FA 34 - Inventory - Weighted Average (Average Cost) Method

Summary

This 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).