# Average Cost Method Definition

## What Is the Average Cost Method?

The average cost method assigns a cost to inventory items based on the total cost of goods purchased or produced in a period divided by the total number of items purchased or produced. The average cost method is also known as the weighted-average method.

### Key Takeaways

• The average cost method is one of three inventory valuation methods, with the other two common methods being first in first out (FIFO) and last in first out (LIFO).
• The average cost method uses the weighted-average of all inventory purchased in a period to assign value to cost of goods sold (COGS) as well as the cost of goods still available for sale.
• Once a company selects an inventory valuation method, it needs to remain consistent in its use in order to be compliant with generally accepted accounting principles (GAAP).

## Understanding the Average Cost Method

Businesses that sell products to customers have to deal with inventory, which is either bought from a separate manufacturer or produced by the company itself. Items previously in inventory that are sold off are recorded on a company’s income statement as cost of goods sold (COGS). The COGS is an important figure for businesses, investors, and analysts as it is subtracted from sales revenue to determine gross margin on the income statement. To calculate the total cost of goods sold to consumers during a period, different companies use one of three inventory cost methods—first in first out (FIFO), last in first out (LIFO), or average cost method.

The average cost method uses a simple average of all similar items in inventory, regardless of purchase date, followed by a count of final inventory items at the end of an accounting period. Multiplying the average cost per item by the final inventory count gives the company a figure for the cost of goods available for sale at that point. The same average cost is also applied to the number of items sold in the previous accounting period to determine the cost of goods sold.

## Example of the Average Cost Method

For example, consider the following inventory ledger for Sam’s Electronics: