Weighted-average cost flow assumption
/What is the Weighted-Average Cost Flow Assumption?
The weighted-average cost flow assumption is a costing method that is used to assign costs to inventory and the cost of goods sold. Under this approach, the cost of goods available for sale is divided by the number of units produced in the period to arrive at an average cost per unit. This amount is then assigned to the units sold in the period and the units remaining in stock. This method is only used when the periodic inventory system is in place.
Characteristics of the Weighted-Average Cost Flow Assumption
The key characteristics of the weighted-average cost flow assumption are as follows:
Uniform cost assignment. The cost of goods sold and ending inventory are based on a weighted average cost per unit.
Neutral to inventory flow. This approach assumes that inventory movement does not influence the underlying cost calculation.
Homogeneity of inventory. This approach assumes that inventory items are indistinguishable from each other, treating all units as if they have the same cost. It does not track the specific costs of individual inventory batches.
Smooths price fluctuations. This approach mitigates the effects of price volatility by averaging the costs of inventory over time. The result is a moderate impact on the cost of goods sold when there is a price spike.
Reduces accounting burden. This approach is easier to calculate compared to tracking specific costs or applying cost assumptions like FIFO or LIFO.
Compliance with standards. This approach is accepted under both the IFRS and GAAP accounting frameworks.
The weighted-average cost flow assumption provides a middle-ground approach to inventory costing, offering simplicity and price stability effects. It’s suitable for businesses with homogenous inventory and where exact cost tracking is less practical.
How to Use the Weighted-Average Cost Flow Assumption
There is a specific calculation process required if you are to use the weighted-average cost flow assumption. The key points are as follows:
Calculate the weighted-average cost. The weighted-average cost is determined by dividing the total number of units available for sale into the total cost of the items available for sale.
Calculate the cost of goods sold. Multiply the weighted-average cost from the first step by the number of units sold during the reporting period. This gives you the cost of goods sold.
Calculate the ending inventory balance. Multiply the weighted-average cost from the first step by the ending units in stock. This gives you the ending inventory cost.