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Average cost method

The Average Cost Method is an accounting method that some corporations and individuals use for asset management and asset valuation, usually inventory.

Expanded Definition

To use the average cost method, a company or person adds up all inventory (or stocks or other assets) on hand and available for sale in a given time frame (a quarter or a year, for example) and takes the weighted average of all of it. This weighted average is then used as the COGS.

For example, say that Slydell Jenkins Manufacturing sold 100 ball bearings that had cost $75 apiece to make. Their next batch of 50, however, cost the company $100 each because of rising steel prices, and the batch of 50 after that cost $125 per bearing . Thus, under the average cost method, the COGS of the company's inventory would be ( (100 * $75) + (50 * $100) + (50 * $125) ) / (100 + 50 + 50), or $93.75 per bearing. That would be the number it used for COGS on its income statement and for inventory on its balance sheet.

The same method applies to investing. If Sally buys 10 shares of XYZ Corp. at $20 per share and 10 more at $40 per share later on, her average cost would be ( (10 * $20) + (10 * $40) ) / (10 + 10), or $30 per share. She could use the same method for any mutual funds she owns, using either the single category method or the multiple category method.

Because of the potential lack of tax advantages and the paucity of of useful information this method provides, corporations rarely use it. Many investors like to use it, though, especially those who use dollar cost averaging .

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