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documentation/content/applications/finance/accounting/get_started/avg_price_valuation.rst
Felicious c7531dd242 [IMP] inventory: landed cost conditions 
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===============================
Average price on returned goods
===============================
.. |AVCO| replace:: :abbr:`AVCO (Average Cost Valuation)`
.. _inventory/avg_cost/definition:
*Average cost valuation* (AVCO) is an inventory valuation method that evaluates cost based on the
total cost of goods bought or produced during a period, divided by the total number of items
on-hand. Inventory valuation is used to:
- reflect the value of a company's assets;
- keep track of the amount of unsold goods;
- account for monetary value in goods that have yet to generate profit;
- report on flow of goods throughout the quarter.
Because |AVCO| uses the weighted average to evaluate the cost, it is a good fit for companies that
sell only a few different products in large quantities. In Odoo, this costing analysis is
*automatically updated* each time products are received.
Thus, when shipments are returned to their supplier, Odoo automatically generates accounting entries
to reflect the change in inventory valuation. However, Odoo does **not** automatically update the
|AVCO| calculation, because :ref:`this can potentially create inconsistencies with inventory
valuation <inventory/avg_price/leaving_inventory>`.
.. note::
This document addresses a specific use case for theoretical purposes. For instructions on how to
set up and use |AVCO|, refer to the :doc:`inventory valuation configuration
<../../../inventory_and_mrp/inventory/product_management/inventory_valuation/inventory_valuation_config>`
doc.
.. seealso::
- :doc:`Using inventory valuation
<../../../inventory_and_mrp/inventory/product_management/inventory_valuation/using_inventory_valuation>`
- :ref:`Other inventory valuation methods <inventory/warehouses_storage/costing_methods>`
Configuration
=============
To use average cost inventory valuation on a product, navigate to :menuselection:`Inventory -->
Configuration --> Product Categories` and select the category that will be using |AVCO|. On the
product category page, set :guilabel:`Costing Method` to `Average Cost (AVCO)` and
:guilabel:`Inventory Valuation` to `Automated`.
.. seealso::
:doc:`Inventory valuation configuration
<../../../inventory_and_mrp/inventory/product_management/inventory_valuation/inventory_valuation_config>`
Using average cost valuation
============================
The average cost method adjusts the inventory valuation when products are received in the warehouse.
This section explains how it works, but if the explanation is unnecessary, skip to the :ref:`return
to supplier use case <inventory/avg_cost/return>` section.
.. _inventory/avg_cost/formula:
Formula
-------
When new products arrive, the new average cost for each product is recomputed using the formula:
.. math::
Avg~Cost = \frac{(Old~Qty \times Old~Avg~Cost) + (Incoming~Qty \times Purchase~Price)}{Final~Qty}
- **Old Qty**: product count in stock before receiving the new shipment;
- **Old Avg Cost**: calculated average cost for a single product from the previous inventory
valuation;
- **Incoming Qty**: count of products arriving in the new shipment;
- **Purchase Price**: estimated price of products at the reception of products (since vendor bills
may arrive later). The amount includes not only the price for the products, but also added costs,
such as shipping, taxes, and :doc:`landed costs
<../../../inventory_and_mrp/inventory/product_management/inventory_valuation/landed_costs>`. At
reception of the vendor bill, this price is adjusted;
- **Final Qty**: quantity of on-hand stock after the stock move.
.. _inventory/avg_cost/definite_rule:
.. important::
When products leave the warehouse, the average cost **does not** change. Read about why the
average cost valuation is **not** adjusted :ref:`here <inventory/avg_price/leaving_inventory>`.
.. _inventory/avg_cost/math_table:
Compute average cost
--------------------
To understand how the average cost of a product changes with each shipment, consider the following
table of warehouse operations and stock moves. Each is a different example of how the average cost
valuation is affected.
