Average costing

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Under the average-cost method, it is assumed that the cost of inventory is based on the average cost of the goods available for sale during the period. Average cost is computed by dividing the total cost of goods available for sale by the total units available for sale. This gives a weighted-average unit cost that is applied to the units in the ending inventory.

[edit] Average-Cost Method Illustration

Date    Transaction          Number of Items     Unit Cost   Total Cost 

June 1  Beginning Inventory   50                  1.00        50.00 
June 6  Purchased             50                  1.10        55.00 
June 13 Purchased            150                  1.20       180.00 
June 20 Purchased            100                  1.30       130.00 
June 25 Purchased            150                  1.40       210.00 
        Totals               500                             625.00 

Average Unit cost:  $625/500 = $1.25
Ending inventory:    220 units @ $1.25 = $275

Cost of Goods Available for Sale         $625
Less June 30 Inventory                 $275
Cost of Goods Sold                       $350

The average-cost method tends to level out the effects of cost increases and decreases because the cost for the ending inventory calculated under the method is influenced by all the prices paid during the year and by the beginning inventory price. The criticism for this method is that the more recent costs are more relevant for income measurement and decision-making.