How to Use NetSuite Average Cost Method for Inventory Valuation

Key Takeaways

• Average costing is NetSuite's default inventory method, dividing total inventory value by total units available
• The costing engine recalculates averages hourly by default, meaning costs don't update instantly after receipts
• Once an item has transaction history, you cannot change its costing method—creating new items is required
• Organizations using proper costing methods can significantly reduce inventory valuation errors, with Group Average Costing maintaining a single average cost across multiple locations
• $0 inventory values are the most common average costing problem, typically caused by inventory adjustments without unit costs

Understanding the Average Cost Method in NetSuite

The average cost method calculates your inventory value using a straightforward formula: total inventory value divided by total quantity on hand. Every time you receive inventory at a different price, NetSuite automatically recalculates this average to reflect the new blended cost.

Here's how it works in practice:

• Starting inventory: 100 units at $10 each \= $1,000 total value
• New receipt: 50 units at $13 each \= $650 added value
• New average: $1,650 ÷ 150 units \= $11 per unit

This moving average calculation applies automatically across all inventory transactions. When you sell items, NetSuite applies the current average cost to calculate COGS, then recalculates the average when new inventory arrives at different prices.

The key advantage is simplicity. Unlike FIFO or specific identification methods that require tracking individual shipments, average costing maintains a rolling weighted cost per item (typically per location with Multi-Location Inventory, unless using Group Average Costing). This eliminates the complexity of tracking which specific units you're selling.

NetSuite's costing engine runs on an hourly schedule by default, recalculating averages and posting COGS across all affected transactions. This means there's a delay between receiving inventory and seeing updated average costs—a detail that surprises many new users.

Why the Average Cost Method Matters for Your Business in NetSuite

Choosing the right costing method directly impacts your financial statements, tax obligations, and operational efficiency. Average costing delivers specific advantages that make it the preferred choice for most businesses using NetSuite.

Financial Statement Accuracy

Average costing provides a balanced inventory valuation that smooths out price fluctuations. When purchase prices vary throughout the year, your COGS and ending inventory values reflect realistic costs rather than artificially high or low figures based on which specific units you happen to sell.

GAAP and Audit Compliance

The method is fully compliant with GAAP standards and provides a clear audit trail. Every cost change is traceable through NetSuite's transaction history and System Notes, giving auditors the documentation they need.

Operational Benefits

• Simplified tracking: No need to identify which specific shipment each sold unit came from
• Real-time cost reflection: Average costs automatically incorporate your most recent purchases
• Reduced labor: Automated costing eliminates tedious manual calculations, freeing up significant time for accounting teams
• Faster month-end close: Organizations with automated costing often report significantly faster month-end close cycles

When Average Costing Works Best

This method is ideal when you:

• Purchase similar items at varying prices from multiple vendors
• Don't need to track specific lots or serial numbers for cost purposes
• Want the simplest ongoing management with automatic calculations
• Need to smooth out price volatility in your financial reporting

Setting Up NetSuite for Average Cost Inventory Valuation

Proper configuration ensures accurate cost calculations from day one. The setup process involves enabling features, configuring preferences, and creating items correctly.

Configuring Item Records for Average Costing

Step 1: Enable Required Features

Look for the option to enable features in your NetSuite account settings. In the Items & Inventory section, verify these options are checked:

• Inventory Management (required for any costing method)
• Multi-Location Inventory (if you need location-specific average costs)
• Group Average Costing (if you want one average across multiple locations)

Step 2: Create Items with Average Costing

For new inventory items:

1. Navigate to your Items list and create a new Inventory Item
2. Look for the Costing Method field in the purchasing or inventory section
3. Select Average (or Group Average if using location costing groups)
4. Complete remaining item fields and save

Critical Warning: NetSuite locks the costing method once an item has any transaction history. If you need to change methods later, you must create a new item and migrate data.

Reviewing Accounting Preferences

Configure system-wide defaults in your Accounting Preferences:

1. Look for the Items/Transactions preferences section
2. Set Default Costing Method to "Average" so new items automatically use this method
3. In your Inventory Costing Preferences, configure:
4. Costing engine schedule (default runs hourly)
5. Verify timezone settings align with your business operations

For multi-location businesses considering Group Average Costing, you can create Location Costing Groups to enable a single average cost across all locations within the group—simplifying inter-location transfers and consolidated reporting.

