Q. 1 Why is inventory closing performed?
Ans. Inventory closing is performed to reach out to the actual COGS of issued item quantity. This actual COGS make sure the right profit is calculated for the issued quantity. It can be more understanding with the example given in second question of how does weighted average costing method works.
Q.2 How does weighted average costing method works?
The same can be explained with the following data;
When receipt transactions & issue transactions are posted in system, it updates item COGS based on running calculated average cost method.
In the above example, first time item is sold with COGS value of 12. Second time item is sold with COGS value as 10.8. Assuming the total sales value of sold item qty (1+1) = 50, the profit comes as 50 – (12+10.8) = 27.20. Though this profit cannot be justified since same item cost differentiates whenever it is sold.
To reach to the actual COGS, we run inventory costing on a specific interval i.e. monthly, quarterly. The inventory closing is done to get the right COGS based on the costing method defined in the system. In an example where costing method is defined as weighted average cost & considering above mentioned data, system calculates average cost of receipts quantity first;
(D2+D3+D6)/(C2+C3+C6) i.e. (16+20+30)/(1+2+3) i.e. 66/6 = 11
So COGS per item shall be 11.
For sold quantity of 2, posted COGS = 22.8
Recalculated COGS = 22 (11*2)
Inventory adjustment entry will be posted with .8 to rectify the COGS & to reach to the correct sales profit i.e. 50-22 = 28.