Definition of Weighted Average Method and Its Importance

Definition: The weighted average method in accounting is one of the inventory valuation methods approved in accounting standards, aimed at determining the cost of goods sold and ending inventory in a fair and logical manner. It relies on combining the costs of all purchases to obtain a unified average that reflects the actual cost per unit.

Accounting Importance:

Fair Inventory Valuation: Ensures fair distribution of costs between goods sold and remaining inventory, especially in price-volatile environments. Avoids accounting problems arising from significant differences in purchase prices and provides balanced inventory value in the balance sheet.

Implementation Simplicity: Reduces administrative and accounting complexities compared to other methods like FIFO, especially for companies with frequent and repeated transactions. Doesn't require precise tracking of purchase dates or inventory numbering, saving time and effort in accounting records.

Cost Stability: Mitigates the impact of temporary price fluctuations on financial statements and provides continuity in cost of goods sold. Prevents profit manipulation through selecting specific batches for sale and ensures fairness in calculating actual company profitability.

Standards Compliance: Accepted and approved in international and local accounting standards, meeting transparency and disclosure requirements. Gains acceptance from auditors and regulatory bodies, aligning with generally accepted accounting principles for asset valuation.

Practical Application: Ideal for commercial and industrial companies dealing with homogeneous goods, and institutions with repeated purchases at varying prices. Suits sectors facing regular price fluctuations and provides practical solutions for multi-branch or warehouse companies.

Applications of Weighted Average in Accounting

The weighted average method finds wide applications in various accounting fields to provide fair and accurate cost and asset valuations, including:

Inventory Valuation: Calculating cost of goods sold and ending inventory for homogeneous goods, especially in commercial and industrial companies with repeated purchases at varying prices.

Unit Cost Calculation: Determining average production cost per unit in industrial companies, considering different production quantities and their varying costs during the accounting period.

Indirect Cost Allocation: Allocating fixed and variable costs to cost centers or products based on usage ratios or actual production.

Depreciation Rate Calculation: Applying depreciation to fixed assets when usage periods or operating intensity differ for similar assets.

Financial Analysis: Calculating weighted financial ratios such as average return on investment and inventory turnover when different periods or volumes exist.

Budgeting and Planning: Determining expected costs and accounting standards for future periods based on weighted historical data.

Branch Accounting: Consolidating costs and financial results of different branches while considering each branch's activity volume and contribution to overall results.

Steps for Calculating Weighted Average

Step One: Determine values and weights for each element.

Step Two: Multiply each value by its corresponding weight.

Step Three: Sum all multiplication results.

Step Four: Sum all weights.

Step Five: Divide the sum of products by the sum of weights.

Step Six: Verify the accuracy of the result.

Example - Commercial Company Inventory:

• Opening Inventory: 500 units at 45 SAR = 22,500 SAR
• First Purchase: 800 units at 48 SAR = 38,400 SAR
• Second Purchase: 1,200 units at 52 SAR = 62,400 SAR
• Third Purchase: 600 units at 55 SAR = 33,000 SAR

Calculation:

• Total Costs: 156,300 SAR
• Total Quantities: 3,100 units
• Weighted Average: 156,300 ÷ 3,100 = 50.42 SAR per unit

Application: When selling 1,500 units, cost of goods sold = 1,500 × 50.42 = 75,630 SAR

Difference Between Weighted Average and Other Methods

Comparison Aspect	Weighted Average	First In, First Out (FIFO)	Last In, First Out (LIFO)
Cost of Goods Sold	Average between prices	Lower in rising prices	Higher in rising prices
Ending Inventory Value	Medium	Highest value	Lowest value
Implementation	Simple and direct	Requires precise date tracking	Complex in application
Inflation Impact	Moderate	Shows higher profits	Shows lower profits
Stability	Relatively stable	Fluctuates with prices	Fluctuates inversely
Required Records	Less complex	Detailed and precise	Very complex
Accounting Acceptance	Internationally accepted	Internationally accepted	Limited use

Relative Advantages: Weighted average provides balance between simplicity and fairness, while FIFO is more realistic for goods flow, and LIFO reduces taxes during inflation periods.