Managing Inventory Transactions with Average Costing in NetSuite

Every transaction type affects your average cost differently. Understanding these impacts helps you maintain accurate inventory values and avoid common errors.

Recording Purchases and Receipts

Item receipts are the primary driver of average cost calculations. When you receive inventory:

1. The system adds receipt quantity and value to existing totals
2. NetSuite recalculates the new average (during the next costing engine run)
3. The updated average applies to all future sales until the next receipt

Important: The cost on your item receipt drives the average calculation. If the vendor bill arrives later with a different amount, the variance posts to your Accrued Purchases account rather than changing the average cost.

For businesses dealing with freight, duties, and other additional costs, understanding landed cost implementation is essential for accurate total cost tracking.

Processing Sales and Returns

When you fulfill sales orders or process returns:

• Sales: NetSuite applies the current average cost to calculate COGS at the time of fulfillment
• Returns: Returned items re-enter inventory at their original cost (the average at time of sale), which then blends into the current average

The costing engine recalculates COGS if the average cost changes between the sale transaction date and the engine's next run. This means your COGS may adjust slightly after initial posting—normal behavior that ensures accurate period costs.

Handling Inventory Adjustments

Inventory adjustments are where most average costing problems originate. The most common error is creating adjustments without specifying a unit cost.

Best Practices for Adjustments:

• Always enter an Estimated Unit Cost when adding inventory via adjustment
• Use the item's current average cost or last purchase price as your cost basis
• For quantity decreases, the adjustment uses the current average automatically
• Consider implementing required field validation on adjustment forms to prevent $0 cost entries

For wholesale distributors and manufacturers processing high volumes of adjustments, custom forms with mandatory cost fields prevent downstream valuation errors.

Common Challenges and Solutions for Average Cost in NetSuite

Even with proper setup, specific issues commonly arise with average costing. Here's how to identify and resolve them.

$0 Inventory Values

This is the single most common problem with average costing. Inventory shows zero value despite having positive quantities on hand.

Cause: Inventory adjustments created with blank or $0 estimated unit cost fields.

Solution:

1. Create a saved search filtering for Inventory Adjustments with Estimated Unit Cost \= $0 and Adjust Qty By > 0
2. Edit each adjustment to add the correct unit cost (use Last Purchase Price from the item record)
3. Wait for the costing engine to recalculate
4. Implement form validation to require cost entry going forward

Negative Inventory Costing Issues

When inventory goes negative, NetSuite falls back to the last purchase price instead of the average, causing cost discontinuity.

Solution: Review the Negative Inventory page regularly, correct transactions causing negative balances, and consider enabling purchase order requirements to prevent overselling.

Costing Not Updating Immediately

Users often expect instant cost updates after receipts, but costing updates run on a schedule (commonly hourly) based on Inventory Costing Preferences.

Solution: Plan month-end processes around the costing schedule. Ensure all receipts are entered and the costing engine completes before closing the period.

Cannot Change Costing Method

Once an item has transactions, the costing method field is locked.

Solution: Create a new item with the desired costing method, then migrate inventory and historical data. Use item number suffixes (e.g., WIDGET-001-AVG) to track the transition.

Reporting and Analyzing Inventory Valuation with Average Cost

NetSuite provides multiple tools for monitoring and analyzing your average cost data.

Standard Inventory Reports

Access inventory reports to review:

• Inventory Valuation Summary: Shows current average cost and total value by item
• Inventory Valuation Detail: Transaction-level detail affecting valuations
• COGS Analysis: Review cost of goods sold by period and item

Custom Saved Searches

Build saved searches to monitor costing health:

• Items with $0 or unusually low/high average costs
• Average cost changes exceeding 15% month-over-month
• Inventory adjustments missing unit costs
• Items with negative on-hand quantities

SuiteAnalytics Workbooks

For deeper analysis, use SuiteAnalytics to:

• Trend average costs over time by item or category
• Compare average costs across locations
• Analyze cost variance impacts on gross margin
• Build executive dashboards showing inventory valuation KPIs

Set up automated alerts when average costs change beyond acceptable thresholds. This proactive monitoring prevents small errors from compounding into significant financial misstatements.

