AVCO (Weighted Average Cost) Method (Cambridge International AS Accounting)

AVCO method

Spec point — how to calculate the value of closing inventory using the first in first out (FIFO) and weighted average cost (AVCO) methods (perpetual and periodic)

What is the AVCO method?

• The AVCO method is an inventory valuation method that calculates the average cost of each unit
• The average cost must be recalculated after each purchase

How do I find the value of inventory using the AVCO method?

• You have to go through the transactions in chronological order

After each purchase transaction

• STEP 1 Calculate the total number of units

  • Add the number of units purchased to the current number of units

  • You might need to calculate the number of units purchased

    • $\mathrm{Number} \mathrm{of} \mathrm{units} \mathrm{purchased}=\frac{\mathrm{Total} \mathrm{price}}{\mathrm{Purchase} \mathrm{price} \mathrm{per} \mathrm{unit}}$

• STEP 2 Calculate the total value of all the inventory

  • Add the total price of the units purchased to the current value of the inventory

  • You might need to calculate the total price of the units purchased

    • $\mathrm{Total} \mathrm{price}=\mathrm{purchase} \mathrm{price} \mathrm{per} \mathrm{unit}\times\mathrm{number} \mathrm{of} \mathrm{units} \mathrm{purchased}$

• STEP 3 Calculate the new average cost of each unit

  • $\mathrm{Average} \mathrm{cost} \mathrm{of} \mathrm{each} \mathrm{unit}=\frac{\mathrm{Total} \mathrm{value} \mathrm{of} \mathrm{inventory}}{\mathrm{Number} \mathrm{of} \mathrm{inventory} \mathrm{units}}$

After each sales transaction

• STEP 1 Calculate the total number of units remaining

  • Subtract the number of units sold from the current number of units

• STEP 2 Calculate the total value of the remaining inventory

  • Multiply the number of units remaining by the current average cost of each unit

• The average cost of each unit does not change after a sale

Exam Hint Make sure to not use the selling price of products when calculating the value of inventory. Inventory is always recorded at their purchase price.

Worked Example A business owner has no inventory on 1 February. Below are a list of transactions involving the sales and purchases of inventory.

2 Feb: 8 units purchased at $10 each

7 Feb: 6 units sold

9 Feb: 9 units purchased at $11 each

16 Feb: 10 units sold

24 Feb: 7 units purchased at $12 each

27 Feb: 6 units sold

Calculate the value of the closing inventory using the AVCO method.

Answer:

Date	Number of units	Total value	Average cost of each unit
2 Feb	8	8 × $10 = $80	$10
7 Feb	8 - 6 = 2	2 × $10 = $20	$10
9 Feb	2 + 9 = 11	$20 + (9 × $11) = $119	$119 ÷ 11 = $10.82
16 Feb	11 - 10 = 1	1 × $10.82 = $10.82	$10.82
24 Feb	1 + 7 = 8	$10.82 + (7 × $12) = $94.82	$94.82 ÷ 8 = $11.85
27 Feb	8 - 6 = 2	2 × $11.85 = $23.70	$11.85

Final answer: Closing inventory is $23.70

Exam Hint This is the same example as on the FIFO revision note. Comparing the value of closing inventory, AVCO leads to a value $0.30 less than FIFO.

During times of rising prices, FIFO generally leads to a higher valuation of closing inventory.