Average costing method is a way to calculate the cost of items by taking the average price of all the items in a group. Average costing method also known as Weighted Average.
Imagine you have a bunch of identical products with different purchase prices. Instead of keeping track of each item's specific cost, you add up the total cost of all the items and then divide it by the total number of items. This gives you an average cost per item.
Business Scenario:
Imagine a clothing store that sells a particular style of t-shirts. These t-shirts may be purchased from suppliers at different prices throughout the year due to factors like seasonality, promotions, or changes in the supplier's pricing.
If the business opts to implement the average costing method, what GL entries and value entries would be generated to account for this?
Configuration related to Average Costing Method
In the Inventory Setup please make sure that you selected Average Cost Calc. Type and Average Cost Period. These are two mandatory fields to use average costing method.
You can only use one average cost period and one average cost calculation type in a fiscal year.The Accounting Periods page shows which average cost period, and which average cost calculation type is in effect during that period, for each accounting period
Add these two columns by using Personalize option.Purchase Scenario
Let's input the purchase invoice based on the table below and examine the corresponding GL entries, Item ledger entries, and Value entries.
Below are the G/L entries
Below are the Item Ledger Entries and Value entries
The unit cost is calculated using the Average formula, just like in the FIFO costing method.
Unit Cost = Total Purchase Amount ÷ Total Available Inventory
Sales Scenario: Post sales invoice on 2-Sep, with quantity 100pcs
Below are the G/L Entries
Below are the Item Ledger Entries and Value entries
Below is the Calculation of COGS Amount
COGS Unit Cost = Total Purchase Amount ÷ Total Available Inventory
When using the Average costing method, applied entries for shipment cannot be viewed in the Item Ledger.
In the Value Entries, there is a Boolean flag named Valued by Average Cost, and it is marked as true once the cost adjustment for COGS is finalized.
Please take note that I have already configured the Inventory setup with the following settings: Cost Adjustment - Always, Average Cost Period - Day, and Average Cost Calculation Type - Item & Location & Variant.
As a result, there is no need to execute the Batch job Adjust Cost - Item entries. However, if the business opts for Cost Adjustment - Never, then this batch job must be run to ensure the accurate calculation of COGS.
For all other options, the system will automatically adjust the cost by running Adjust Cost – Item Entries batch job and calculate COGS amount based on the chosen period.
Example: Average Cost Period – Day
Example: Average Cost Period – Month
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