Understanding weighted average cost

Definition

Weighted average cost is the inventory method that blends every purchase into one unit cost. On the books, this is a cost-flow assumption, not a claim that every bag in the room cost the same at the dock.

Each unit on hand carries the same blended cost. Sales use that same blended cost, so inventory and cost of goods sold stay in step.

The blend is weighted by how many units you bought at each price. A large cheap buy pulls the average down more than a small expensive one.

Where it shows up

Balance Sheet: Related to the inventory line, which carries a blended unit cost.

P&L: Related to cost of goods sold, which uses the same blended unit cost.

See also: Inventory Valuation · Cost Of Goods Sold · Inventory

When you look at your Balance Sheet, inventory sits with the other current assets. Under this method, that line is units on hand times the current blended cost.

The Income Statement does not name the average. It shows cost of goods sold built from that same blended unit cost.

There are no old layers and new layers left to point at. Every unit, sold or still on the shelf, carries the one average.

Cash is not blended. Cash moved when you paid the roaster or the importer, not when the average was recalculated.

How it works

You still record each purchase at what you actually paid, including landed costs that belong with the goods. Those purchases go into a pool with the units you already held.

The new unit cost is total cost in the pool divided by total units in the pool. That single figure replaces the old mix until the next buy.

When you sell units, you multiply the quantity sold by the current average. That amount leaves inventory and becomes cost of goods sold.

A later purchase changes the average for the units that remain and for later sales. You do not go back and reprice the units you already sold.

A physical count still confirms how many units are there. The method only supplies the one cost to multiply by.

You apply the average to a class of goods and keep using it. It is a standing rule, not a worksheet you invent when prices feel messy.

Example

A coffee roaster buys green beans in two lots. Ten bags cost $8 each ($80), and twenty bags cost $11 each ($220).

The pool is now 30 bags and $300 of cost. The weighted average is $300 divided by 30, or $10 per bag.

The roaster sells 12 bags to cafes. The sale of those 12 bags is recorded:

Debit: Cost of goods sold $120

Credit: Inventory $120

Cost of goods sold is 12 times $10, or $120. Inventory falls by $120, leaving 18 bags at the same $10, or $180.

Assets are lower by the $120 that left. The P&L now holds that $120 as cost against the bean sales.

The bags on the floor were bought at two different invoice prices. The method treats every remaining bag as $10 until the next purchase changes the blend.

Common mix-ups

Weighted average cost is not a simple average of the two invoice prices. Ten bags at $8 and twenty bags at $11 do not average to $9.50; the extra bags at $11 pull the figure to $10.

The method is not FIFO or LIFO with extra math. Those methods keep layers; this one erases the layers into one cost.

The average is not a standard cost you picked in January. A standard cost is a planned figure; the weighted average is built from real purchases as they arrive.

Related terms

• Inventory Valuation: The method used to assign cost to units held and units sold.
• FIFO: An inventory method that assumes the oldest units are sold first.
• LIFO: An inventory method that assumes the newest units are sold first.
• Cost Of Goods Sold: The direct cost of the products sold during the period.
• Inventory: Goods held for sale or used to produce goods for sale.
• Landed Cost: The full cost of getting a purchased item to your door, including freight and duties.
• Standard Cost: A pre-set expected cost per unit used for planning and comparison.
• Physical Inventory Count: A full hands-on count of stock used to correct the recorded balance.