FA 34 - Inventory - Weighted Average (Average Cost) Method
Summary
TLDRThis video script explains the concept of weighted average in inventory accounting through a relatable gas tank analogy. It walks through a step-by-step example of calculating the weighted average cost of inventory, including purchases and sales, and demonstrates how to record journal entries for these transactions. The script clarifies the process of adjusting the average cost after each purchase and sale, emphasizing the importance of this method in determining cost of goods sold and gross profit.
Takeaways
- 📘 The script discusses the weighted average method of inventory valuation, emphasizing its difference from simple average calculations.
- 🚗 It uses the gas tank analogy to explain the concept of weighted average, where the cost of the initial amount of gas in the tank influences the average cost more than the subsequent addition.
- 🔢 The weighted average is calculated by dividing the total cost of all items by the total quantity, not by averaging the individual costs of each batch.
- 🛒 The script provides a step-by-step example of how to apply the weighted average method to inventory transactions, including purchases and sales.
- 📈 The example illustrates the process of recalculating the average cost after each inventory transaction, showing how the new average is determined.
- 💰 The cost of goods sold (COGS) is recalculated using the weighted average method after each sale, affecting the gross profit calculation.
- 📋 The script mentions that the sales revenue remains constant regardless of the inventory valuation method used, but the COGS and thus the gross profit can vary.
- 📝 Journal entries are provided for the purchase and sale transactions, showing how they are recorded under the weighted average method.
- ✍️ The journal entries for purchases are consistent across all inventory valuation methods, but the COGS entries differ based on the method used.
- 🗓️ Specific dates are given for the transactions, such as May 24th for a purchase and May 31st for a sale, to demonstrate the application of the weighted average method in a real-world scenario.
- 👍 The presenter encourages viewers to give the video a thumbs up if it helped them understand the FIFO, LIFO, and weighted average methods better.
Q & A
What is the concept of weighted average in inventory valuation?
-The weighted average in inventory valuation is a method where the cost of goods is averaged across all inventory items, taking into account the quantity and cost of each item. It reflects the overall cost of the inventory, rather than the cost of individual items sold.
Can you explain the 'gas tank' example used in the script to illustrate the weighted average concept?
-The 'gas tank' example demonstrates how the weighted average is calculated by considering the total quantity and cost of gas in a tank. If you add more expensive gas to a tank already filled with cheaper gas, the average cost of the gas in the tank is not the simple average of the two prices but rather the total cost of gas divided by the total quantity in the tank.
What is the formula for calculating the weighted average cost of inventory?
-The formula for calculating the weighted average cost of inventory is: Total Cost of Inventory / Total Quantity of Inventory.
How does the weighted average method differ from FIFO and LIFO in inventory valuation?
-The weighted average method differs from FIFO (First In, First Out) and LIFO (Last In, First Out) in that it does not assign costs based on the order of items purchased or sold. Instead, it takes into account all items in inventory and calculates an average cost.
What is the initial average cost of inventory in the script's example on May 1st?
-The initial average cost of inventory on May 1st is $3 per unit, with 20 units in the beginning inventory, totaling $60.
What is the total cost of the purchase made on May 5th, and how many units were purchased?
-On May 5th, 5 units were purchased at a cost of $3.25 per unit, resulting in a total cost of $16.25.
How is the new average cost of inventory calculated after the purchase on May 5th?
-After the purchase on May 5th, the new average cost is calculated by adding the total cost of the new purchase to the previous total cost ($60 + $16.25) and dividing by the new total quantity (20 + 5), resulting in an average cost of $3.05 per unit.
What is the total sales revenue and cost of goods sold (COGS) after the sales on May 31st?
-After the sales on May 31st, the total sales revenue is $350, and the cost of goods sold (COGS) is $112.
How does the weighted average method affect the calculation of gross profit?
-The gross profit is calculated by subtracting the cost of goods sold (COGS) from the total sales revenue. The weighted average method affects the COGS by averaging the cost of all inventory items, which can result in a different gross profit compared to FIFO or LIFO methods.
