Average cost method (AVCO) calculates the cost of ending inventory and cost of goods sold for a period on the basis of weighted average cost per unit of inventory. Weighted average cost per unit is calculated using the following formula:
| Weighted Average | = | Total Cost of Inventory |
| Unit Cost | Total Units in Inventory |
Like FIFO and LIFO methods, AVCO is also applied differently in periodic inventory system and perpetual inventory system. In periodic inventory system, weighted average cost per unit is calculated for the entire class of inventory. It is then multiplied with number of units sold and number of units in ending inventory to arrive at cost of goods sold and value of ending inventory respectively. In perpetual inventory system, we have to calculate the weighted average cost per unit before each sale transaction.
The calculation of inventory value under average cost method is explained with the help of the following example:
Example
Apply AVCO method of inventory valuation on the following information, first in periodic inventory system and then in perpetual inventory system to determine the value of inventory on hand on Mar 31 and cost of goods sold during March.
| Mar 1 | Beginning Inventory | 60 units @ $15.00 per unit |
| 5 | Purchase | 140 units @ $15.50 per unit |
| 14 | Sale | 190 units @ $19.00 per unit |
| 27 | Purchase | 70 units @ $16.00 per unit |
| 29 | Sale | 30 units @ $19.50 per unit |
Solution
AVCO Periodic
| Units Available for Sale | = 60 + 140 + 70 | = 270 | |
| Units Sold | = 190 + 30 | = 220 | |
| Units in Ending Inventory | = 270 − 220 | = 50 | |
| Weighted Average Unit Cost | Units | Unit Cost | Total |
| Mar 1 Inventory | 60 | $15.00 | $900 |
| Mar 5 Purchase | 140 | $15.50 | $2,170 |
| 27 Purchase | 70 | $16.00 | $1,120 |
| 270 | * $15.52 | $4,190 | |
| * $4,190 ÷ 270 | |||
| Cost of Goods Sold | 220 | $15.52 | $3,414 |
| Ending Inventory | 50 | $15.52 | $776 |
AVCO Perpetual
| Date | Purchases | Sales | Balance | ||||||
| Units | Unit Cost | Total | Units | Unit Cost | Total | Units | Unit Cost | Total | |
| Mar 1 | 60 | $15.00 | $900 | ||||||
| 5 | 140 | $15.50 | $2,170 | 60 | $15.00 | $900 | |||
| 140 | $15.50 | $2,170 | |||||||
| 200 | $15.35 | $3,070 | |||||||
| 14 | 190 | $15.35 | $2,916 | 10 | $15.35 | $154 | |||
| 27 | 70 | $16.00 | $1,190 | 10 | $15.35 | $154 | |||
| 70 | $16.00 | $1,120 | |||||||
| 80 | $15.92 | $1,274 | |||||||
| 29 | 30 | $15.92 | $478 | 50 | $15.92 | $796 | |||
| 31 | 50 | $15.92 | $796 | ||||||