Weighted Average Cost

The calculation begins with the cost of goods available for sale: opening inventory at its carrying cost plus all purchases, freight-in and other capitalisable costs for the period. Divide that total by the number of units available, and the result is a single cost per unit applied uniformly to units sold and units remaining. Multiply by units sold for cost of goods sold, by units on hand for ending inventory; the two figures must reconcile back to goods available.

The timing convention matters. Under a periodic system the average is struck once, after the period closes, so a late low-priced purchase pulls down the cost of goods sold on sales that occurred earlier. Under a perpetual system a new moving average is computed immediately after each purchase and each sale is charged at the average prevailing at that moment, leaving later purchases untouched by earlier sales.

Weighted average cost dominates where units are physically or economically interchangeable and lot identity is lost: refined fuels, chemicals, grains, cement, base metals, fasteners, pharmaceutical actives. It is also the pragmatic choice for high-volume manufacturers whose raw material costs move continuously, since tracking individual layers adds cost without adding information.

The inventory accounting policy note discloses the method, and many groups state that different methods apply to different classes of inventory, which is permitted provided the choice is consistent for inventories of similar nature and use. IFRS allows only specific identification, FIFO or weighted average cost; LIFO is prohibited. US GAAP additionally permits LIFO, so a US filer using average cost has no LIFO reserve to disclose and its inventory needs no conversion for cross-border comparison on that axis.

Because the same figure feeds both the income statement and the balance sheet, weighted average cost smooths the effect of price volatility rather than isolating it. When input prices rise steadily, cost of goods sold falls between the FIFO and LIFO amounts and ending inventory likewise sits between the two, but the position within that range depends on when purchases occurred and in what quantities, not on any arithmetic symmetry.

The consequences flow through the ratio set. Relative to FIFO in an inflationary period, gross margin and net income are lower, ending inventory is lower, so the current ratio is lower while inventory turnover is higher. Compared with LIFO the signs reverse. Inventory remains subject to write-down to net realisable value, and under IFRS a later recovery in value permits reversal of a prior write-down up to the original cost.

Expect to be handed a beginning balance and two or three purchases at different unit costs, plus unit sales, and asked for cost of goods sold, ending inventory or gross profit. Compute goods available in both units and currency, divide, then allocate. If the question specifies a perpetual system, sequence the transactions and recompute the average only after purchases; a sale never changes the average cost per unit.

You should also be able to rank the three methods for cost of goods sold, ending inventory, gross profit, current ratio and inventory turnover under rising and falling prices, and to explain why the ranking flips when prices fall. A common variation gives ending inventory under one method and asks for another, which is solved by working from the goods-available total rather than recomputing from scratch.