What are the journal entries made on May 24th and May 31st according to the weighted average method?
-On May 24th, a debit is made to inventory and a credit to accounts payable for the amount of the purchase ($18.50). On May 31st, a debit is made to accounts receivable or cash and a credit to sales revenue for the amount of the sale ($130). Additionally, a debit is made to COGS and a credit to inventory for the cost of the items sold ($45.50).
Outlines
📈 Weighted Average Inventory Method Explained
This paragraph explains the concept of the weighted average inventory method using a gas tank analogy. The presenter clarifies that weighted average is not a simple mean between two prices but rather a calculation that gives more weight to the larger quantity. The example provided involves adding 99 liters of gas at $1 per liter and then 1 more liter at $2 per liter, resulting in a weighted average cost of $1.01 per liter. The principle is then applied to an inventory problem, starting with 20 units at $3 each, followed by a purchase of 5 units at $3.25 each, and recalculating the average cost to $3.05 after each transaction. Sales are simplified as they are based on the average cost of inventory, regardless of the order of purchases.
🔍 Journal Entries for Inventory Transactions
The second paragraph delves into the accounting aspect of inventory management, focusing on journal entries for the weighted average method. It starts by calculating the cost of goods sold (COGS) and the remaining inventory value after sales, using the weighted average cost. The presenter then provides a step-by-step guide on how to record journal entries for purchases and sales, emphasizing the consistency of these entries across different inventory valuation methods. The example includes a purchase made on May 24th for $18.50 and a sale on May 31st, with COGS calculated at $45.50. The paragraph concludes with a summary of sales revenue, COGS, and gross profit, highlighting the differences in COGS between the weighted average method and other methods like FIFO and LIFO.
Mindmap
Keywords
💡FIFO
💡LIFO
💡Weighted Average
💡Inventory Valuation
💡Cost of Goods Sold (COGS)
💡Gross Profit
💡Journal Entries
💡Average Cost
💡Beginning Inventory
💡Purchase
💡Sales
Highlights
Introduction to the concept of weighted average in inventory valuation.
Explanation of the gas tank analogy to understand weighted average.
Illustration of calculating weighted average with a practical example of gas prices.
Clarification that weighted average is not the simple average of prices.
Description of the beginning inventory and its valuation on May 1st.
Process of updating the weighted average after a purchase on May 5th.
Calculation of the new average cost of inventory after the purchase.
Explanation of how sales affect the weighted average cost of inventory.
Demonstration of calculating the cost of goods sold using the weighted average method.
Update of the weighted average after another purchase on May 20th.
Calculation of the new weighted average cost after the May 20th purchase.
Process of updating the inventory valuation after a purchase on May 24th.
Final calculation of the weighted average cost after the May 24th purchase.
Explanation of the sale process and its impact on the weighted average cost.
Calculation of the cost of goods sold and the remaining inventory value on May 31st.
Completion of the inventory table and calculation of sales, COGS, and gross profit.
Journal entries for the purchase on May 24th under the weighted average method.
Journal entries for the sale on May 31st and the impact on COGS.
Summary of the weighted average method's application and its challenges.
Encouragement for viewers to give a thumbs up for understanding FIFO, LIFO, and weighted average methods.