+--------------------------------+---------------+-------------------+---------------+------------+
| Operation | Incoming Value| Inventory Value | Qty On Hand | Avg Cost |
+================================+===============+===================+===============+============+
| | | $0 | 0 | $0 |
+--------------------------------+---------------+-------------------+---------------+------------+
| Receive 8 tables at $10/unit | 8 * $10 | $80 | 8 | $10 |
+--------------------------------+---------------+-------------------+---------------+------------+
| Receive 4 tables at $16/unit | 4 * $16 | $144 | 12 | $12 |
+--------------------------------+---------------+-------------------+---------------+------------+
| Deliver 10 tables | -10 * $12 | $24 | 2 | $12 |
+--------------------------------+---------------+-------------------+---------------+------------+
.. _inventory/avg_cost/ex-1:
.. exercise::
Ensure comprehension of the above computations by reviewing the "Receive 8 tables at $10/unit"
example.
Initially, the product stock is 0, so all values are $0.
In the first warehouse operation, `8` tables are received at `$10` each. The average cost is
calculated using the :ref:`formula <inventory/avg_cost/formula>`:
.. math::
Avg~Cost = \frac{0 + 8 \times $10}{8} = \frac{$80}{8} = $10
- Since the *incoming quantity* of tables is `8` and the *purchase price* for each is `$10`,
- The inventory value in the numerator is evaluated to `$80`;
- `$80` is divided by the total amount of tables to store, `8`;
- `$10` is the average cost of a single table from the first shipment.
To verify this in Odoo, in the *Purchase* app, order `8` quantities of a new product, `Table`,
with no previous stock moves, for `$10` each.
In the table's :guilabel:`Product Category` field in the :guilabel:`General Information` tab of
the product form, click the :guilabel:`➡️ (arrow)` icon, to open an :guilabel:`External Link` to
edit the product category. Set the :guilabel:`Costing Method` to `Average Cost (AVCO)` and
:guilabel:`Inventory Valuation` to `Automated`.
Then, return to the purchase order. Click :guilabel:`Confirm Order`, and click :guilabel:`Receive
Products` to confirm receipt.
Next, check the inventory valuation record generated by the product reception by navigating to
:menuselection:`Inventory --> Reporting --> Inventory Valuation`. Select the drop-down for
`Table`, and view the :guilabel:`Total Value` column for the *valuation layer* (:dfn:`inventory
valuation at a specific point in time = on-hand quantity * unit price`). The 8 tables in-stock
are worth $80.
.. image:: avg_price_valuation/inventory-val-8-tables.png
:align: center
:alt: Show inventory valuation of 8 tables in Odoo.
.. tip::
When the product category's :guilabel:`Costing Method` is set to :guilabel:`AVCO`, then the
average cost of a product is also displayed on the :guilabel:`Cost` field, under the
:guilabel:`General Information` tab, on the product page itself.
Product delivery (use case)
~~~~~~~~~~~~~~~~~~~~~~~~~~~
For outgoing shipments, :ref:`outbound products have no effect on the average cost valuation
<inventory/avg_cost/definite_rule>`. Although the average cost valuation is not recalculated, the
inventory value still decreases because the product is removed from stock and delivered to the
customer location.
.. exercise::
To demonstrate that the average cost valuation is not recalculated, examine the "Deliver 10
tables" example.
.. math::
Avg~Cost = \frac{12 \times $12 + (-10) \times $12}{12-10} = \frac{24}{2} = $12
#. Because 10 tables are being sent out to customers, the *incoming quantity* is `-10`. The
previous average cost (`$12`) is used in lieu of a vendor's *purchase price*;
#. The *incoming inventory value* is `-10 * $12 = -$120`;
#. The old *inventory value* (`$144`) is added to the *incoming inventory value* (`-$120`), so
`$144 + -$120 = $24`;
#. Only `2` tables remain after shipping out `10` tables from `12`. So the current *inventory
value* (`$24`) is divided by the on-hand quantity (`2`);
#. `$24 / 2 = $12`, which is the same average cost as the previous operation.
To verify this in Odoo, sell `10` tables in the *Sales* app, validate the delivery, and then
review the inventory valuation record by going to in :menuselection:`Inventory --> Reporting -->
Inventory Valuation`. In the topmost valuation layer, delivering `10` tables reduces the
product's value by `-$120`.
**Note**: What is not represented in this stock valuation record is the revenue made from this
sale, so this decrease is not a loss to the company.
.. image:: avg_price_valuation/inventory-val-send-10-tables.png
:align: center
:alt: Show how deliveries decrease inventory valuation.
.. _inventory/avg_cost/return:
Return items to supplier (use case)
===================================
Because the price paid to suppliers can differ from the price the product is valued at with the
|AVCO| method, Odoo handles returned items in a specific way.
#. Products are returned to suppliers at the original purchase price, but;
#. The internal cost valuation remains unchanged.
The above :ref:`example table <inventory/avg_cost/math_table>` is updated as follows:
+--------------------------------+---------------+-------------------+---------------+------------+
| Operation | Qty*Avg Cost | Inventory Value | Qty On Hand | Avg Cost |
+================================+===============+===================+===============+============+
| | | $24 | 2 | $12 |
+--------------------------------+---------------+-------------------+---------------+------------+
| Return 1 table bought at $10 | -1 * $12 | $12 | 1 | $12 |
+--------------------------------+---------------+-------------------+---------------+------------+
In other words, returns to vendors are perceived by Odoo as another form of a product exiting the
warehouse. To Odoo, because the table is valued at $12 per unit, the inventory value is reduced by
`$12` when the product is returned; the initial purchase price of `$10` is unrelated to the table's
average cost.
.. example::
To return a single table that was purchased for `$10`, navigate to the receipt in the *Inventory*
app for the :ref:`8 tables purchased in Exercise 1 <inventory/avg_cost/ex-1>` by going to the
:guilabel:`Inventory Overview`, clicking on :guilabel:`Receipts`, and selecting the desired
receipt.
Then, click :guilabel:`Return` on the validated delivery order, and modify the quantity to `1` in
the reverse transfer window. This creates an outgoing shipment for the table. Select
:guilabel:`Validate` to confirm the outgoing shipment.
Return to :menuselection:`Inventory --> Reporting --> Inventory Valuation` to see how the
outgoing shipment decreases the inventory value by $12.
.. image:: avg_price_valuation/inventory-valuation-return.png
:align: center
:alt: Inventory valuation for return.
.. _inventory/avg_price/leaving_inventory:
Eliminate stock valuation errors in outgoing products
-----------------------------------------------------
Inconsistencies can occur in a company's inventory when the average cost valuation is recalculated
on outgoing shipments.
To demonstrate this error, the table below displays a scenario in which 1 table is shipped to a
customer and another is returned to a supplier at the purchased price.
+------------------------------------------+---------------+-------------------+---------------+------------+
| Operation | Qty*Price | Inventory Value | Qty On Hand | Avg Cost |
+==========================================+===============+===================+===============+============+
| | | $24 | 2 | $12 |
+------------------------------------------+---------------+-------------------+---------------+------------+
| Ship 1 product to customer | -1 \* $12 | $12 | 1 | $12 |
+------------------------------------------+---------------+-------------------+---------------+------------+
| Return 1 product initially bought at $10 | -1 \* $10 | **$2** | **0** | $12 |
+------------------------------------------+---------------+-------------------+---------------+------------+
In the final operation above, the final inventory valuation for the table is `$2` even though there
are `0` tables left in stock.
.. admonition:: Correct method
Use the average cost to value the return. This does not mean the company gets $12 back for a $10
purchase; the item returned for $10 is valued internally at $12. The inventory value change
represents a product worth $12 no longer being accounted for in company assets.
Anglo-Saxon accounting
======================
In addition to using |AVCO|, companies that use **Anglo-Saxon accounting** also keep a holding
account that tracks the amount to be paid to vendors. Once a vendor delivers an order, **inventory
value** increases based on the vendor price of the products that have entered the stock. The holding
account (called **stock input**) is credited and only reconciled once the vendor bill is received.
