What is Average Cost?
When you buy stock treated as Inventory, Saasu adds the value of that stock to an accumulated cost base. Saasu then simply divides this accumulated cost base by the quantity of stock to achieve an average cost price.
MATHS: Accumulated Cost Base / Quantity = Average Cost
Current value of stock is based on the purchases and sales you have made. For example, if you have purchased 100 units @ $50 each and you hold these in inventory, you will have $5,000 in stock value. The average is based on all purchases you have made for the particular item held in stock.
Under the perpetual average inventory system it will use the average cost as at the time you enter the sale. So, if you go in and modify historical purchases or add in other transactions that may affect the stock average cost (more purchase, inventory adjustments due to stock take or shrinkage etc), the COGS posted to the sales will not get updated.
- When you add a Purchase that has 10 units at $10 each so the average cost = $10.
- When you add a Sale that has 1 unit at $15 each the average cost = $10. The system DR COGS $10 and CR Asset: Inventory $10. The average cost at this stage is still $10.
- When you modify purchase, lets say change the unit price from $10 (Step 1) to $12. At this stage, COGS for Sale added in Step 2 stays the same even though you have modified it to $12. At a glance, it seems that the average is $12. However, as at the time you modified the purchase, there were only 9 units left (not 10 as originally purchased). The system re-calibrated the avergage cost to $12.222 each (sometimes referred to moving average method), which is the correct value because you just sold one unit at a time slightly lower average cost.
We’ll look at some examples of what causes problems with average cost numbers that you weren’t expecting.
Edit old purchase transactions
- Lets say you put a Purchase in for 10 unit of Surfboards at $500 each = $5,000 of stock value
- You then sell 9 surfboards at $1,000 each = $9,000 of sale value
- You then edit the original purchase and change the Surfboard price to $450 each because your suppliers final tax invoice was lower due to a volume discount you hadn’t allowed for
- You have then altered the accumulated cost value down by $500 to $4,500.
- There is now $0 of stock value left but you still have one surfboard. When you sell that surfboard it will have an ave cost of $0
Entering transactions out of date order
This can lead to problems where you products change in price over time.
Add backdated purchase transactions
You have entered Sales and you haven’t necessarily booked the correct amount of stock value use when sold because you are entering a backdated purchase that may influence the value of stock.
Adding freight and other charges into existing purchases.
The affect here is that you are changing the stock value booked but subsequent sales are already in the system so that value is adding to the accumulated cost available. This can typically result in Zero stock positions but accumulated stock value still existing in the system.
Forgot to add opening inventory quantities to Saasu.
Often we find customers working around the system by entering Quantity of stock in the inventory opening balance screen but not giving it any value. This has the effect of added quantity but not adding accumulated stock value. Subsequent Sales are then booked at zero Cost of Sales (Saasu has no accumulated stock value to draw upon). Often the user has the intent of going back to the inventory opening balances later and adding value but this will add accumulated stock value while possibly leaving quantities of stock in the system with very strange average costs number. As an example.
- Lets say you add 10 unit of Surfboards to the Inventory opening balance screen for $0
- You then sell 5 surfboards at $1,000 each = $5,000 of sale value.
- You will have booked 5 Sales at $0 each.
- You then alter the Inventory opening balance to add in your $7,000 of value now that you have some opening levels from the business owner.
- There is now 2 units of stock at $3,500 average cost!
To fix this situation you need to either:
(a) Delete transactions associated with this item, enter the correct opening balances and then rekey the transactions.
(b) Do an Inventory Adjustment transaction to book the correct Cost Of Sales for the transactions that have already occurred.
Note that both methods may have impacts on remittances you may have already made to your tax authority so only perform these fixes if you are prepared to remit adjustments. Otherwise method (b) in your current accounting period is less
In essence it is about the situations where you aren’t entering transactions in the order in which they occurred. i.e. you aren’t actually capturing transaction when they happen but instead are retrospectively fixing, editing or entering data. Present time cost of sales and average costs numbers really rely on the value of stock you hold on balance sheet. If the past gets changed it has to be brought to account so it does influence the present day numbers.
How to Fix Incorrect Average Cost or Cost of Goods Amounts
This will depend on what actions you took, similar to those stated above, that caused the amounts to be altered. Generally what you will need to do to correct the Average Cost / Cost of Goods Sold (COGS) is roll back the transactions to a date where the COGS is correct. You will then need to update the sales or purchases transactions by:
- deleting the line item from the sale or purchase
- saving the transaction
- re-entering the line item that you just deleted with the same quantities
- you will need to amend these transactions in order