Transcripts
we've been working their way through
this 72a this FIFO LIFO weighted average
problem and now we're on to weighted
average the third one is the the
trickiest of the three and I always like
to and I will react splain this when I
think of weighted average I always think
of this gas tank example if I put 99
liters in my car and it cost me $1 per
litre means I got 99 dollars worth of
gas in my car and let's say it's a
hundred liter gas tank and I put one
more leader in at two dollars per liter
so that's two dollars worth of gas in
the tank and somebody asks me what's the
average cost of the gas in your gas tank
I wouldn't say oh well it's a buck 50
you know the average between one and two
one plus two divided by two right I
wouldn't say it's a buck fifty because
of course you know I've got some gas
that's a dollar and some guess it's two
dollars so I've got a buck fifty on
average is the cost of gas and my gas
tank that's a simple average a weighted
average would say no no this 99 litre
should take precedence so if the 99
liters takes precedent that means it
should have more weight in our average
and it does if we take a weighted
average here's how you do it
you total the number of units in this
case leaders you total the total cost in
this case 101 dollars 99 plus two and
then rather than taking average between
one and two you just go 101 divided by
100 and you get one point zero one
that's 101 over 100 and that is your
weighted average well that principle is
just all over this problem so let's do
it our beginning inventory twenty at
three dollars on May the 1st so that is
our average 20 at three four sixty bucks
okay so next May the fifth we make a
purchase now whenever we make a purchase
we've got work to do as weighted
averages so we sorry I missed the
purchases column we purchase five at
three twenty five and five times three
twenty five is six
25 we had 20 at $3 for 60 we're adding
to it 5 at 325 for 1625 and now I need
to reassess how do I do that well I add
my total quantity I had my total cost
and then I divide the two so 20 plus 5
is of course 25 60 plus 16 is of course
76 76 point 2 5 divided by 25 gives us
3.05 and you can see it's not rounding
at all 3.0 5 is the number so our
average cost of inventory is 305 now
when I make sales the sales are easy
because I don't have to say what did I
buy first what did I buy last and keep
track I just say oh I sold twenty two
pieces of inventory they all cost 305
right that's the average cost of my
inventory so 22 times 305 is 67 ten if I
had 25 units I sold 22 I'm left with 3
at 3:05 + 3 times 305 is 915 moving on
to May 20th on May 20th I make a
purchase I purchase 7 units at 3:55 7
times 3 55 is 2485 ok so now I had 3 at
3:05 for 9.15 I'm adding to it 7 at 355
for 2485 summing it up here
three plus seven is ten nine plus 24 is
34 34 divided by 10 gives us three
dollars and 40 cents as our weighted
average their May 24th I make another
purchase I purchase five at three
dollars and seventy cents five times
three seventy is eighteen fifty and I
had ten units at three forty four thirty
four thirty four dollars I'm adding five
at 374 eighteen fifty again summing it
up riajuu don't want to shift cells up
control you underlined is what I wanted
to do here 10 plus 5 is 15 34 plus 18 50
is 52 50 52 50 divided by 15 is three
dollars and fifty cents that's my
average cost now on May 31st I make a
sale what do I sell I sell 13 units
what's the average cost of goods sold
350 now again we're keeping in mind I
recognize that the revenue here is $130
but that number doesn't go anywhere on
the chart right the chart is all about
cost 22 times 10 is 220 we're gonna use
those numbers later 13 times 350 though
45 50 leaving me two units at 350 for
$7.00 and that point we have completed
our inventory table here we got a
compute sales cogs and gross profit our
sales Rev 220 plus 130 our total sales
revenue is 350 dollars this did not
change across the methods same every
time our cost of goods sold the sum of
this column 67 plus 45 equals 67 plus 45
112 bucks 350 minus 112 is 237
- cogs is gross profit okay last step
here do a couple of journal entries May
24th we make a purchase well this is
always the same when you make a purchase
debit inventory credit AP by the way I'm
answering Part C here just do journal
entries for May 24th and May 31st under
all methods so that's what we're doing
debit inventory credit AP for the amount
of the purchase on May 24th which was
$18.50 this is not different under any
method on May 31st I make a sale
remember whenever we make a sale there's
always two pieces debit AR or cash so
I'm clear here credit sales sales Rev
that amount hasn't changed it's a
hundred and thirty bucks
the only difference between all of our
methods is this cogs amount cost of
goods sold double cogs credit inventory
for the amount from our table for this
amount 45 dollars and fifty cents in
this case it was different in the other
two methods okay there we have it we
have salt 72 a we've made it to the
bottom and we've done the weighted
average method which i think is a little
more challenging if this has helped you
in better understanding FIFO LIFO
weighted average method I do hope you'll
give this video the thumbs up alright
that's all for this video see you next
time
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