In accounting, costing methods control how the company accounts for the expenses needed to produce products or services. This does not actually control the prices of the products or the costs necessary to make the products, but it does control how the expenses appear on company books. The simple average cost method combines various categories of product costs and then divides them out among the units produced to create an average cost marker. While easy to use, this method does have its downsides.
The primary problem with the simple average method is that it is an average, and sometimes manufacturing does not progress smoothly enough to allow for such averages. If every batch has the same number of units or at least close, then costs per unit will be fairly accurate. But if the number of units per lot or batch varies widely, then costs assigned to each product will vary the same way, creating inaccurate and inappropriate cost values.
Vague Cost Management
When using the average method, costs must be lumped together into a general pool before being divided out across units. This makes it very difficult for cost managers to assign and follow the costs of a particular part or material all the way through the production process -- the accounting method gets in the way. As a result, highly accurate cost management is more difficult to accomplish and can take extra time in order to work out.
Some manufacturers try to circumvent the problems associated with the average method by creating a weighted average, which tips the scale more on some factors than others. In theory, this allows the business to focus on the most important costs and it can be a useful tool, but the company must still decide what factors to weight. If the business decides to weight the wrong costs, then the figures will not give an accurate representation of costs.
Work in Process Inventory Costs
Work in process inventory costs is a special cost entry used to describe manufactured items that have not yet been completed. In the average method, the work in process figures are not kept separate. Instead, they are pooled with material costs and then divided out. This can create confusion and makes it difficult to track work in process effectively for company records.