.. seealso::
- :ref:`Anglo-Saxon vs. Continental <inventory/warehouses_storage/accounting-types>`
The table below reflects journal entries and accounts. The *stock input* account stores the money
intended to pay vendors when the vendor bill has not yet been received. To balance accounts when
returning products that have a price difference between the price the product is **valued at** and
the price it was bought for, a *price difference* account is created.
.. _inventory/avg_price/price-table:
+-----------------------------------------+---------------+--------------+-------------------+---------------+------------+
| Operation | Stock Input | Price Diff | Inventory Value | Qty On Hand | Avg Cost |
+=========================================+===============+==============+===================+===============+============+
| | | | $0 | 0 | $0 |
+-----------------------------------------+---------------+--------------+-------------------+---------------+------------+
| Receive 8 tables at $10 | ($80) | | $80 | 8 | $10 |
+-----------------------------------------+---------------+--------------+-------------------+---------------+------------+
| Receive vendor bill $80 | $0 | | $80 | 8 | $10 |
+-----------------------------------------+---------------+--------------+-------------------+---------------+------------+
| Receive 4 tables at $16 | ($64) | | $144 | 12 | $12 |
+-----------------------------------------+---------------+--------------+-------------------+---------------+------------+
| Receive vendor bill $64 | $0 | | $144 | 12 | $12 |
+-----------------------------------------+---------------+--------------+-------------------+---------------+------------+
| Deliver 10 tables to customer | $0 | | $24 | 2 | $12 |
+-----------------------------------------+---------------+--------------+-------------------+---------------+------------+
| Return 1 table initially bought at $10 | **$10** | **$2** | **$12** | 1 | $12 |
+-----------------------------------------+---------------+--------------+-------------------+---------------+------------+
| Receive vendor refund $10 | $0 | $2 | $12 | 1 | $12 |
+-----------------------------------------+---------------+--------------+-------------------+---------------+------------+
Product reception
-----------------
Summary
~~~~~~~
At product reception, Odoo ensures companies can pay for goods that were purchased by preemptively
moving an amount matching the price of received goods into the :doc:`liability account
</applications/finance/accounting/get_started/cheat_sheet>`, **Stock Input**. Then, once the bill
has been received, the amount in the holding account is transferred to *Accounts Payable*. Transfers
into this account means the bill has been paid. **Stock Input** is reconciled once the vendor bill
is received.
Inventory valuation is a method of calculating how much each in-stock product is worth internally.
Since there is a difference between the price the product is **valuated at** and the price the
product was actually **purchased for**, the **Inventory Valuation** account is unrelated to the
crediting and debiting operations of the **Stock Input** account.
To conceptualize all this, follow the breakdown below.
Accounts balanced at received products
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
In this example, a company starts with zero units of a product, `table`, in stock. Then, 8 tables
are received from the vendor:
#. The **Stock Input** account stores `$80` of credit owed to the vendor. The amount in this account
is unrelated to the inventory value.
#. `$80` worth of tables came **in** (**debit** the *Inventory Value* account `$80`), and
#. `$80` must be paid **out** for received goods (**credit** the *Stock Input* account `$80`).
In Odoo
*******
Odoo generates an accounting journal entry when shipments that use |AVCO| costing method are
received. Configure a :guilabel:`Price Difference Account` by selecting the :guilabel:`➡️ (arrow)`
icon next to the :guilabel:`Product Category` field on the product page.
Under :guilabel:`Account Properties`, create a new :guilabel:`Price Difference Account` by typing in
the name of the account and clicking :guilabel:`Create and Edit`. Then set the account
:guilabel:`Type` as `Expenses`, and click :guilabel:`Save`.
.. image:: avg_price_valuation/create-price-difference.png
:align: center
:alt: Create price difference account.
Then, receive the shipment in the *Purchase* app or *Inventory* app, and navigate to the
:menuselection:`Accounting app --> Accounting --> Journal Entries`. In the list, find the
:guilabel:`Reference` that matches the warehouse reception operation for the relevant product.
.. image:: avg_price_valuation/search-for-entry-of-tables.png
:align: center
:alt: Show accounting entry of 8 tables from the list.
