Weighted Average Costing
🎯 Learning Objectives
- Understand the weighted average costing method and when to apply it
- Calculate the weighted average unit cost for periodic and perpetual systems
- Explain the "smoothing" effect of weighted average on COGS and income
- Compare weighted average results to FIFO and LIFO methods
- Apply weighted average in inventory valuation scenarios
📚 Background & Principles
Weighted Average Costing assigns an average cost to each unit of inventory by dividing total cost of goods available for sale by total units available. This method smooths out price fluctuations and provides a middle-ground between FIFO and LIFO.
Unlike FIFO and LIFO, weighted average produces different results under perpetual vs. periodic systems because the average is recalculated after each purchase in perpetual systems.
🔑 Key Concepts
Total cost of goods available divided by total units available. Used to value all inventory units.
Calculating one average at period-end using all purchases during the period.
Recalculating average after each purchase. Each sale uses the current moving average cost.
Weighted average produces COGS and income values between FIFO and LIFO extremes.
Beginning Inventory + Purchases (all costs considered in the average).
Beginning Inventory units + Purchased units (all units considered in the average).
🔍 Deep Dive
Explore Weighted Average at different levels of depth:
🟢 Foundational Level
Understanding the "Gas Tank" analogy.
The Fuel Tank Analogy
Analogy: Mixing Gasoline
You have a gas tank. On Monday, you buy 10 gallons at $3.00/gallon ($30). On Friday, you buy 10 more gallons at $3.50/gallon ($35).
The gasoline all mixes together in the tank. You can't separate "Monday gas" from "Friday gas."
Total: 20 gallons, Total cost: $65, Average cost: $65 ÷ 20 = $3.25/gallon
When you use gas, you use the blended $3.25 average, not the specific $3.00 or $3.50 prices.
= Total Cost of Goods Available ÷ Total Units Available
🟡 Standard Level
Calculating weighted average step by step.
Periodic Weighted Average Calculation
Given:
Beginning Inventory: 10 units @ $10 = $100
Jan 15 Purchase: 20 units @ $12 = $240
Jan 28 Purchase: 15 units @ $15 = $225
Goods Available: 45 units = $565
Ending Inventory: 12 units
Total Cost = $565
Total Units = 45
Average Cost = $565 ÷ 45 = $12.56 per unit
Ending Inventory = 12 units × $12.56 = $150.72
COGS = 33 units × $12.56 = $414.48
Or: $565 - $150.72 = $414.28 (rounding difference)
🔴 Advanced Level
Comparison with FIFO and LIFO, and moving average in perpetual systems.
FIFO
Weighted Avg
LIFO
Perpetual Moving Average
Key Difference: In perpetual systems, the average is recalculated after EACH purchase.
Example: If you have 10 units @ $10, average = $10.00
Then buy 5 units @ $12, new average = ($100 + $60) ÷ 15 = $10.67
Sales use the current moving average at the time of sale.
🎨 Interactive: Weighted Average Calculator
See how different purchases blend together to create an average cost.
Current Inventory
New Purchase
📊 Method Comparison Summary
Understanding how weighted average compares to FIFO and LIFO during price changes.
📦 FIFO
Oldest costs → COGS
Newest costs → Inventory
Effect: Higher income in rising prices
⚖️ Weighted Avg
All costs averaged
Smooths the extremes
Effect: Moderate income
📉 LIFO
Newest costs → COGS
Oldest costs → Inventory
Effect: Lower income in rising prices
- Products are homogeneous (identical units)
- Price fluctuations are significant
- Consistent income reporting is desired
- Simpler method than tracking multiple cost layers
🚫 Common Misconceptions & Professional Tips
✅ Reality: Weighted average considers BOTH quantities AND prices. A purchase of 100 units at $10 should have more influence than a purchase of 10 units at $10 on the average cost.
✅ Reality: Unlike FIFO, PERIODIC and PERPETUAL weighted average CAN produce different results. Perpetual (moving average) recalculates after each purchase, while periodic uses period-end totals.
✅ Reality: The "best" method depends on the business context. FIFO matches physical flow for perishable goods. LIFO provides tax benefits. Weighted average smooths results for homogeneous products with price volatility.
🧠 Memory Aids & Quick Reference
WAC = Total Cost Available ÷ Total Units Available
Then: COGS = Units Sold × WAC
Then: Ending Inventory = Units Remaining × WAC
All costs mix together into one average. Smooths price fluctuations.
Units Sold × Weighted Average Cost
Units Remaining × Weighted Average Cost
COGS and inventory between FIFO and LIFO extremes
📖 Glossary
Inventory costing method using average cost of all units available for sale to value COGS and ending inventory.
Calculating weighted average at period-end using total purchases and units for the entire period.
Perpetual system weighted average recalculated after each purchase. Also called "rolling average."
Total cost of all inventory that could have been sold: Beginning Inventory + Purchases.
Total quantity of inventory that could have been sold: Beginning units + Purchased units.
Method for assigning costs to COGS and inventory. Weighted average is one of the three main assumptions.
Inventory consisting of identical or interchangeable units. Good candidate for weighted average.
Weighted average's tendency to produce COGS and income values between FIFO and LIFO extremes.
🎯 Final Knowledge Check
Test your understanding of Weighted Average Costing:
Question 1: How is weighted average unit cost calculated?
Question 2: Beginning Inventory 10 @ $10, Purchases 20 @ $12, Ending Inventory 12 units. What is ending inventory value?
Question 3: In rising prices, weighted average produces:
Question 4: What distinguishes moving average from periodic weighted average?
Question 5: Weighted average is best suited for: