Under the moving average inventory method, you re-calculate the average cost of each inventory item in stock after every inventory purchase. The calculation is the total cost of the items purchased divided by the number of items in stock. The cost of ending inventory and the cost of goods sold are then set at this average cost.
Since the moving average cost changes whenever there is a new purchase, the method can only be used with a perpetual inventory tracking system; such a system keeps up-to-date records of inventory balances. You cannot use the moving average inventory method if you are only using a periodic inventory system, since such a system only accumulates information at the end of each accounting period, and does not maintain records at the individual unit level.
The moving average method tends to yield inventory valuations and cost of goods sold results that are in-between those derived under the first in, first out (FIFO) method and the last in, first out (LIFO) method. Also, when inventory valuations are derived using a computer system, the computer makes it relatively easy to continually adjust inventory valuations with this method. Conversely, it can be quite difficult to use the moving average method when inventory records are being maintained manually, since the clerical staff would be overwhelmed by the volume of required calculations.