Click on the line for 8 tables. This accounting journal entry shows that when the 8 tables were
received, the `Stock Valuation` account increased by `$80`. Conversely, the **Stock Input** account
(set as `Stock Interim (Received)` account by default) is credited `$80`.
.. image:: avg_price_valuation/accounting-entry-8-tables.png
:align: center
:alt: Debit stock valuation and credit stock input 80 dollars.
Accounts balanced at received vendor bill
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
In this example, a company starts with zero units of a product, table, in stock. Then, 8 tables are
received from the vendor. When the bill is received from vendor for 8 tables:
#. Use `$80` in the **Stock Input** account to pay the bill. This cancels out and the account now
holds `$0`.
#. Debit **Stock Input** `$80` (to reconcile this account).
#. Credit **Accounts payable** `$80`. This account stores the amount the company owes others, so
accountants use the amount to write checks to vendors.
In Odoo
*******
Once the vendor requests payment, navigate to the :menuselection:`Purchase app --> Orders -->
Purchase` and select the :abbr:`PO (Purchase Order)` for 8 tables. Inside the :abbr:`PO (Purchase
Order)`, select :guilabel:`Create Bill`.
Switch to the :guilabel:`Journal Items` tab to view how `$80` is transferred from the holding
account, `Stock Interim (Received)` to `Accounts Payable`. :guilabel:`Confirm` the bill to record
the payment to the vendor.
.. image:: avg_price_valuation/receive-8-table-bill.png
:align: center
:alt: Show bill linked to the purchase order for 8 tables.
On product delivery
-------------------
In the :ref:`above example table <inventory/avg_price/price-table>`, when 10 products are delivered
to a customer, the **Stock Input** account is untouched because there are no new products coming in.
To put it simply:
#. **Inventory valuation** is credited `$120`. Subtracting from inventory valuation represents
`$120` worth of products exiting the company.
#. Debit **Accounts Receivable** to record revenue from the sale.
.. image:: avg_price_valuation/sell-10-tables.png
:align: center
:alt: Show journal items linked to sale order.
.. spoiler:: Understand Anglo-Saxon expensing
In the accounting journal entry invoicing a customer for 10 tables, the accounts **Product
Sales**, **Tax Received**, and **Accounts Receivable** all pertain to the sale of the product.
**Accounts Receivable** is the account where the customer payment will be received.
Anglo-Saxon accounting recognizes the cost of goods sold (COGS) once the sale is made. So, up
until the product is sold, scrapped, or returned, costs of keeping the product in stock are not
accounted for. The **Expense** account is debited `$120` to log the costs of storing 10 tables
during this period of time.
On product return
-----------------
In the :ref:`above example table <inventory/avg_price/price-table>`, when returning 1 product to a
vendor purchased at `$10`, a company expects `$10` in the **Accounts Payable** account from the
vendor. However, **Stock Input** account must be debited `$12` because the average cost is `$12` at
the time of the return. The missing `$2` is accounted for in the :guilabel:`Price Difference
Account`, which is set up in the product's :guilabel:`Product Category`.
.. note::
Behavior of *price difference accounts* varies from localization. In this case, the account is
intended to store differences between vendor price and *automated* inventory valuation methods.
Summary:
#. Debit **Stock Input** account `$10` to move the table from stock to stock input. This move is to
indicate that the table is to be processed for an outgoing shipment.
#. Debit **Stock Input** an additional `$2` to account for the **Price Difference**.
#. Credit **Stock Valuation** `$12` because the item is leaving the stock.
.. image:: avg_price_valuation/expensing-price-difference-account.png
:align: center
:alt: 2 dollar difference expensed in Price Difference account.
Once the vendor's refund is received,
#. Credit **Stock Input** account `$10` to reconcile the price of the table.
#. Debit **Accounts Payable** `$10` to have the accountants collect and register the payment in
their journal.
.. image:: avg_price_valuation/return-credit-note.png
:align: center
:alt: Return to get 10 dollars back.
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