The Moving Average Method
In this method, the costing program creates an average cost and applies it to all instances of the same part. When new instances of this part enter inventory with a different cost, the average cost is recalculated and applied to the entire inventory of the part. Example. Consequently, parts leaving inventory do not affect the average part cost.
Example:
The current Inventory of a certain parts is 10 units, at an average cost of 10 $ per unit.
If 5 units are added to inventory at the cost of $16 per unit, the result, according to the formula: (10*10+5*16)/(5+10).
The FIFO Method (First In, First Out)
In this method, an item maintains the cost it received when entering inventory. Consequently, inventory can be viewed as a pipe containing sub-groups of a given part, each entering at a different time at a (potentially) different price. On the one hand, all group costs combine into a weighted average, which constitutes the part's unit cost. On the other hand, when a group of parts exits the pipe (i.e., leaves inventory) it maintains its original entry cost. Costing then recalculates the part's unit cost based on the entry costs of the remaining inventory.
Notes:
·Parts entering inventory with no designated cost form a new "group" of parts at the average cost.
·In this method, the removal of parts from inventory does affect the part cost, to the extent that the cost of that group deviates from the part cost.
Example :
The current inventory of certain part consists of 2 groups at different costs:
Group1: 15 units, at the cost of $15 per unit
Group1: 10 units, at the cost of $10 per unit
The overal cost of the part is $13 per unit, according to the formula:
(15*15+10*10)/(10+15) = 325/25
When the parts are removed from inventory, they are taken from the first group.
The overal cost the remaining inventory is then $11.6 per unit, according to formula:
((15-10)*15+10*10)/(10+(15-10))=175/15.
·When manufactured parts leave inventory without a work order number, their transaction cost is calculated according to the Moving Average method, even if you are working with FIFO. In such a case, FIFO is still used to calculate the part cost.
·The transfer of parts from a warehouse flagged as participating in costing to a warehouse that is not is considered removal from inventory, which affects part cost.
.
