing about inventory management for the past three years. When not writing about inventory management, you can find her eating her way through Auckland.

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