Average Cost Method

We're going to tell you the definition of this one and you're going to complain "well, that's kind of obvious." Maybe. But, would you really prefer if it was confusing? Would you prefer if it was called "Mean Inventory Outlay Accounting Methodical Process (MIOAMP)." We thought not.

Anyway, the average cost method represents a way to record the value of inventory on a balance sheet. As the name implies, you divide the total cost of the inventory by the amount you have in stock. So each piece of inventory is recorded at the average price of all the inventory (this way you don't have to track specific costs for individual inventory pieces).

You own a company that installs entertainment systems. You keep a bunch of TVs in stock for rush jobs. However, sometimes you get a deal on the TVs. Sometimes you don't.

So you have five TVs in stock that cost you $500 each, you have three in stock that cost you $600, and two from way back before you knew how to negotiate that cost you $1,000 each. The total cost of all the TVs is $6,300, and there are 10 TVs in stock. So average cost of the TVs is $630 each. When one of them is sold, you subtract $630 from the inventory on the balance sheet, regardless of which specific TV was installed and what its original cost was.