Periodic Average Cost Method

The periodic average cost method values inventory by including all the period expenses, invoices, and other adjustments that are known only at the end of the period. It helps you to value the inventory on a periodic basis.

The principal objectives of the periodic average cost method are:

Capture actual acquisition costs based on supplier invoiced amounts plus other direct procurement charges required by national legislation or company policy.
Capture actual transaction costs using fully absorbed resource and overhead rates.
Average the inventory costs over a prescribed period, rather than on a transactional basis.

Some of the key benefits of using the periodic average cost method include:

Address regulatory and organization requirements to support full absorption costing.
Helps to smooth the impact of significant price changes within a period, due to currency or other external factors.

Unlike the other cost methods, a cost book must be enabled for periodic average cost for the cost processor to calculate and use the periodic average cost for all the items associated with the cost book.

The periodic average cost of an item is the average cost for the item in a given period for a cost organization, cost book, and valuation unit combination. This is the formula to calculate the periodic average cost:

Periodic Average Cost = [(prior period average cost * prior period ending balance) + SUM (transaction cost * transaction quantity) + overheads + adjustments] / (prior period ending balance + transaction quantity for this period)

Let’s take a simple example to understand this cost calculation. The inventory at the end of March for the item AS1000 is listed in this table. Here, cost is the calculated periodic average cost of AS1000 for the month of March.

Item	Quantity	Cost	Value
AS1000	50	$10.00	$500.00

For the month of April, the receipt transactions for this item are listed in this table.

Transaction	Quantity	Cost	Value
T1	50	$10.00	$500.00
T5	100	$9.95	$995.00
T9	50	$10.10	$505.00

Also, for the month of April, you had an adjustment of $25.00 and no overheads. Based on this, let’s calculate the periodic average cost for the month of April.

Prior period average cost = $10.00

Prior period ending balance = 50

Adjustment = $25.00

Total receipt quantity for April = 200

Periodic Average Cost = {(10*50) + [(10*50) + (9.95*100) + (10.10*50)] + 25}/(50+200)

Periodic Average Cost = {(500) + [(500) + (995) + (505)] + 25}/250

Periodic Average Cost = {2525}/250 = 10.10

So, the periodic average cost for AS1000 for the month of April in $10.10. After this cost is calculated, the same would be used to cost all the cost derived transactions for that period.

When using the periodic average cost method, for a cost organization and cost book combination, all receipts are processed at the actual receipt costs. However, the issues are costed with a single cost that is the periodic average cost, which is calculated as a single composite cost of all the cost owned transactions.

Here are a few terms that you must understand before you start using the periodic average cost method:

Cost owned transactions: Transactions where the costs are defined. The transaction cost for such transactions are included when calculating the periodic average cost. Cost owned transactions include:
- Purchase order receipts
- All kinds of adjustments
- WIP completion / returns transactions
- Resource or overhead transactions
- Reversal of resource charges
- RMA referenced to original sales order
- Return to vendor
- Miscellaneous receipt and issue transactions with a cost
- Inter-organization transfers that cross valuation unit
- Intransit transfers (within and across valuation units)
Note: For inter-organization transfers that cross valuation unit and intransit transfers the prior period average cost is used.
Cost derived transactions: Transactions that are costed using the calculated periodic average cost. Cost derived transactions include:
- Miscellaneous transactions without cost
- Negative material issue
- Component issues to WIP
- Component returns from WIP
- All direct transfers within the same valuation unit
- RMA not referenced to the original sales order, or RMA within the same period
Prior period average cost: This is the final periodic average cost calculated for the prior period, when that period was closed. The prior period average cost can also be an adjustment that you enter to override an existing cost. There are scenarios where a prior period cost might not be available:
- The first opened period for a cost book.
- A new item is transacted and there aren’t any transactions for this item in the prior periods.
You need to create an opening balance in these scenarios, else the prior period cost is set to 0. You can enter a prior period cost by creating an opening cost override.
Prior period ending balance: The inventory balance at the end of the prior period, if available. This can also be considered as the opening balance at the start of a new period. If an item is being transacted for the first time, then the prior period ending balance will be 0.

To ensure that items have a cost at most times, the periodic average cost for an item is carried forward from one period to next period even if the on-hand quantity in those periods is 0.

For example, the item AS2000 was received in January and completely depleted in February. The periodic average cost for this item is carried forward to March. This ensures that the item has a cost when transacted in a future period.

Period	Period End Quantity	Periodic Average Cost
January	100	$10.00
February	0	$10.00
March	0	$10.00

Let's look at how this periodic average cost would be used in a future period.

If there is only one receipt (R1) for AS2000 in April for 10 units without any cost specified and there aren’t any other cost owned transactions for this item, then the receipt will be costed at $10.

If there is another receipt which is cost owned (R2) for 10 units at $15 in April, then receipt R1 will be costed at $15.