How to Calculate Ending Inventory Using Average Cost Method

Ending inventory represents the value of goods a business has on hand at the close of an accounting period. This figure is a current asset on the balance sheet and significantly influences the calculation of the cost of goods sold on the income statement. The average cost method offers a straightforward approach to determining this value, particularly useful for businesses dealing with large volumes of identical items. Employing this method helps in financial reporting and provides insights for future operational planning.

Identifying Necessary Inventory Data

Calculating ending inventory using the average cost method requires specific data. First, beginning inventory includes the units and total cost of all inventory from the prior accounting period, representing stock available at the start of the current period.

Next, details of all purchases made during the current accounting period are needed, including units acquired and their total cost. Finally, a physical count of the units remaining on hand at the end of the period is essential to determine the ending inventory value.

Calculating the Cost of Goods Available for Sale

The first step in the average cost method is determining the total cost of all goods available for sale during the accounting period. This figure, known as the Cost of Goods Available for Sale (COGAS), combines beginning inventory value with the cost of new acquisitions. The formula is: Beginning Inventory Cost + Cost of Purchases = Cost of Goods Available for Sale.

For example, if beginning inventory cost $1,000 and purchases totaled $1,425, COGAS would be $2,425. Total units available for sale are also computed by adding beginning inventory units to units purchased. If initial inventory was 100 units and 125 units were purchased, total units available for sale would be 225 units.

Determining the Weighted-Average Cost Per Unit

With the Cost of Goods Available for Sale established, the next step is to calculate the weighted-average cost per unit. This calculation forms the core of the average cost method, as it assigns a uniform cost to each unit of inventory. The formula is: Cost of Goods Available for Sale / Total Units Available for Sale = Weighted-Average Cost Per Unit.

Using the previous example, with COGAS at $2,425 and 225 total units available, the weighted-average cost per unit is approximately $10.78 ($2,425 / 225 units). This approach factors all inventory costs throughout the period into a single average, simplifying the valuation of both ending inventory and cost of goods sold.

Final Calculation of Ending Inventory

The final step in the average cost method is to apply the weighted-average cost per unit to the number of units remaining in inventory to arrive at the ending inventory value. This provides the monetary amount assigned to the unsold goods at the period’s close. The formula is: Ending Physical Units × Weighted-Average Cost Per Unit = Ending Inventory Value.

Continuing our example, if a physical count revealed that 70 units remained in inventory at the end of the period, these 70 units would be multiplied by the weighted-average cost per unit of $10.78. This calculation yields an ending inventory value of $754.60 (70 units $10.78). This final figure represents the cost assigned to the inventory that will be carried forward as an asset on the balance sheet into the next accounting period.