In accounting, the calculation of weighted average cost can be carried out by using the weighted average to determine the amount included in COGS and inventory.
The weighted average cost method divides the cost of goods available for sale by the number of units available for sale.
Formula for Calculating Weighted Average Cost (WAC)
Immediately, this is how to calculate the weighted average inventory cost
WAC = Cost of Goods Available for Sale / Units Available for Sale
Ket:
- Cost of Goods Available for Sale is calculated as the value of initial inventory + purchase
- Available for Sale Units are the number of units that can be sold by the company or the total number of units in inventory
Cost of Goods Available for Sale
Costs of goods available for sale are allocated to COGS or to terminate inventory. Allocating the cost of goods available for sale is called the assumed cost flow, for example:
- FIFO (first in first out)
- LIFO (last in first out)
- WAC (Weighted average cost)
WAC Calculation Method in the Periodic and Eternal Inventory System
Using the weighted average cost method we will produce different inventory cost allocations under a periodic and lasting inventory system.
- Periodic inventory system
In a periodic inventory system, the company will calculate the ending inventory and apply product costs to determine the cost of ending inventory. The cost of goods available for sale will later be determined by combining the costs of ending inventory, initial inventory costs, and purchases throughout the period.
- A perpetual inventory system
The perpetual inventory system keeps track of inventory and costs of goods available for sale continuously. This system provides more information for inventory level management.
But this inventory tracking method can be expensive for companies. In this perpetual inventory system, the weighted average cost method is also called the “moving average cost method”.
Example of the WAC Method
Below we will exemplify the use of the weighted average cost method and identify differences in the allocation of inventory costs in the periodic and lasting inventory systems.
Example:
A company at the beginning of the fiscal year per January 1 reported an initial inventory of 300 units at a cost (in Dollars) of $ 100 per unit. And during the first quarter, the company made the following purchases:
- January 15, purchases 100 units at a cost of $ 130 = $ 13,000
- 9 February, purchases 200 units at a cost of $ 150 = $ 30,000
- March 3, purchased 150 units at a cost of $ 200 = $ 300,000
In addition to purchases, the company also makes the following sales:
- Sales at the end of February were 100 units
- Sales at the end of March were 70 units
So under the periodic inventory system, we will determine the cost of goods available for sale at the end of the first quarter as follows:
WAC per unit = ($ 30,000 + $ 13,000 + $ 30,000 + $ 30,000) / 750 = $ 137.33
In other words, for the sale of 170 units during January – March, we had to allocate $ 137.33 for each unit sold. The rest will be put into the final inventory.
Therefore:
- 170 x $ 137.33 = $ 23,346.10 in the cost of goods available for sale
- $ 103,000 – $ 23,346.10 = $ 79,653.90 in ending inventory
Note: The calculation results have been rounded off.
Under the perpetual inventory system, we will determine the average before unit sales.
Therefore, before selling 100 units in February, the average we have is:
WAC per unit = ($ 30,000 + $ 13,000 + $ 30,000) / 600 = $ 121.67
So for the sale of 100 units in February, the costs to be allocated are:
- 100 x $ 121.67 = 12,167 in the cost of goods available for sale
- $ 73,000 – $ 12,167 = $ 60,833 left in inventory
Note: The calculation results have been rounded off.
Before the sale of 70 units in March, the costs that could be allocated were:
- 70 x $ 139.74 = $ 9,781.80 in the cost of goods available for sale
- $ 90,833 – $ 9,771.0 = $ 81,051.20 in ending inventory
* Note: The calculation results have been rounded off.
Benefits and Disadvantages of the Weighted Average Cost Method
- Benefits of the weighted average cost method
The advantage of applying the weighted average cost method is that we can easily track inventory costs. You can store inventory without having to determine which batch you have.
You also do not need to specify the price of the item, simply by marking the average price of the unit stock.
The calculation used to determine the weighted average cost is also considered easier than the valuation method which takes several steps to calculate the value of inventory or the cost of goods available for sale.
By using this method, we can also minimize documents, because it only requires a single cost calculation and use this for all other calculations. No need to keep detailed records of every purchase, just need a total record.
- The disadvantages of the weighted average cost method
This method requires all identical units, but in the field the situation will be different. A new product batch may be upgraded, or additional features provided, maybe even a better price will be present. In addition, problems arise when suppliers replace the product with a new version, but give the same name as the old stock. Finally, the weighted average cost method is retropective. In the sense of having to look back during the purchase period to see what was paid per unit.
