How to Find Ending Inventory Using the Average Cost Method
Master a core accounting technique to accurately value inventory assets and enhance your financial statements. Understand a systematic approach to asset valuation.
Ending inventory represents the value of goods a business still possesses at the close of an accounting period, which are intended for sale. This figure is recorded as a current asset on a company’s balance sheet, indicating the value of unsold products available for future revenue generation. Determining this value accurately is important for financial reporting, as it directly impacts both the reported profitability and asset base of a business. The average cost method offers one approach to valuing these remaining goods.
Understanding Essential Inputs
Calculating ending inventory through the average cost method begins by gathering two pieces of information: the total cost of goods available for sale and the total number of units available for sale. The cost of goods available for sale (COGAS) represents the aggregate expense associated with all inventory items a business could have sold during a specific period. This amount includes the cost of any inventory held at the beginning of the period, known as beginning inventory, combined with the total cost of all subsequent purchases made throughout that period. Businesses maintain records to sum these expenditures.
The second input is the total units available for sale (UAS), which accounts for every item ready for sale during the accounting period. This figure combines the number of units present in the beginning inventory with all additional units acquired through purchases. Companies track these quantities using inventory management systems or physical counts. These initial data points form the foundation for applying the average cost method.
Calculating the Weighted-Average Cost Per Unit
Once the total cost of goods available for sale and the total units available for sale are determined, the next step involves calculating the weighted-average cost per unit. The formula is: the total cost of goods available for sale is divided by the total units available for sale. For instance, if a business had $5,000 worth of inventory available from 500 units, the weighted-average cost per unit would be $10.
This calculation is particularly useful for businesses dealing with identical or indistinguishable inventory items, such as bulk commodities like grains, liquids, or mass-produced components. Applying this method helps smooth out cost fluctuations that might occur from individual purchases made at different prices during the period. The resulting weighted-average cost per unit represents a blended cost that is applied uniformly to all units. This average serves as the standardized cost basis for all inventory units for that specific period.
Determining Ending Inventory Value
Once the weighted-average cost per unit is established, the next step is to determine the financial value of the remaining inventory. This involves identifying the number of units that have not been sold by the end of the accounting period, known as ending inventory units. Businesses ascertain this quantity through a physical inventory count or by reconciling sales records.
To calculate the ending inventory value, the weighted-average cost per unit, derived from the previous calculation, is multiplied by the number of ending inventory units. For example, if the weighted-average cost per unit was $11.22 and 150 units remained, the ending inventory value would be $1,683. This calculated amount represents the asset value reported on the balance sheet, reflecting the cost of goods still held by the business. The portion of the cost of goods available for sale not attributed to ending inventory is recognized as the cost of goods sold on the income statement.
Applying the Method: A Practical Example
Consider a small retail business that sells a single type of product. On January 1, the business had a beginning inventory of 100 units, each costing $10, totaling $1,000. During January, the business made two purchases: 200 units at $12 each on January 10, costing $2,400, and 150 units at $11 each on January 20, costing $1,650. Throughout the month, the business sold a total of 300 units.
First, determine the total cost of goods available for sale and the total units available for sale. The total cost of goods available for sale is the sum of beginning inventory cost and all purchases: $1,000 (beginning) + $2,400 (purchase 1) + $1,650 (purchase 2), which equals $5,050. The total units available for sale are the sum of beginning units and all purchased units: 100 (beginning) + 200 (purchase 1) + 150 (purchase 2), totaling 450 units.
Next, calculate the weighted-average cost per unit by dividing the total cost of goods available for sale by the total units available for sale. This yields $5,050 divided by 450 units, resulting in a weighted-average cost per unit of approximately $11.22. This average cost will be applied to all units. To find the number of units in ending inventory, subtract the units sold from the total units available for sale: 450 units – 300 units sold, leaving 150 units in ending inventory.
Finally, determine the ending inventory value by multiplying the remaining units by the weighted-average cost per unit. The ending inventory value is 150 units multiplied by $11.22, which calculates to $1,683.