How to Calculate Weighted Average Inventory

Inventory is a significant asset for many businesses, and accurately valuing it is important for financial reporting and decision-making. Businesses must select an inventory costing method to determine the monetary value of goods remaining unsold and the cost of goods sold. The weighted average inventory method offers a straightforward way to assign costs to inventory. This method helps businesses reflect a balanced cost for their goods, useful when individual unit costs fluctuate over time.

Understanding Weighted Average Inventory

The weighted average inventory method, also known as the weighted average cost (WAC) method, determines the average cost of all goods available for sale. This approach treats all units as interchangeable, regardless of their actual purchase price. It averages the cost of beginning inventory with the cost of all purchases made during a specific period. This method suits businesses where inventory items are identical and difficult to distinguish, such as bulk commodities.

Businesses frequently choose the weighted average method due to its benefits. It provides a smoothed cost valuation, which can reduce the impact of price fluctuations on reported profits. This stability makes it easier for companies to manage costs and make informed decisions about pricing and production. The weighted average method is a widely accepted accounting method under Generally Accepted Accounting Principles (GAAP) in the United States and International Financial Reporting Standards (IFRS) globally.

The simplicity of the weighted average method is another advantage. It requires less detailed record-keeping compared to other methods that track individual item costs. This streamlined process leads to less administrative burden and faster calculations for inventory valuation. By providing a single average cost, it simplifies inventory management, especially for businesses with high inventory turnover.

Calculating Weighted Average Inventory

The calculation of weighted average inventory depends on the inventory accounting system a business uses: periodic or perpetual. Both systems determine the average cost, but they differ in when and how frequently this average is calculated. The choice of system impacts how frequently the average cost per unit is updated.

Periodic Inventory System Calculation

Under the periodic inventory system, the weighted average cost is calculated only at the end of an accounting period, such as a month, quarter, or year. This system does not continuously track inventory levels; instead, it relies on a physical count to determine ending inventory. The calculation involves combining all costs and units from the beginning inventory and all purchases made throughout the period.

To calculate the weighted average cost per unit under the periodic system, first determine the total cost of goods available for sale. This is the sum of the cost of beginning inventory and all purchases made during the period. Next, sum the total units available for sale, which includes units in beginning inventory plus all purchased units. Finally, divide the total cost of goods available for sale by the total units available for sale to arrive at the weighted average cost per unit.

For example, a business has a beginning inventory of 100 units at $10 ($1,000). During the period, it purchases 200 units at $12 ($2,400) and 150 units at $11 ($1,650). The total cost of goods available for sale is $1,000 + $2,400 + $1,650 = $5,050. Total units available are 100 + 200 + 150 = 450 units. The weighted average cost per unit is $5,050 / 450 units, approximately $11.22.

Perpetual Inventory System Calculation

In contrast, the perpetual inventory system continuously updates inventory records after every purchase and sale. When using the weighted average method with a perpetual system, the average cost is recalculated after each new purchase. This approach is often called the “moving average” method because the average cost per unit changes with each new acquisition.

To calculate the moving average cost, start with the existing inventory balance. When a new purchase occurs, add the units and their cost to the existing inventory units and total cost. Then, divide the new combined total cost by the new combined total units to determine the updated weighted average cost per unit. This new average cost applies to any sales until the next purchase.

For instance, consider a beginning inventory of 100 units at $10 ($1,000). A purchase of 50 units at $12 ($600) occurs. The new total units are 150 (100+50) and the new total cost is $1,600 ($1,000+$600). The updated weighted average cost is $1,600 / 150 = $10.67 per unit. If 70 units are sold, their cost of goods sold is 70 units $10.67 = $746.90. The remaining inventory is 80 units at $10.67 per unit, totaling $853.60. A subsequent purchase of 80 units at $11 ($880) would update the total units to 160 and total cost to $1,733.60, recalculating the average cost to $10.84 per unit.

Applying the Weighted Average Cost

Once the weighted average cost per unit has been determined, it is used to value both the cost of goods sold (COGS) and the ending inventory. This application directly impacts a company’s financial statements, providing a clear picture of its profitability and asset value. The consistent application of this cost simplifies financial reporting.

To calculate the Cost of Goods Sold, multiply the number of units sold by the weighted average cost per unit. For example, if the weighted average cost was $11.22 per unit and 300 units were sold, the Cost of Goods Sold would be $11.22 300 = $3,366. This amount is reported on the income statement as an expense, affecting the company’s gross profit and net income.

The value of ending inventory is calculated by multiplying the number of units remaining by the same weighted average cost per unit. If 150 units remained in inventory and the weighted average cost was $11.22, the ending inventory value would be $11.22 150 = $1,683. This ending inventory figure is presented as a current asset on the company’s balance sheet. The chosen inventory valuation method significantly influences both the income statement and the balance sheet.