Weighted average cost

What it means

Weighted average cost values disposals of one kind of stock at the average acquisition cost of the units held, weighted by quantity. Every purchase moves the average, so the same item leaves stock at a different cost through the year.

It is not an estimate or a rounding. The Accounting Act allows it alongside FIFO and requires the average to be recalculated at least once a month, so disposals in between leave at the last valid average.

The average is always calculated for one kind of stock, never across the whole range. For items that can be identified one by one, such as individual cars at a used-car dealer or a product made to a specific order, it is not used at all: the disposal is valued at the actual acquisition cost of that particular unit.

How it works in practice

The entity picks the method in its internal rules and keeps it for the whole period and the whole class of stock. Switching between FIFO and the average depending on which looks better in a given month is not allowed.

Under method A the valuation runs continuously and the books take it from the stock records; under method B purchases go straight to expenses and the average is only worked out at the year-end count.

In wholesale with fluctuating purchase prices, such as steel products or food, the average smooths out the swings: one expensive purchase is spread over the price of the whole warehouse. When choosing the method we show the client, on its own data for the past year, what the margin would have been under the average and under FIFO, and then record the decision in the policy.

What to watch out for

The warehouse averages the invoiced price while the books add freight, duty and insurance into the acquisition cost. Consumption is then understated all year, the margin looks better than it is, and the difference hits expenses in one lump at the annual count.

If the stock program lets an issue through before the receipt is recorded, the balance briefly goes negative and the average is recalculated from meaningless numbers. The result is disposals valued at zero or at an extreme price, which then take days to trace during the stock count; blocking negative balances in the program is far cheaper.