Weighted average cost

Weighted average cost, also known as the weighted average method, is a method used to calculate the average cost of a group of similar items or units when the individual items have different costs. This method is commonly used in inventory valuation and cost accounting to determine the average cost of inventory items.

The weighted average cost is calculated by multiplying the quantity of each item by its respective cost, summing up these values, and then dividing the total cost by the total quantity of items.

The formula for calculating the weighted average cost is as follows:

Weighted Average Cost = (Σ (Quantity of Item i * Cost per Item i)) / Total Quantity of Items

Where:

  • Σ denotes the summation or adding up of the values for each item i in the inventory.
  • Quantity of Item i is the number of units of item i in inventory.
  • Cost per Item i is the cost of one unit of item i.
  • Total Quantity of Items is the sum of the quantities of all items in inventory.

Here’s an example to illustrate the calculation of the weighted average cost:

Suppose a company has the following inventory of widgets:

  • 100 units at $5 per unit
  • 150 units at $6 per unit
  • 200 units at $4 per unit

To find the weighted average cost:

Weighted Average Cost = [(100 * $5) + (150 * $6) + (200 * $4)] / (100 + 150 + 200) = [$500 + $900 + $800] / 450 = $2200 / 450 ≈ $4.89 per unit

In this example, the weighted average cost of the widgets is approximately $4.89 per unit.

The weighted average cost method is beneficial when there are fluctuations in the cost of inventory items over time. It provides a more accurate representation of the overall cost of inventory and is often used in perpetual inventory systems, where the cost of each item in stock is tracked separately. By using the weighted average cost, companies can better manage their inventory and determine the cost of goods sold and ending inventory for financial reporting purposes.

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