Weighted Average: What Is It, How Is It Calculated and Used?

Calculating WAC when using a periodic inventory system is probably the easiest out of the different inventory systems. The calculation is done at the end of the cycle, so all you have to do is figure out the total cost of goods available for sale and divide it by the number of units. Be patient when doing weighted average, especially under the perpetual method. Tie back to goods available for sale to ensure you did your calculations correctly. Do a quick mental check to make sure your weighted average cost per unit makes sense. If you take a few seconds to do these things, you will greatly increase the chance that your calculations are correct.

The two figures affected above are the cost allocated to COGS and ending inventory. Using this method, we can see that over the first quarter of sales of 125 baseball bats, we would allocate $51.667 per baseball bat sold. When you have to keep less detailed records about how much each item cost and when it was sold, you save time. And when you save time, you can also save money by needing less help on the administrative side of your business. We will need to calculate a simple average for the first quarter in each of 2013 and 2014. Note that the data are equally important and each appears only once, thus having the same frequency.

1. A weighted average, as opposed to a simple average, considers the relative weight or contribution of the items being averaged.
2. Thus, the totals are the same, but the moving weighted average calculation results in slight differences in the apportionment of costs between the cost of goods sold and ending inventory.
3. Your WAC will vary depending on which of the two inventory systems you use (see below).
4. Accountants often assume that unitsare at the same stage of completion for both labor and overhead.Accountants call the combined labor and overhead costs conversioncosts.

It allows businesses to have a better understanding of their inventory and provides information for managing inventory levels in a more timely manner. When you allocate https://www.wave-accounting.net/ the cost of goods available, it is called a cost flow assumption. The COGS is a metric for companies to use when trying to determine a company’s gross profit.

If weighted average periodic is the easiest of all the methods, the weighted average perpetual is the hardest. It is not that the method is hard, it is just annoying because you must calculate a new weighted average cost for each sale, based on the units available for sale at that time. When doing weighted average perpetual, do not separate the purchases and sales. Statistical measures can be a very important way to help you in your investment journey.

This will help him in making the best decision while buying the product. Perpetual inventory systems can keep a more accurate account of records about COGS and the cost of goods purchased. All products in inventory have barcodes and can be tracked all the way to sale through point-of-sale technology. Through this technology, companies are now able to see all the information they need about products and more. Despite these differences in the amount allocated to COGS and ending inventory, the total cost remains the same for both inventory systems. Make sure, when using a perpetual inventory system, not to separate the purchases and sales.

Example of WAC vs. FIFO vs. LIFO

This method can be extremely costly for a company, but it does have its benefits. When using a periodic inventory system, it may be helpful to separate purchases from sales. Suppose you are the owner of a shoe store, and you buy 100 pairs of shoes for $30 per shoe. The next month, you purchase another 200 pairs of shoes at this time for $40 each. At the end of the year (your accounting period), you managed to sell 50 shoes in total.

This step shows that 3,000 units were in WIP inventory on May 1and 6,000 units were started during May. These 9,000 units will end up in one of two places,either completed and transferred out (to the Finishing department)or not completed and therefore in ending WIP inventory. The FIFO method assumes that the oldest inventory units are sold first, while the LIFO method assumes that the most recent inventory units are sold first. LIFO better matches current costs with revenue and provides a hedge against inflation. Each number in a data set is multiplied by a predetermined weight value during the calculation of the weighted average.

Why would you use a weighted average?

Then the total amount paid for the shares, $3,000 in this case, is divided by the number of shares acquired over both years, 150, to get the weighted average price paid of $20. As you examine the diagram, think of the amountof water in the glasses as costs that the company has alreadyincurred. The perpetual inventory system is generally more effective than the periodic inventory system. The computer software that most of these businesses use makes the process simple and hands-free. The WAC is one of the most effective methods that are commonly used by businesses to value inventory. The WAC method is one of the simplest methods to value inventory and can be used whether the goods are produced in-house or purchased by the company.

