Average cost of inventory, often shortened to the average cost method, is another name for the weighted-average cost flow assumption. Under this method a business values both its ending inventory and its cost of goods sold using an average cost per unit, weighted by the number of units bought at each price. The main entry includes the formula and a worked example.
How the phrase is used
Accountants use "average cost" as the everyday label for this cost flow assumption, set alongside first in, first out (FIFO) and last in, first out (LIFO). IFRS refers to it as the weighted average cost formula, and it is one of the two cost formulas IFRS allows for interchangeable items, the other being FIFO.
The phrase can be read in two ways. Under a periodic system, one average is calculated for the whole period by dividing the cost of goods available for sale by the units available. Under a perpetual inventory system, a new average is worked out after each purchase, which is known as the moving average method.
Outside cost accounting, "average inventory" is also used for a different figure: the average of opening and closing inventory balances, used in ratios such as inventory turnover. That is a measure of how much stock a business holds on average, not a method of assigning costs.