By Mansi Dupte
Published on - 12th January 2024
Gaining knowledge of the Inventory Weighted Average Cost (IWAC) is similar to being able to use an accurate instrument for financial clarity. Businesses can take a more sophisticated approach to valuation with the help of the IWAC technique, which assigns a unit cost to inventory goods.
Inventory management includes giving each unit a significant value in addition to just counting the number of items on the shelf. This is accomplished by taking into account the fluctuating costs of items over time, giving a more realistic picture of a company's financial situation.
Consider a situation in which a company purchases inventory at various times of the year. Conventional approaches may oversimplify by considering every unit as though it were acquired for the same price. Inventory Weighted Average Cost enters the picture here, providing a sophisticated fix that mimics the dynamic nature of business operations.
Dynamic Valuation:
IWAC takes into account the expenses incurred at various moments in time to adjust to the constantly shifting environment of procurement.
Precision In Unit Cost:
The cost of each unit is determined using the actual costs incurred at the time of purchase, giving a more realistic picture of the monetary commitment.
Financial Transparency:
IWAC helps create more accurate financial statements and reports, which gives businesses a better understanding of their financial health.
Smoothing Cost Fluctuations:
IWAC provides consistency in financial reporting by reducing the impact of abrupt price variations through cost averaging.
Compatibility With Inflation:
IWAC mitigates the financial impact and keeps it from having an excessive impact on inventory valuation in inflationary environments.
Knowing IWAC is a strategic step toward more accurate financial reporting and well-informed decision-making; it's not just an issue of financial finesse.
Strategic in nature, Inventory Weighted Average Costing (IWAC) finds its place in particular situations where other costing techniques are inadequate. Let's examine the conditions in which organizations seeking sophisticated financial accuracy prefer to use IWAC.
Scenario:
When a company purchases inventory at various points in time during the accounting quarter.
Use of IWAC:
To provide a more true depiction of financial realities, IWAC accounts for these variances by offering a unit cost that represents the weighted average.
Scenario:
Items having consistent costs across time.
Use of IWAC:
IWAC can be a useful technique for attaining simplicity without compromising accuracy in scenarios where product costs stay mostly stable.
Scenario:
Industries where price swings happen often.
Use of IWAC:
IWAC prevents unnecessary distortion in financial reporting and ensures stability by mitigating the effects of abrupt price swings.
Scenario:
Companies that use a periodic inventory system, wherein inventory is counted periodically.
Use of IWAC:
IWAC provides a workable way to figure out unit prices and integrates easily with periodic inventory systems.
Scenario:
When companies try to strike a balance between accuracy in value and simplicity.
Use of IWAC:
By striking this equilibrium, IWAC offers a more sophisticated valuation technique without the complexity of approaches like FIFO or LIFO.
Scenario:
Working in a setting where inflationary pressures are common.
Use of IWAC:
IWAC provides a more stable and accurate inventory valuation by mitigating the effects of inflation.
Scenario:
Companies who, for the sake of simplicity, adopt a consistent costing method.
Use of IWAC:
IWAC provides a simple and reliable approach, especially for businesses that handle a wide variety of inventory goods.
A simple method that takes expenditures incurred at several periods in time is used to calculate Inventory Weighted Average Cost or IWAC. The following is the formula:
IWAC = (C1 X Q1) + (C2 X Q2) + .... + (Cn X Qn) Q1 + Q2 + .... + Qn
Where: C1, C2,... Cn are the respective costs of inventory items purchased at different times. Q1, Q2,... Qn are the quantities of inventory items purchased at different times.
Multiply the cost (C) of each unit by its quantity (Q) purchased at different times. Sum up these products for all purchases. Divide the total by the sum of quantities to get the weighted average cost per unit.
Suppose a small retail business, XYZ Mart, has made three separate purchases of a particular product for a month. Here are the details:
Purchase 1:
Quantity: 100 units
Cost per unit: Rs. 5
Purchase 2:
Quantity: 150 units
Cost per unit: Rs. 6
Purchase 3:
Quantity: 200 units
Cost per unit: Rs. 4
Now, let’s apply the formula and substitute the values in it
IWAC = [(C1 X Q1) + (C2 X Q2) + (C3 X Q3)] / [Q1 + Q2 + Q3]
IWAC = [(5X100) + (6X150) + (4X200)] / [10 + 150 + 200]
IWAC = [(500) + (900) + (800)] / [450]
IWAC = 2200 / 450
IWAC = 4.89
In this instance, the Inventory Weighted Average Cost for XYZ Mart is around Rs. 4.89 per unit. This indicates that the company values its inventory at an average cost of Rs. 4.89 per unit after accounting for the various expenses related to each transaction and the quantities purchased.
