Assignment Help for Advantages and Disadvantages of Average Cost Method

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Advantages of Average Cost Method

Time saving: The simplicity of applying the average cost method in inventory valuation makes companies save time. This method is less difficult and time-consuming than other inventory valuation methods. Instead of looking at the price of the inventory items in accordance to the original price of those items and their delivery date, the estimator of inventory value only need to focus on one single average price and then quote a selling (retail) price on the basis of average cost of inventory. Due to this, the estimator allowed to invest less time in valuing inventory.

Accurate calculation of COGS: The calculation of the cost of goods sold becomes much more reliable, consistent as well as less affected due to prices fluctuations under average cost method in comparison to LIFO and FIFO methods. In the situation when the price rises, FIFO method understates COGS, and LIFO method overstates COGS by considering the entire period in accordance with the last price prevailing in the market and both of these two methods provide the wrong valuation of inventory. On the other side, averages cost method stands at the middle point of the valuation of inventory made under LIFO and FIFO. Therefore, the way to make period-to-period comparisons as considered in average cost method is more meaningful than the other two methods. Along with this, it requires fewer adjustments for the purpose of inventory cost analysis as compared to FIFO and LIFO method.

Disadvantages of Average Cost Method

Besides the above stated advantages, the average cost method also includes some disadvantages. The disadvantages of this method of inventory costing are discussed below.

Unrecovered Costs: Average cost method become unable to deliver the accurate result if the prices of inventory vary widely and pricing often fail to recover the costs of expensive units as present in the total inventory. In fact, it also leads a company to face financial loss by valuing sales price of inventory items less than actual.

Mispricing of the non-identical batches of inventories: This method of inventory valuation assumes all units as identical. However, this is not always happened in every case. If a product is upgraded or modified by adding some additional features, it needs to be considered at a higher price than before and then the older units. This can be an issue when a production company uses to replace an existing product with an upgraded one but mark it at the same price as the older one was valued. Average cost method does not consider such changes in inventory price in accordance with the modification of one or more than one inventory items. This makes it improper to use by companies that often replace their inventory items from an older version to a newer version.

Vague and inconsistent management of cost: While using the average cost method, costs are lumped together and form a general pool before getting divided across units. It creates difficulties for the cost managers while assigning costs to inventory items and follow such costs in relation to a specific material throughout the entire production process. Therefore, accuracy in cost management becomes difficult to accomplish.

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