Average cost is calculated on FIFO(first in first out) basis of buying and selling. While the total value (Quantity*Avg Cost) is called as holding cost. Let’s understand this calculation by taking an example:
On 1st Sep:
| Date | Buy/Sell | Quantity | Cost | Value |
| 1st Sep | Buy | 150 | Rs. 1000 | Rs. 1,50,000 |
| 2nd Sep | Buy | 50 | Rs. 1100 | Rs. 55,000 |
| 200 | Rs. 1025 | Rs. 2,05,000 |
2nd order: Quantity = 50 | Cost = Rs. 1100
To calculate the average cost, first calculate the value (Quantity x Cost). Hence:
1st trade: Rs. 1,50,000
2nd trade: Rs. 55,000
Total quantity = 200
Total value: Rs. 2,05,000
Divide total value by total quantity:
Rs. 2,05,000 ÷ 200 = Rs.1025 is the average cost
While the holding cost
Now let us see what happens when you add a sell order to this.
On 10th Sep:
Date | Buy/Sell | Quantity | Cost | Value |
| 1st Sep | Buy | 150 | Rs. 1000 | Rs. 1,50,000 |
| 2nd Sep | Buy | 50 | Rs. 1100 | Rs. 55,000 |
| 200 | Rs. 1025 | Rs. 2,05,000 | ||
| 10 Sep | Sell | 100 | Rs. 1200 | Rs. 1,20,000 |
Sell order placed on 10th Sep: 100 (out of 200) at Rs. 1200
Now the FIFO method will be applied here. The method will check the first trade (on the buy-side). In this case, it is 150. 100 will be deducted from 150. The balance left is shown below.
After applying the FIFO method,
Balance: 150 - 100 = 50
Date | Buy/Sell | Quantity | Cost | Value |
| 1st Sep | Buy | 50 | Rs. 1000 | Rs. 50,000 |
| 2nd Sep | Buy | 50 | Rs. 1100 | Rs. 55,000 |
| 100 | Rs. 1050 | Rs. 1,05,000 |
In case the sell quantity was more than 150, then it would have moved to the next trade to deduct the remaining quantity.)
Average cost = Total Price ÷ Total Quantity
i.e. Rs. 1,05,000 ÷ 100 = Rs. 1050 is the new average cost