Accounting
Costing you can defend in a meeting
If you cannot explain how an item cost was calculated, you cannot defend the margin that depends on it. What moving average actually does, and where it goes wrong.
The Rocket ERP team
Rocket ERP3 min read
Every margin figure in your business rests on one number per item: what that item cost. If the method producing it cannot be explained in two sentences, every report built on it is an assertion rather than a measurement.
What a moving average cost actually is
The idea is simple. The item has a quantity on hand and a total value. A receipt adds its quantity and its value, and the cost per unit becomes the new total value divided by the new total quantity. An issue takes out quantity at the current average, which leaves the average unchanged.
So the cost of an item changes when goods come in, never when goods go out. That single sentence resolves most arguments about costing, because it tells you where to look: if a cost changed and nothing was received, something edited history.
Where it goes wrong, in order of frequency
Costs that arrive after the goods. Freight, customs and clearing invoiced separately, weeks later. If they are booked as expenses rather than added to the item value, the cost is understated and the margin is overstated, permanently.
An invoice edited after posting. The receipt that set the average is changed, so the average changes retroactively while the entries it produced do not.
Negative stock. An average cost over a negative quantity is not meaningful. Once it happens, every subsequent calculation inherits the distortion.
Returns at the wrong cost. A customer return should come back at the cost it left at, not at today average. Booking it at today average quietly moves value between periods.
The rounding question nobody asks until it bites
Cost per unit is a division, and divisions do not come out even. Over thousands of movements, rounding at two decimal places accumulates into a visible difference between the sum of the lines and the balance of the account.
The practical answer is to hold cost at more decimal places than you display, and to compare quantities with a tolerance rather than an exact test. A quantity of 0.0000001 is zero for every business purpose, but a strict comparison treats it as stock on hand - and will refuse a sale, or report a balance, on the strength of a rounding artefact.
What to check in your own data this week
List any item with a negative quantity at any point in the last year. Each one is a costing distortion with a date.
Find the freight and clearing accounts in the ledger. If they carry a balance that never clears, those costs are not reaching item cost.
Pick your three highest-value items and read their movement history. You should be able to follow every change in cost to a receipt. If you cannot, note which change you cannot explain.
The aim is not a perfect number. It is a number whose derivation you can show, to an auditor or to a partner, without rebuilding it in a spreadsheet first.