The calculation used to determine the weighted average cost is also easier than that of other valuation methods which take multiple steps to calculate the inventory value or COGS. The weighted average cost method makes it easy to understand the value of your inventory. Prices fluctuate, so it can be difficult to know exactly how much you paid for each individual unit. The WAC method simplifies accounting by revealing the average cost of each piece. When the weighted average cost method is no longer useful, that’s when other accounting methods, like FIFO and LIFO, come in handy. When you have a lot of inventory on hand and you do not know the order in which you are selling it, you are mixing all of your units.

direct materials, direct labor, and overhead).

Since any number multiplied by 1 is the same number, the simple average formula omits the weighting in the numerator as it would have produced unnecessary calculations. In the denominator, the sum of the weights of 1 is no different from counting the total number of pieces of data. In essence, you can use a weighted average formula to solve simple averages. The first method is used when the weights add up how to calculate present value to one, whereas the second method is used when they do not. Method 2 calculates the weighted average by multiplying each value by its weight, adding the products, and then dividing the sum of the products by the total weights. The total costs to be accounted for include the costs inbeginning WIP inventory and the costs incurred during the period.Figure 4.5 shows these costs for the Assembly department.

Figure 4.5 shows that costs totaling $386,000 must be assignedto (1) completed units transferred out and (2) units in ending WIPinventory. Later in step 3, we will use equivalent unit information for theAssembly department to calculate the cost per equivalent unit. While the weighted average method is a generally accepted accounting principle, this system doesn’t have the sophistication needed to track FIFO and LIFO inventories. Normally, when computing an average, each data point carries the same weight. In comparison, normal average calculations treat each number in a data set as if they were assigned equal weight.

Sky-high inflation and supply chain interruptions are making inventory costs change like never before. The weighted average cost per unit accounting method can help you keep track of costs, which can impact your prices and save you time and money on administrative tasks. Use it in conjunction with the FIFO and LIFO accounting methods as you operate your store to have a better understanding of your business and drive decisions. The cost per equivalent unit is calculated for direct materials,direct labor, and overhead. Simply divide total costs to beaccounted for by total equivalent units accounted for.

Recall that Desk Products, Inc., has two departments—Assemblyand Finishing. Although this chapter focuses on the Assemblydepartment, the Finishing department would also use the four stepsto determine product costs for completed units transferred out andending WIP inventory. Table 4.2 presents information for theAssembly department at Desk Products for the month of May.

The table below shows the frequency with which he rides a certain number of minutes in a given day over the course of 28 days. Weighted averages are useful anytime some values are more important than others. Thus, weight values must be considered to obtain an authentic look at a student’s performance. Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more.

How to calculate weighted average cost

Weighted average is the summation of the product of the weights and quantities, divided by the summation of the weights. Note that the cost of goods sold of $67,166 and the ending inventory balance of $48,834 equal $116,000, which matches the total of the costs in the original example. Thus, the totals are the same, but the moving weighted average calculation results in slight differences in the apportionment of costs between the cost of goods sold and ending inventory. Essentially, the concept ofequivalentunits involves expressing a given number ofpartially completed units as a smaller number of fully completedunits. We do this because it is easier to account for whole unitsthen parts of a unit. We are adding together partially completedunits to make a whole unit.

This weighted average figure is then used to assign a cost to both ending inventory and the COGS. The cost assigned by the weighted average cost method is somewhere between the oldest and newest units purchased into inventory. Likewise, the COGS will display a cost somewhere in the middle of the oldest and newest units that were sold during the period. The weighted average cost (WAC) method is an accounting strategy retailers use to calculate the average purchase price of each unit of their inventory. Because prices fluctuate, and as they purchase additional batches of inventory, it becomes difficult to keep track of which item cost exactly how much. Keeping track of inventory costs can be difficult when prices fluctuate.

This method assumes that all units are identical, but this is not always the reality. Newer batches of product may have had upgrades or additional features added and may eligible for a better price than the older stock units. This is particularly problematic when a supplier replaces a product with a new version, giving it the same name as the previous version.