Averaging. Because the identity of the items conveyed to buyers is unknown, this final cost flow assumption holds

that using an average of all costs is the most logical solution. Why choose any individual cost if no evidence exists

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of its validity? The first item received might have been sold or the last. Selecting either is an arbitrary decision. If

items with varying costs are held, using an average provides a very appealing logic. In the shirt example, the two

units cost a total of $120 ($50 plus $70) so the average is $60 ($120/2 units).

Figure 9.3 Journal Entry—Reclassification of the Cost of One Piece of Inventory Using Averaging

Although no shirt did cost $60, this average serves as the basis for both cost of goods sold as well as the cost of

the item still on hand. All costs are included in arriving at each reported figure.


Cost of Goods Sold (One Unit—the Average One) $60

Gross Profit ($110 less $60) $50

Ending Inventory (One Unit—the Average One) $60

Averaging has many supporters. However, it can be a more complicated system to implement especially if costs

change frequently. In addition, it does not offer the benefits that make FIFO (higher reported income) and LIFO

(lower taxes in the United States) so appealing. Company officials often arrive at such practical decisions based

on an evaluation of advantages and disadvantages and not on theoretical merit.