weighted average cost accounting

weighted average cost accounting

Exploring the Principles and Applications of Weighted Average Cost Accounting

1. Introduction to Weighted Average Cost Accounting

Agencies utilize several different methods to monitor cost-based reimbursement contracts. Monitoring methods include cost studies, investigative reports, and the use of indices to study changes in contractor costs. Agencies also use audits for appraisal. Firms consider total costs when they set stipulated prices for contracts or their products. Cost-based contract prices compensation fluctuates with changes in firm costs. When companies expend more capital to produce labor services or acquire linked benefits or incur higher direct labor costs, the contractor can no longer sustain contract prices under period-specific price commitments such as those established previously in contract agreements. In these cases, agencies must review the interpretation of the original labor costs or establish a purchase order. Unfortunately, there are several stipulation schedules and contract payment methods used by the Office of Federal Procurement Policy and by certain divisions of the U.S. Department of Agriculture. Each stipulation schedule presupposes a method for solving disputes that arise from auditing contract costs.

Firms pricing for cost-based reimbursement contracts may change periodically. Changes in firm stipulated prices usually result in contract price modifications. The modification may be a general price change that affects many contracts, and stipulated prices are broadly established by independent regulatory agencies. Contract price modifications take place because of changes in input costs. Changes in prices cause total contract costs to differ from final estimated costs. A review of the contract cost computation process may be advisable for contract monitoring.

2. Calculation and Components of Weighted Average Cost

This average cost per equivalent unit is then used to recognize cost transferred to the next department and the cost of work in process inventory at the end of the period. In some situations, it is desirable to recognize the cost for a department by the specific elements that comprise that cost, for example, direct labor and direct material, and variable overhead. In other situations, the general category of manufacturing costs may be appropriate, for example, direct manufacturing labor and manufacturing overhead.

Weighted average cost is also calculated in terms of equivalent units. In the average cost method, all materials and conversion costs are pooled together, per equivalent unit cost of work done up to that point in the department. The total cost is divided by the number of production units to find out the per equivalent unit cost.

3. Advantages and Disadvantages of Using Weighted Average Cost Accounting

The cost price of a sale is determined by calculating the average cost of inventory. The sale is charged at this item’s cost price, and the quantity times average cost of sales is recaptured and set aside. The main advantage of WACA is that it provides a simple building block for incorporating other objectives and the different ways in which prices might change. In the decision context, it helps in minimizing the company’s total production cost. Its initial design to value WIP and finished goods provides a simple costing method of addressing the shortcomings of traditional product costing. The main disadvantage of WACA is that it may produce distorted product cost information when used to value production. It is not suitable for valuing normal inventory but useful for production inventory because WACA minimizes variances between production cost and the product’s true cost of production. Regular use of WACA on production inventory is consistent with managers’ need to minimize the company’s total production cost to add value to products and decrease finished goods inventory shortages.

Weighted average cost accounting (WACA) is a simplified method for calculating the average cost of inventory using weighted average factors based on inventory purchased over a period of time when it is too difficult to recalculate the cost or specific identification is impractical. WACA is suitable for use in industries that use large quantities of similar low-cost items. It is one of the two methods of moving average costing, and they are the only two methods that can be used if goods sold are costed by considering the cost of sales value first.

4. Comparison with Other Costing Methods

A decision to change from one method to the other should only be taken after careful evaluation of its short and long-term effects. There are costs like system costs, retraining costs, higher computer costs, and cost recognition that may ultimately outweigh delays and greater recordkeeping costs involved with the change.

The bearing of increasing or decreasing input costs on the valuation of work-in-process in comparative production situations can be shown as follows: It is pointed out above that weighted average costs are higher than FIFO costs in increasing cost situations and lower than FIFO costs in falling cost situations. This means that actual levels of operating profit may differ substantially under the two methods if output is sold at target.

Weighted average and FIFO are the two most widely used cost accounting methods. The way in which cost flows through the process and thereby affects or influences the valuation of work-in-process in respect of the two methods is significantly different. This means that work-in-process is valued at an average price-cost for the whole period of production in the case of the weighted average method and at the actual price-cost for the current charge flowing in the case of the FIFO method. We will look at some of the relative advantages and disadvantages of both methods.

5. Case Studies and Real-World Applications

After we have presented and summarized the set of case studies, we return to the issue of the investor/beneficiary and financial/physical nexus required by “value for money” criteria present in governmental accounting. We also discuss how WACC accounting satisfies all three accounting theories—positive practical, formal ethical, and normative ethical—that exist in the accounting literature. We hope these case studies convincingly demonstrate the useful application of WACC accounting in establishing cost foundation (the conceptual framework) to allow the structured, normative accounting process.

This section introduces a series of case studies that show how the application of WACC accounting is both useful in addressing complex accounting issues and legal mandates on cost allocation, as well as ethically valid by meeting requirements for normative ethical accounting theory. The case studies we have chosen draw from prior WACC accounting ‘how-to’ research papers, and should serve to demonstrate how WACC accounting is both useful and desirable in meeting criteria for all three types of non-capital-providers: regulatory (legal), political demands; contractor requirements; and both public and private definitions of social wealth.