Optimizing Your NetSuite Inventory Costing for Wholesale & Manufacturing

Different industries have unique costing requirements. Here's how to optimize average costing for common scenarios.

Wholesale Distribution

Wholesale distributors benefit most from average costing when dealing with:

• Multiple vendors offering the same products at varying prices
• High transaction volumes where tracking individual shipment costs is impractical
• Price volatility that needs smoothing for financial reporting

Optimization strategies:

• Enable Group Average Costing if you transfer inventory between warehouses frequently
• Implement advanced inventory features for bin management and cycle counting
• Use saved searches to identify vendor pricing trends affecting your average costs

Manufacturing

Manufacturers using average costing should consider:

• Component items use average costing; assembly costs reflect the sum of component averages plus labor and overhead
• Work orders pull components at their current average cost
• Finished goods assemblies calculate their average based on build costs over time

For complex manufacturing with tight cost variance requirements, Standard Costing may be more appropriate—but average costing works well for make-to-stock environments where component prices fluctuate.

When to Consider Other NetSuite Inventory Costing Methods

Average costing isn't universally ideal. Here's when other methods make more sense.

Choose FIFO When:

• Selling perishable goods (food, medicine, cosmetics)
• Physical inventory flow matches first-in-first-out
• You need to track expiration dates by shipment

Choose Standard Costing When:

• You're a manufacturer with stable production costs
• Variance analysis is critical for cost control
• You have resources to maintain and update standard costs regularly

Choose Lot/Serial Costing When:

• Regulatory requirements mandate batch traceability
• High-value items need individual cost tracking
• Recall management requires knowing exact costs per batch

Stick with Average Costing When:

• You have similar items purchased at varying prices
• Simple ongoing management is a priority
• Price fluctuations need smoothing in financial reports
• Items aren't perishable or lot-specific

For guidance on selecting the right method for your specific situation, consider scheduling a free 30-minute consultation with a NetSuite expert.

Why Partner with Anchor Group for Your NetSuite Inventory Valuation

Implementing average costing correctly requires more than following setup steps—it demands understanding how costing decisions ripple through your financial statements, inventory operations, and business processes.

Anchor Group's team doesn't just know NetSuite—we nerd out over inventory automation, custom workflows, and finding smarter ways to help your backend systems support real business goals. As Oracle NetSuite Alliance Partners with expertise in wholesale distribution and manufacturing, we've solved the average costing challenges you're facing.

What Sets Us Apart:

• Practical troubleshooting: We've documented solutions for fixing $0 inventory values, costing engine timing issues, and negative inventory problems
• Industry expertise: More of our clients are wholesale distributors than any other category—we understand procurement, vendor coordination, and fulfillment
• Midwestern approach: Working with us feels like calling up your neighbor for help—familiar, reliable, and no fuss

If you're struggling with inventory valuation errors, preparing for an audit, or simply want your costing setup reviewed by experts, schedule a free consultation. You bring the business problem. We'll bring the solution.

Frequently Asked Questions

What is the average cost method in NetSuite?

The average cost method calculates inventory value by dividing total inventory value by total quantity on hand. NetSuite automatically recalculates this average whenever you receive inventory at a different price, then applies the current average to calculate COGS when you sell items.

How does NetSuite calculate average cost for inventory?

NetSuite uses a moving average formula: (Existing Inventory Value + New Receipt Value) ÷ (Existing Quantity + Receipt Quantity) \= New Average Cost. The costing engine recalculates this hourly by default, updating all affected transactions.

Can I change my inventory costing method in NetSuite?

You cannot change the costing method on items that already have transaction history. If you need to switch methods, you must create new items with the desired costing method and migrate your inventory data. This limitation exists because changing methods retroactively would invalidate historical financial reporting.

What should I do if my NetSuite inventory shows $0 value?

This typically results from inventory adjustments entered without unit costs. Create a saved search to find all adjustments with $0 estimated unit cost, edit each adjustment to add the correct cost (use Last Purchase Price as reference), then wait for the costing engine to recalculate. Implement required field validation on adjustment forms to prevent future occurrences.

How long does it take for average costs to update after receiving inventory?

The costing engine runs hourly by default. After you save an item receipt, the new average cost won't appear immediately—it updates during the next scheduled costing engine run. Plan month-end processes around this timing, ensuring all receipts are entered before the engine's final run of the period.