Retail POS offers two methods for tracking inventory costs: average cost and first in, first out (FIFO). While FIFO tracks the cost of each unit, the average cost method calculates the cost of goods sold (COGS) with a single rolling average. Understanding average cost and how it’s calculated can help you manage inventory and troubleshoot issues.
Understanding average cost calculations
The way average cost is calculated is based on an item’s current inventory level, which includes quantity on hand (QOH), reserved, and in-transit units.
When an inventory movement occurs, the average cost is updated using this formula:
{new average cost} = ({current inventory level} x {current average cost} + {change in quantity} x {cost of new units}) ÷ ({current inventory level} + {change in
quantity})
Only some kinds of inventory movements cause the average cost of an item to change:
- Interactions with vendors, like receiving units on a purchase order or sending vendor returns. Retail POS treats items created during a sale and manual adjustments like vendor interactions.
- Actions combining existing inventory, like building or breaking assemblies and boxes.
- Actions that create inventory, like unreferenced refunds, over-counting inventory, or units auto-received through a sale may cause average cost to be recalculated, if your cost control settings are set to Default cost.
Other inventory movements, like sales, don’t change the average cost. The value of inventory will still be deducted based on the current average cost of the units sold.
Total value of inventory
When using the average cost method, the total value of inventory is calculated by multiplying your current total inventory, which includes QOH and any reservations, by the current average cost. If you have negative inventory, the sum cost of negative inventory units will be subtracted from the total.
Calculating average cost with negative inventory
When the inventory level of an item is zero or negative, its average cost freezes. This value is the last known cost, which Retail POS uses for estimates, cost control, and pricing purposes. When new units are received, the average cost is reset to the cost of those units.
Negative inventory:
- Doesn’t change the average cost of an item.
- Recorded at a fixed cost based on your account’s cost control settings.
- Subtracted from an item’s value of inventory.
If the average cost of an item changes as inventory is received, this doesn’t affect the cost of any remaining negative inventory or its impact on the value of inventory.
An item can have both reserved/in-transit units and negative QOH at the same time. In these cases:
- Average cost still reflects the cost of reserved/in-transit units.
- The inventory’s total value will reflect the reserved/in-transit units at the current average cost, minus the fixed cost of the negative inventory.
Reviewing an item’s average cost adjustment history
You can review which inventory movements caused the average to change in an item’s inventory history:
- Navigate to Inventory > Item search.
- Locate the item using the search features.
- Click History.
- In the Inventory Movement Logs table, check the ∆ Avg Cost (change in average cost) and the ∆ Value (change in total value of inventory) columns. These columns display when values changed, and by how much.
If the average cost is higher or lower than expected, this can help identify the cause. Inventory movements made with data entry errors, like an incorrect cost or quantity, can cause unexpected average costs.
The average cost of an item is shared across all locations, so it may be necessary to use the location filter to identify which inventory movement caused an unexpected change.
Correcting inventory movements
To correct an inventory movement with errors:
- If possible, reverse the original inventory movement by processing a void, returning a transfer, or reopening a vendor return.
- Manually edit the inventory lots created by the action.
- Manually remove all current inventory lots, then re-add them with the corrected costs/quantities.
Average cost is not an average of the costs of units remaining in inventory lots. Inventory lots are primarily used with the FIFO accounting method. You may see some inventory lots information in Retail POS, as both accounting methods are supported in the platform. These values should not be confused with the actual inventory metrics for average cost tracking.
For example, the Inventory Lots table in an item’s Inventory should be only considered a history of recent receptions, not a breakdown of current costs.
What's next?
Editing unit cost, average cost and FIFO cost
Edit the cost of inventory items to ensure accurate reporting.
Learn moreUnderstanding the Negative inventory report
Run a report to identify the reasons for negative inventory adjustments.
Learn more