Weighted Average Cost (AVCO) Method

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Definition and Explanation:

The weighted average cost (AVCO) method or standard cost method involves computing the weighted average cost of the inventory held after each inventory acquisition takes place. Any inventory sold or used is then valued at this weighted average figure until another acquisition (purchase) takes place, when a new weighted average cost is computed.

Advantages:

(i) AVCO gives most satisfactory results in periods of wide fluctuations in prices as variation in prices are minimized.

(ii) AVCO gives the second highest values for both inventory and cost of goods sold; the situation will be the same even if prices are falling.

(iii) This is acceptable to the inland revenue.

(iv) Due to use of average prices, comparison between profits of different periods becomes easier and realistic.

(v) As the price paid for most recently purchased, plays significant role in calculating average cost, so value assigned to closing inventory units is fairly closed to the current market value.

(vi) AVCO values identical items at the same cost even if they are purchased at different prices and different dates.

Disadvantages:

(i) Prices used to value inventories may bear no relationship to any price actually paid to suppliers.

(ii) The number and complexity of the calculations with AVCO can create rounding off problem which increase the risk of error.

Solved Problems and Examples:

Problem # (1):

Don Barco has recently started a new business which deals in a single product. The first three months of his year of trading showed the following purchases and sales:

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Required:

Calculate value of inventory as at 31 March 2015 under AVCO method of inventory valuation. Calculations should be taken to a maximum of two decimal places.

Solution # (1):

Calculation of Closing Inventory (AVCO Perpetual and AVCO Periodic)

AVCO

Problem # (2):

Caveat Emptor buys and sells a single product from two years. His first three months of current year’s trading showed the following purchases and sales.

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Caveat had 110 units in inventory on 31 December 2014 costing $11 each.

For your convenience you may assume that all purchases took place at the first day of each month, whereas sales are made on the last day of the relevant month.

Required:

Calculate closing inventories under both AVCO Perpetual and AVCO Periodic systems.

Solution # (2):

Calculation of Closing Inventory (AVCO Perpetual and AVCO Periodic)

AVCO 2