The Simple Average Price Method is a material pricing technique used in cost accounting to issue materials from stores. Under this method, the issue price of materials is calculated by taking the average of different purchase prices of materials available, without considering the quantity purchased at each price. For example, if a company buys the same material at ₹10, ₹12, and ₹14 per unit, the issue price will be the simple average i.e., (10+12+14) ÷ 3 = ₹12 per unit. This method is simple to apply and avoids wide fluctuations in issue prices. However, it may not reflect the actual cost of materials consumed since quantities are ignored, making it less accurate in cases of large price variations.
Simple Average Price Method Formula:
Explanation:
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This formula calculates the average of the purchase prices of materials, ignoring the quantities purchased.
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Each purchase price is given equal weight, regardless of whether the quantity bought is large or small.
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The derived average price is then used as the issue price for materials consumed in production.
Features of Simple Average Method:
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Equal Weightage to Prices
In the Simple Average Method, each purchase price is given equal importance irrespective of the quantity bought. For instance, whether 100 units are purchased at ₹10 or 10 units at ₹12, both prices are treated equally. This ensures an uncomplicated approach to pricing but ignores purchase volumes. As a result, the issue price may not represent the true weighted cost, yet the method remains convenient and widely applicable in businesses with minimal price fluctuations.
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Ease of Calculation
The method is straightforward and easy to apply since it involves adding the prices of all purchase lots and dividing by the number of lots. No advanced calculations or complex records are required, making it time-saving for accountants. This feature is particularly useful for small businesses or firms dealing with limited purchase variations. Its simplicity reduces clerical workload, though it may sometimes compromise accuracy if the quantities purchased vary significantly across different lots.
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Stability in issue Prices
The Simple Average Method helps in maintaining some degree of stability in the issue prices of materials. Since the average of purchase prices is considered, sudden fluctuations in market prices are smoothed out to some extent. This prevents large variations in material cost allocation to production. However, when there is a wide range of price differences, the averaging may not provide a realistic cost, leading to under- or overvaluation in certain situations.
Advantages of Simple Average Method:
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Simplicity and Easy Calculation
The biggest advantage of the Simple Average Method is its simplicity. The method requires only the addition of different purchase prices and dividing by the number of price quotations, without considering the quantity purchased. This makes it very easy to understand and apply, even for small organizations with limited accounting staff. It avoids complex computations like weighted averages or perpetual inventory tracking. As a result, businesses with low transaction volumes or stable purchase patterns can save time, reduce clerical effort, and maintain smooth material costing procedures without investing in advanced systems or specialized cost accountants.
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Avoids Extreme Price Influence
The Simple Average Method helps avoid the influence of extreme price fluctuations by averaging the prices equally. Unlike methods such as FIFO or LIFO, where the latest or earliest prices directly affect material cost, this method balances the issue price between high and low purchase costs. This ensures that neither unusually high nor unusually low prices dominate cost allocation. For organizations experiencing occasional market price spikes or discounts, the method provides a fair compromise. Thus, it stabilizes material issue pricing, making production cost estimation more consistent and preventing sudden distortions in profitability due to irregular purchase prices.
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Useful for Stable Price Situations
This method is particularly beneficial in industries or situations where material prices do not fluctuate drastically and purchases are made in relatively small, frequent lots. In such cases, the average price closely reflects actual costs, ensuring that inventory valuation and cost allocation remain realistic. For example, if raw material prices vary only slightly, the Simple Average Method provides results almost identical to weighted averages. Therefore, it saves effort while still maintaining reasonable accuracy. It is a practical method for businesses operating in stable markets, offering efficiency without compromising much on cost control effectiveness.
Challenges of Simple Average Method:
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Ignores Quantity Purchased
A major challenge is that the method does not consider the quantity of materials purchased at different prices. For example, if 1,000 units are purchased at ₹10 and 50 units at ₹15, both prices are treated equally when calculating the average. This leads to an issue price that does not reflect the actual weighted cost. As a result, material costs may be understated or overstated, affecting the accuracy of production costing and profitability analysis in organizations with frequent bulk purchases.
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Unrealistic Issue Price
Since equal importance is given to all purchase prices, the calculated average may not represent the true economic cost of materials. In cases where purchase prices fluctuate significantly, the issue price may turn out either higher or lower than the actual purchase cost. This could distort cost of goods sold and inventory valuation. Therefore, businesses with volatile market conditions find it difficult to rely on this method, as it can mislead management decision-making and financial performance measurement.
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Not Suitable for Frequent Price Changes
When material prices change frequently, the Simple Average Method becomes less effective. Averaging prices without considering purchase volumes fails to account for market volatility. For instance, if frequent small purchases are made at higher rates, they may disproportionately affect the average issue price. This causes discrepancies in cost allocation, leading to inaccurate budgetary control and variance analysis. In dynamic industries where price changes are common, the method provides unreliable results and is unsuitable for accurate cost accounting.
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