Weighted Average Inventory Method

Definition

Weighted average inventory is the costing method that allocated equal cost to all inventory. It is the method that determines the amount go to the income statement and remains in the balance sheet. At the end of the month, some inventory may remain in the store, and some are solved to the customers. We can the quantity of inventory from physical count or system generated. However, the inventory value may be different if we apply different methods.

Weighted average allocate cost to all product, it happens when inventory items are hard to assign a specific cost to the individual unit. Most of the products are quite similar or even the same, so it is not necessary to analyze all the costs as the variance is not significant.

The weighted average cost per unit depends on the total cost and the total number of units. This method can be applied to both manufacturing and trading company.

Formula

Weighted Average Cost of Inventory

Weighted Average Inventory Example

For example, ABC is a retail company that purchases cloth from oversea and sell to the local customer. During the month, ABC has the following transaction:

  • 01 Jan 202X, purchase 1,000 units @ $ 12
  • 15 Jan 202X, purchase 1,500 units @ $ 15
  • At the end of Jan, 2,000 units of clothes are sold, and 500 units remain in the store

By using a weighted average, please calculate inventory cost, total inventory in Balance Sheet, and Cost of Goods Sold.

Solution

Total cost of inventory = (1,000 x $ 12) + (1,500 x $ 15) = $ 34,500

Total inventory quantity = 1,000 units + 1,500 units = 2,500 units

Weighted average cost = $ 34,500 / 2,500 units = $ 13.8 per units

Cost of Goods Sold = 2,000 units x $ 13.8 = $ 27,600

Inventory balance at end of Jan 202X = 500 units x $ 13.8 = $ 6,900

Periodic Weighted Average Inventory

The periodic inventory system will calculate the average cost once per month. This cost will apply to all inventory sold and remaining balance. It is much more easy and simple. The example above reflect with periodic weighted average inventory because we calculate the cost per unit only one time ($ 13.8) and use it to determine COGS for the whole month.

Perpetual Weighted Average Inventory

Perpetual inventory system, the average cost will be calculated every time the average cost change due to the new purchase. When the company purchases a new inventory with a cost higher or lower than the average price, the accountant will calculate the new average cost.

Perpetual Weighted Average Inventory Example

Continue from above example, assume that the 2,000 units sold separately into :

  • From 02-14 Jan 202X sold 800 units
  • From 16-31 Jan 202X sold 1,200 units

Please calculated average cost, COGS, and Inventory balance by using a perpetual system.

Solution

  • First weighted average = $ 12 per unit
  • Second weighted average = (200 x 12 ) + (1,500 x 15) / (1,500 + 200) = $ 14.64 per unit.

This is the average when we purchase new products at different prices.

Date Transaction Qty (unit) Cost ($) Total Cost ($)
01 Jan 202X Purchase 1,000 12 12,000
Average 12
02-14 Jan 202X Sale (800) 12 9,600
15 Jan 202X Purchase 1,500 15 22,500
Average 14.64
16-31 Jan 202X Sale (1,200) 14.64 17,568
31 Jan 202X Remaining 500 14.64 7,320

Cost of goods sold = (800 x 12) + (1,200 x 14.64) = $ 27,168

Inventory = 500 x 14.64 = 7,320

We can see that we go two different weighted average cost per unit, as the system require to recalculate every time the cost per unit change.