Understanding Average Cost Variance - An Oracle White Paper

Purpose: Under average cost systems, the unit cost of an item is the average value of all receipts of that item to inventory, on a per unit basis. Each receipt of material to inventory updates the unit cost of the item received. Issues from inventory use the current average cost as the unit cost. By using Oracle Cost Management’s average costing method, inventory can be perpetually valued at an average cost, weighted by quantity (inventory cost = average unit cost * quantity).

For purchased items, this is a weighted average of the actual procurement cost of an item. In an average cost environment, all items in inventory are valued at their procurement cost, i.e. PO cost. This valuation methodology results in a unit cost for each item, which is a weighted average of the purchase order unit costs for all quantity on hand. Average cost variances are generated if you issue additional material even though the inventory balances for that material is negative. Inventory balances can be driven negative if the Allow Negative Balances parameter is set in the Organization Parameters window in Oracle Inventory. If negative quantities are allowed, when a receipt (or transfer in) transaction occurs for an item with negative on–hand inventory, the transaction is valued at the current average unit cost or at the normal transaction cost.

This behavior of Average Costing method has been explained by carrying out miscellaneous transactions of a buy item. 7 scenarios have been covered using various possible combinations of onhand quantity, transaction quantity, average cost and transaction cost.

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This paper has been authored keeping in view an audience familiar with Oracle Cost Management in general and Average Costing method in particular. An attempt has been made to explain the functionality of Cost Variance in Average Costing method when the onhand quantity of an item is driven negative along with the inventory valuation of the item. Later the onhand quantity of the same item is driven positive and the functionality explained. The functionality of Average Cost Variance has been explained in detail based on these scenarios.

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Search Words: Recalculation, Material Transaction Distributions, Cost Variance Account, Item Cost History