# Cost Method: Average Cost

An example of a single material added to inventory with 0.00 units on hand and an initial per unit cost of \$1.25.

An adjustment is made to establish the material’s beginning balance, followed by a purchase, sale, and finally another purchase.

This table displays the quantity on hand and unit costs resulting from each event.

IN Materials (INMT)

Event

Date

Qty on Hand

Last Unit Cost

Avg Unit Cost

Std Unit Cost

Beginning Balance

0

1.25/ea

1.25/ea

1.25/ea

Adjustment Entry for Beginning Balance (100 @ 1.25/ea)

10/01/10

100

1.25/ea

1.25/ea

1.25/ea

Buy 100 @ 1.00/ea

10/04/10

200

1.00/ea

1.125/ea

1.25/ea

Sell 50

10/06/10

150

1.00/ea

1.125/ea

1.25/ea

Buy 100 @ 2.00/ea

10/07/10

250

2.00/ea

1.475/ea

1.25/ea

This table illustrates how the Average Cost method affects updates and the resulting value of Inventory. The Posted Total Cost represents the actual cost associated with each transaction, and the Change to Inventory represents the debit or credit posted to your GL Inventory Accounts. These two values always equal each other when using this cost method.

Event

Posted Total Cost

Change to Inventory

Ending Inventory

Adjustment Entry for Beginning Balance (100 @ 1.25/ea)

125.00

(100 * 1.25/ea) = 125.00

125.00

Buy 100 @ 1.00/ea

100.00

(100 * 1.00/ea) = 100.00

225.00

Sell 50

-56.25

(-50 * 1.125/ea) = -56.25

168.75

Buy 100 @ 2.00/ea

200.00

(100 * 2.00/ea) = 200.00

368.75

The Average Unit Cost for a material is continuously updated by the system with each purchase. Any ‘in’ transaction or adjustment will trigger an update. The total cost attributed to a sale (any ‘out' transaction) relies on the material’s cost method and the current value of its Average, Last, or Standard Unit Cost. Therefore, when using Average Unit Cost as your cost method, the order of transaction processing plays a crucial role in determining this value and the corresponding GL updates to your Inventory accounts.

Important: Because inventory adjustments are included in average cost calculations, it is important that you make sure all transactions are properly sourced (i.e. post a sale as a sale, not as a negative adjustment, which reduces the total value of the material). You should only use adjustments when a direct impact on quantity and value (i.e. average cost) is desired.