Inventory accounting has a heavy emphasis on how a company values goods held for sale. Valuation methods dictate how a company attributes product costs between the inventory and cost of goods sold accounts. Weighted average is one such inventory valuation method. In many cases, it is the easiest of the inventory valuation methods a company can use.
The weighted-average inventory valuation method spreads total inventory costs among all goods held for resale. The basic formula includes dividing total inventory cost by the number of goods associated with the total inventory cost. Companies can either compute this as a batch valuation or adjust all current and new inventories for the cost adjustments. Either way is usually acceptable in a business.
A company purchases 1,000 units for $7,500 total. The individual inventory cost for this batch of goods is $7.50 per unit. This is the batch-level method for either producing or purchasing goods in the business. Total inventory adjustments are slightly different. If a company purchases a second 1,000 batch of goods for $8,000, then the per-unit cost moves to $7.75 for all items held by the company.
Weighted-average inventory valuation attempts to smooth the company’s reported cost of goods sold. This should result in relatively few changes to a company’s net income at the same sales revenue levels. Another advantage to this method is the ability to sell any good first during business operations. Other inventory valuation methods dictate certain goods sell first, creating more inventory management activities. This is not present under the weighted-average method.
Production companies are often heavy users of the weighted-average inventory valuation method. Process costing systems manufacture goods in a continual manner. Weighted-average valuation allows a company to avoid separating goods out of this system, which s often extremely difficult. Other companies can also use this method to great benefit. Companies that sell several small or similar goods often use this method.