Inventory Valuation

Inventory Valuation – Weighted Average Method

Introduction

In the realm of inventory and Cost of Goods Sold (COGS) valuations, various cost flow methods are available. Perpetual systems, which continuously update the inventory, effectively address issues associated with periodic-based systems. There are three widely accepted cost methodologies for inventory valuation: FIFO, LIFO, and Weighted-Average Cost, also known as Average Cost.

• FIFO (First-In, First-Out): This method assigns the cost of the earliest available unit at the time of sale to COGS, regardless of which unit from the inventory pool is used.

• LIFO (Last-In, First-Out): This method assigns the cost of the most recently acquired unit at the time of sale to COGS, regardless of which unit from the inventory pool is used.

• Average Cost: This method calculates the cost assigned to COGS and inventory each time new units are purchased and added to the inventory. It is a standard functionality supported by Xorosoft.

Why Move to Perpetual Average Cost Method

The Perpetual Average Cost method is widely accepted by numerous accounting standards, including US GAAP and IFRS. At its core, it is a straightforward average calculation. Using an average significantly simplifies the calculations and record-keeping associated with maintaining inventory and determining the Cost of Goods Sold. In contrast, FIFO and LIFO require tracking individual items, which can be costly and inefficient, especially with large volumes of indistinguishable items.

The Average Cost method excels in normalizing cost fluctuations and volatilities and helps reduce inappropriate manipulation of income. It is particularly advantageous when tracking individual items is impractical.

Perpetual Average Cost Method

Also known as the Moving Average Cost, the Perpetual Average Cost method recalculates a new average unit cost for the inventory after each purchase of new units. Specifically, the recalculation occurs when items are “received” or “produced” and become available. The new average cost is then used to value the inventory and Cost of Goods Sold until the next purchase.

The average cost formula is as follows:

$New Average Cost=Total Cost of InventoryTotal Quantity of InventoryNew Average Cost=Total Quantity of InventoryTotal Cost of Inventory​$

A sale of inventory does not impact the average cost nor trigger a recalculation. When inventory is sold, the available quantity is reduced, and the COGS/Inventory GL transactions associated with an invoice are recorded using the current average cost assigned to the inventory at that time.

Altering an Older Transaction

When an older transaction is altered, the system will recalculate the average cost of relevant subsequent transactions. If an adjustment results in a negative on-hand balance while recalculating the average cost, the system will generate an error by default.

For example, consider how the average cost is computed at each point in the following scenario:

Common Mistakes

• Value Adjustment: Making a value adjustment in the inventory can affect the average cost.

• Quantity and Value Adjustments: Both types of adjustments should be made with caution.

• Quantity Adjustment Only: This uses the current average cost.

How to View Average Cost for All Transactions

You can clearly see your average cost calculations using the “Inventory Valuation Report.”

1. Navigate to Reports > Operation.

2. Run the “Inventory Valuation Report.”
3. Enter the “Item Number.”

4. Drill down to view all transactions and the affected average costing.

By following these steps and understanding the intricacies of the Perpetual Average Cost method, you can effectively manage your inventory valuations in XoroERP, ensuring accuracy and compliance with accounting standards.