The Simple Moving Average method is used to calculate average cost and average cost per warehouse. If you use this method, a standard cost inventory item can generate a negative average cost if the actual item cost varies significantly from the standard cost.
A negative average cost or negative warehouse average cost should alert you of the possibility that the standard cost is not reflective of the actual costs. You should consider changing to another inventory costing method that more closely matches the characteristics of the inventory item or updating the item's standard cost to reflect current market costs.
The calculation of the average cost during a receipt update for a standard cost item is:
(total cost of the warehouse quantity on hand + total cost of the quantity to be received) / (total warehouse quantity on hand + total quantity to be received)
Note The total value and average cost amounts reflect the actual receipt costs. They do not reflect the value of the item in inventory or the general ledger postings. These are represented by the quantity on hand multiplied by the standard cost.
Example
The simple moving average cost for a standard cost item is calculated as follows:
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