Many businesses use process cost accounting to calculate the cost of their inventory and their cost of goods sold. Inventory values appear on the balance sheet as part of the company’s assets. Cost of goods sold appears on the income statement as an expense. Process cost accounting determines the cost of each individual unit when the production process occurs continuously and each item is identical. While several methods of process costing exist, many companies use the weighted average method of process costing.
Process costing works best for companies that maintain a continuous production process, such as an assembly line. Determining the cost of one item presents a challenge since the company cannot isolate the materials used on one unit or the labor incurred. The company calculates the cost of one item by determining the total cost for the production run and dividing this cost by the number of units produced.
Weighted Average Method
The weighted average method looks at the costs incurred and the quantity of items to account for. This includes considering the beginning inventory quantity and dollar value. This also involves determining the production quantity for the period and the total costs incurred. The company adds the beginning inventory quantity plus the additional quantity produced to determine the total quantity available. The company also adds the beginning inventory value to the total costs incurred during the period to determine the total cost of the items available. The company divides the total cost by the total quantity to determine a cost per unit. The company multiplies this cost per unit by the number of units in ending inventory to determine the ending inventory value. The company multiplies the cost per unit by the number of units sold during the period to determine the cost of goods sold.
Ease of Calculation
One advantage of the weighted average method is the simplicity of the calculation to determine the values for ending inventory and cost of goods sold. The company only needs to consider the total beginning inventory value and the current period costs. Alternative methods of product costing include LIFO and FIFO. FIFO -- meaning first in, first out -- assumes the first products received are the first products shipped out and uses the earlier inventory costs to determine cost of goods sold. LIFO -- meaning last in, first out --assumes the last products received are the first products shipped and uses the later costs to determine the cost of goods sold. Alternative costing methods require the company to keep detailed records of each purchase and the purchase price.
Also, the weighted average method maintains a midlevel unit cost, or one that considers all inventory costs regardless when the company receives the product. The company uses this same cost for both inventory value and cost of goods sold. LIFO and FIFO skew the cost for both calculations based on timing, which manipulate the ending inventory value and the cost of goods sold.