Definition: The weighted average method is an inventory costing method that assigns average costs to each piece of inventory when it is sold during the year.
What Does Weighted Average Method Mean?
Retailers and other businesses that keep and sell inventory must keep track of the cost of inventory on hand as well as the cost of inventory that was sold. In theory this sounds simple, but it can be a lot more complex when large companies deal with thousands or even tens of thousands of inventory sku numbers. There are three different types of inventory costing methods: FIFO (First-in, First-out), LIFO (Last-in, Last-out), and Weighted Average.
Some companies choose to use the weighted average method of costing inventory because it doesn’t require them keep track of individual units of inventory. Instead, the weighted average method of costing inventory assigns an average cost to each piece of inventory when it is sold.
When unit of inventory is sold, the weighted average method of costing inventory takes the average cost of all inventories currently available. This average price is then assigned to the item sold.
Since inventory prices fluctuate, the weighted average cost will also change. Think about it this way. A clothing store buys 10 shirts at the beginning of spring for $10 per shirt. These shirts end up becoming a popular item, so the retailer decides to buy 10 more shirts.
Only this time the retailer has to spend $15 a shirt. See how the price of inventory fluctuates? If the retailer sold all 20 shirts at one time, it would record a cost of $12.50 a shirt or the average price per shirt. This is much different than the FIFO and LIFO inventory costing methods.