Average Cost Method: Definition and Formula With Example

By 澳洲幸运5开奖号码历史查询:Alicia Tuovila

Updated February 04, 2025

Reviewed by

Khadija Khartit

Fact checked by

Vikki Velasquez

Part of the Series

Guide to Accounting

Accounting Explained With Brief Hist🐻ory and Modern Job Requirements

Accounting Basics

Accounting Theories and Concepts

Accounting Methods: Accrual vs. Cash

Accounting Oversight and Regulations

Financial Statements

Corporate Accounting

Public Accounting: Financial Audit and Taxation

Accounting Systems and Record Keeping

Accounting for Inventory

What Is Average Cost Method?

Averaꩲge cost method assigns a cost to inventory items based on the total 🌺cost of goods purchased or produced in a period divided by the total number of items purchased or produced. Average cost method is also known as weighted-average method.

Key Takeaways

Average cost method is one of three inventory 澳洲幸运5开奖号码历史查询:valuation methods, with the other two common methods being first in, first out (FIFO) and last in, first out (LIFO).
Average cost method uses the weighted average of all inventory purchased in a period to assign value to the cost of goods sold (COGS) as well as the cost of goods still available for sale.
Once a company selects an inventory valuation method, it needs to remain consistent in its use to be compliant with generally accepted accounting principles (GAAP).

Understanding Average Cost Method

Businesses that sell products to customers have to deal with 澳洲幸运5开奖号码历史查询:inventory, which is either bought from a separate manufacturer or produced by the company itself. Items previously in inventory that are sold off are recorded on a company’s income statement as 澳洲幸运5开奖号码历史查询:cost of goods sold (COGS). COGS is an important figure for businesses, investors, and analysts as it is subtracted from sales revenue to determine 澳洲幸运5开奖号码历史查询:gross margin on the 澳洲幸运5开奖号码历史查询:income statement.

To calculate the tota﷽l cost of goods sold to ꧒consumers during a period, different companies use one of three inventory cost methods:

澳洲幸运5开奖号码历史查询:First in, first out (FIFO)
澳洲幸运5开奖号码历史查询:Last in, first out (LIFO)
Average cost method

Average cost method uses a simple average of all similar items in inventory, regardless of purchase date, followed by a count of final inventory items at the end of an 澳洲幸运5开奖号码历史查询:accounting period. Multiplying the average cost per ite𓃲m by the final inventory count gives the company a figure for the cost of goods available for sale at that point. The same average cost is also applied to the number of items sold in the previous accounting period to determine the COGS.

Example of Average Cost Method

For example, coꦺnsider the following inventory ledger for Sam’s Electronics:

Purchase date	Number of items	Cost per unit	Total cost
1/1	20	$1,000	$20,000
1/18	15	$1,020	$15,300
2/10	30	$1,050	$31,500
2/20	10	$1,200	$12,000
3/5	25	$1,380	$34,500
Total	100		$113,300

Assume the company sold 72 units in the first quarter. The weighted average cost is the total inventory purchased in the quarter, $113,300, divided byꦉ the total inventory count from the quarter, 100, for an average of $1,133 per unit. The cost of goods sold (COGS) will be recorded as 72 units sold × $1,133 average cost = $81,576. The cost of goods available for sale, or inventory at the end of the period, will be the 28 remaining items still in inventory × $1,133 = $31,724.

Benefits of Average Cost Method

Average cost method requires minimal labor to apply and is, therefore, the least expensive♐ of all the methods. In addition to the simplicity of applying average cost method, income cannot be as easily manipulated as other inventory-costing methods. Companies that sell products that are indistinguis𒊎hable from each other or that find it difficult to find the cost associated with individual units will prefer to use average cost method. This also helps when there are large volumes of similar items moving through inventory, making it time-consuming to track each individual item.

Special Considerations

One of the core aspects of U.S. 澳洲幸运5开奖号码历史查询:generally accepted acc🥃ounting principles (GAAP) is consistency. The consistency principle requires a company to adopt an accounting method and follow it consꦓistently from one accounting period to another.

For example, businesses that adopt average cost method need to continue to use this method for future accounting periods. This principle is in place for the ease of financial statement users so that figures on the financials can be compared 澳洲幸运5开奖号码历史查询:year over year. A company that changes its inventory-costing method must highlight the change in its 澳洲幸运5开奖号码历史查询:footnotes to the financial st🦩atementﷺs and apply the same method retroactively to prior period-comparative 澳洲幸运5开奖号码历史查询:financial statements.

What Is the Average Cost Method Formula?

The average cost method formula is calculated as:

Total Cost of Goods Purchased or Produced in Period ÷ Total Number of Items Purchased or Produced in Period = Average Cost for Period

The result can then be applied to both the co🦋st of goods sold (COGS) and the cost of goods still held in inventory at the end of the peri𝔍od.

Why Should I Use Average Cost Method?

Average cost method is a simple inventory valuation method, especially for businesses with large volumeᩚᩚᩚᩚᩚᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ𒀱ᩚᩚᩚs of similar inventory items. Instead of tracking each individual item throughout the period, the weighted average can be applied across all similar items at the end of the period.

What Inventory Cost Methods Are Acceptable Under Generally Accepted Accounting Principles (GAAP)?

U.S. GAAP allows for last in, first out (LIFO), first in, first out (FIFO), or average cost method of inventory valuation. On the other hand, International Financial Reporting𒅌 Standards (IFRS) do not allow LIFO because it does not typically represent the actual flow of inventory through a business.

The Bottom Line

♍Average cost method is one of three inventory valuation methods. It assigns a cost to inventory items based on the total cost of goods purchased orꦺ produced in a period divided by the total number of items purchased or produced.

Article Sources

Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.