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

Orders placed: 1st order: Quantity = 150 | Cost = Rs. 1000

2nd order: Quantity = 50 | Cost = Rs. 1100

To calculate the average cost, first calculate the value (Quantity x Cost). Hence:

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