Financial Glossary
Average Cost Method (Inventory)
The average cost method, also called weighted average cost, values inventory by dividing the total cost of goods available for sale by the total number of units available, producing a single average cost per unit. That average is then applied to both units sold (cost of goods sold) and units remaining (ending inventory). Because it blends all purchase prices together, it smooths the effect of cost swings rather than tracking specific lots like FIFO or LIFO.
Problem & Application
For businesses buying interchangeable goods at changing prices, such as a camp store, marina supply shop, or e-commerce seller, the average cost method simplifies recordkeeping and avoids the volatility of matching specific units to specific costs. It produces a steadier gross margin than FIFO when prices move, which can make period-to-period results easier to read. Owners should confirm the method they choose is applied consistently, since switching methods affects reported profit and taxable income.
In Short
The average cost method is a straightforward, consistency-friendly way to value inventory and COGS by blending all unit costs. It trades precise lot tracking for simplicity and smoother margins.