Average cost inventory valuation results in ending inventory and COGS valuations
in between those reported by FIFO and LIFO valuation methods.
Let's look at an example. Let's assume the following inventory data:
March 1st Beginning Inventory is 200 units @ $10 each.
March 4th we purchased an additional 300 units @ $20 each.
March 10th sold 400 units @ $50 each. Now that's the retail price, not the cost.
We will need to figure out the cost by applying the average cost valuation to our data.
March 20th we purchased an additional 500 units @ $30 each.
March 25th sold 300 units @ a price of $50 each. Again, we'll figure out the cost in a minute.
Finally, March 30th, we purchased 100 units @ $40 each.
So if you want to pause the video at this point and write down those numbers go ahead, and then start it up when you are ready.
With this data and using moving average, let's record the March 10th and 25th sales,
as well as determine the ending inventory value, assuming this is a perpetual inventory tracker.
Since this company uses the perpetual method of tracking inventory, the dates of the transactions matter.
So we need to list them in chronological order.
Additionally, the purchases and sales are recorded when they happen,
so I like to present the same data in a big Inventory T Account.
In fact, everything I have listed here isn't dependent on the valuation method.
The items that are dependent at the ones highlighted on the credit side of the account.
So, let's figure those out.
We know on March 10th we sold 400 units @ $50 each which give us the sales revenue of $20,000.
but how much is COGS? Let's apply the moving average to figure this out.
In order to figure out the average cost of the goods sold on March 10th,
we need to figure out the average cost from our beginning inventory and the purchase on March 4th.
To do that, we add up the units purchased and the total cost of those purchases and then divide the two to get the average cost.
You can see from the slide that we get an average cost of $16 per unit.
The $16 per unit is applied not only to the 400 units sold, but also the remaining 100 units in inventory.
So COGS for the March 10th sale is $6,400. The inventory from that point is 100 units with an average total cost of $1,600.
The next decision we need to make happens with the sale on March 25th. We sold 300 units @ $50 each.
Let's figure out COGS using the average cost.
To do that, we take the 500 units purchased on March 20th and add them to the 100 units remaining after the prior sale.
Add the total cost related to those and divide to get the average costs.
You can see from the slide that we get an average cost of $27.67 per unit.
So COGS on March 25th is approximately $8,300.
The inventory at this point is 300 units remaining, and the average total cost is also approximately $8,300.
So what's the total amount of COGS and what's the value of ending inventory?
COGS is the credit side of the Inventory Account, which in this case totals $14,700.
Ending inventory is the remaining amount on the debit side of the inventory account.
There are 300 units with an average cost of $8,300. This is what was remaining after we deducted our sales.
We add to that the 100 units from the March 30th purchase with a cost of $4,000.
This totals 400 units of inventory at a value of $12,300.
Finally, if we were completing a Perpetual Inventory Record, you can see the purchases are entered in the purchase columns.
The units sold are recorded, and notice that they total the COGS we already computed.
March 10th - $6,400 and March 25th - $8,300.
Finally ending inventory is the running total that results in 400 units of inventory with a cost of $12,300.
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