Through the use of IWAC, XYZ Mart makes sure that the value of its inventory corresponds to the real expenses made with each purchase, giving a more accurate picture of the financial situation of that particular product.
IWAC (Inventory Weighted Average Cost) :
1. Determines the average cost across all units.
2. Streamlines the process of valuing.
3. Ideal for companies with a wide range of merchandise.
FIFO (First-In-First-Out) :
1. Recognizes and assigns a unique value to every unit.
2. Provides accurate cost monitoring.
3. Frequently used for expensive or special things.
Example: IWAC offers a more balanced cost representation in a rising price situation, whereas FIFO, which assumes that the newest, priciest units are sold first, may lead to greater COGS.
IWAC (Inventory Weighted Average Cost) :
1. Determines the average cost using all of the inventory's units.
2. Offers a consistent method for appraisal.
3. Reduces the effect of transient price changes.
FIFO (First-In-First-Out) :
1. Believes that the first items sold are the ones that were bought last.
2. May produce tax benefits during an inflationary period.
3. Might not be in line with the actual movement of products.
Example: While LIFO could give tax advantages during inflation, IWAC offers a more transparent and consistent value that is in line with the real expenses spent over time.
IWAC (Inventory Weighted Average Cost) :
1. Determines the average cost across all units.
2Streamlines the process of valuing.
3. Ideal for companies with a wide range of merchandise.
Specific Identification :
1. Recognizes and assigns a unique value to every unit.
2. Provides accurate cost monitoring.
3. Frequently used for expensive or special things.
Example: While IWAC provides simplicity and precision, it is a more practical choice for organizations dealing with a range of inventory goods. Specific identification is suitable for things with distinct values.
IWAC (Inventory Weighted Average Cost) :
1. Costs over time are averaged.
2. Offers a technique of valuing that is constant.
**3.**Less receptive to sudden fluctuations in pricing.
Moving Average :
1. Varies the average in response to new purchases.
2. Quicker to reflect current cost adjustments.
3. Moving Average allows adaptability to change in the market.
Example: While IWAC offers a steady and constant value, the moving average is more sensitive to short-term price fluctuations, making it appropriate for enterprises needing to make quick adjustments to market circumstances.
The choice between these approaches is influenced by variables such as market conditions, inventory type, accounting preferences, and firm size. Every approach has benefits and cons, so companies should choose the one that best suits their unique requirements and budgetary objectives.
IWAC reduces the impact of erratic price swings by accounting for expenses at many buying points. This promotes financial stability by ensuring that the reported cost of goods sold (COGS) and ending inventory are more indicative of the general cost trends.
Example: In the retail industry, where seasonal fluctuations in demand or market conditions might affect product prices, IWAC helps to stabilize cost numbers, providing a more stable financial image.
Calculating IWAC is less complicated than calculating LIFO or FIFO. For companies that value a clear-cut approach to valuation, it is more accessible because it just entails adding up all of the expenses and quantities.
Example: IWAC may be more user-friendly and less time-consuming for small enterprises with limited resources for intricate accounting procedures.
Businesses that use a periodic inventory system—where the inventory is counted periodically rather than continuously—are ideally suited for IWAC. It offers a realistic answer for recurring valuation.
Example: The ease of use and precision of IWAC can help retailers who do physical inventory counts at the end of every month to better coincide with their periodic accounting procedures.
IWAC lessens the effect of transient price swings by averaging the expenses over a range of transactions. This is especially beneficial for companies that deal in commodities or items that are susceptible to abrupt changes in the market.
Example: IWAC can help a company that deals with raw materials whose prices fluctuate often from overreacting to brief increases or decreases in procurement expenses.
To balance the possible tax benefits of LIFO and the growing expenses of FIFO, IWAC proposes a consistent valuation technique. It guarantees consistent valuation procedures, which promotes comparability across time.
Example: IWAC is a dependable way to keep values stable for businesses that value consistency in their financial reporting, particularly when working with a variety of inventory products.
Putting IWAC into practice requires strategic decisions based on a company's unique requirements, and these advantages highlight how flexible and useful it is in a range of situations.
That’s it for this blog! In this blog, we thoroughly discussed what is inventory weighted average cost, when it is used, how to calculate inventory weighted average cost, comparison with other valuation methods, examples of it, and 5 benefits of using inventory weighted average cost!
Thank you for reading!