Average Cost Method (AVCO)


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:

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.

DatePurchaseIssuesInventory
Units$/Units$ TotalUnits$/Units$ TotalUnits$/Units$ Total
Jan 1550250550250
Jan 5250100350150
Jan 1015050250100
Jan 15570350570350
Average Cost of Inventory764.286450
Jan 25364.286192.858464.286257.144

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.

Actual Unit Cost Method

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.

Test Your Understanding

ABC LTD is a construction company. It buys raw materials such as sand and clay in bulk and stores it in a central warehouse from where materials are issued to project sites as required. Which of the following methods is most appropriate for valuing inventory?

Actual Unit Cost Method

LIFO Method

FIFO Method

AVCO Method