From a small business accounting perspective, we are trying to determine how best to calculate average cost of inventory.  We are going to use average cost rather than LIFO or FIFO.  With that said, here’s the question.  How should we calculate average cost?  Moving cost average or weighted cost average?  Currently, we are calculating average cost by taking each transaction as a point in time.  For example, let’s assume we have three transactions. 

Transaction A:  3 items at a unit cost of $1/item

Transaction B:  5 items at a unit cost of $1.5/item

Transaction C:  2 items at a unit cost of $2/item

After transaction A, we have an average cost of $1 per item.  After transaction B, we have an average cost calculated as follows:

(3 items * $1/item) + (5 items * $1.5/item)

                                   8 items

That gives us an average cost of $1.3125 per item.  After transaction C,  we have an average cost calculated as follows:

(3 items * $1/item) + (5 items * $1.5/item) + (2 items * $2/item)

                                                    10 items

That gives us an average cost of $1.45 per item after all three transactions.  Is this the correct way to calculate average cost of inventory?