This method values inventory at the weighted average cost of all purchases. Average cost is calculated each time inventory is issued. Consider the following example:
Bike LTD purchased 10 bikes during January and sold 6 bikes, details of which are as follows:
January 1 Purchased 5 bikes @ $50 each
January 5 Sold 2 bikes
January 10 Sold 1 bike
January 15 Purchased 5 bikes @ 70 each
January 25 Sold 3 bikes
The value of 4 bikes held as inventory at the end of January may be calculated as follows:
All issues of inventory will be assumed to carry the average cost of all purchases up to the date of the issue. Average cost will be calculated by dividing total units of inventory by the total cost.
|Units||$/Units||$ Total||Units||$/Units||$ Total||Units||$/Units||$ Total|
|Average Cost of Inventory||7||64.286||450|
As can be seen from above, AVCO method allocates cost on the average cost of purchases during the period. Average cost of inventory changes every time a purchase is made at a different price. Therefore the average cost of inventory changed from $50 to $64.286 after the purchase on January 15.
It may be appropriate to record inventory of very high value at their actual unit costs. This method is only practical where the number of inventory items is very small and distinguishable such as in the property business.