There are several costing setups in Microsoft Dynamics NAV, and each one has its own advantages and disadvantages. Ultimately, the financial management team will choose the company’s preferred costing method. However, the following discussion will hopefully explain some of the benefits of each method.
Dynamics NAV offers users the following choices for costing method: FIFO, LIFO, Average, Standard, and Specific.
Using FIFO, the first items placed in inventory are the first items removed (First In, First Out). The first items removed are assigned the cost of the initial items placed in inventory. There are exceptions with inventory involving lot and serial numbers, but that is an advanced topic beyond the scope of this basic discussion. Using FIFO, the balance sheet will show the actual cost of the items remaining in inventory.
LIFO will apply the cost of the most recent items placed in inventory to the first items removed (Last In, First Out). The cost of the last items placed into inventory will be applied to the first items removed (again, ignoring specific exceptions). Using LIFO, the balance will still show the actual cost of items remaining in inventory.
In Average costing, the cost of the items in inventory are summed and averaged over the amount of inventory for a specified period of time (day, week, month, etc.). Now the average cost will be applied to the items removed from inventory, and the balance sheet will still show the actual cost of the items remaining in inventory.
In contrast to the previous costing methods, which are based on the actual procurement cost of items, cost accountants may choose to assign a fixed amount to items in inventory to include cost elements such as material, labor, overhead, etc. By establishing a “standard”, it becomes easier to identify when cost variances occur in production. The Standard cost will become the Cost of Goods Sold when the item is shipped, and any variances between the actual cost of an item and the standard cost will appear as a Purchase Price Variance on the Profit and Loss statement as a period expense. Standard costing requires significant upfront work on behalf of the cost accountants and production engineers to arrive at an accurate standard cost of an item.
For Specific costing, the assumption is that items are purchased or produced and then sold individually and are serialized. Items are removed from inventory by serial number and are assigned the true cost of procurement for that item. The balance sheet will show the actual cost of the items in inventory.
All of the costing methods are useful, but there are advantages and disadvantages to each method.
Average costing helps smooth out the costs applied to items in inventory (out of season purchases, emergency or rush shipments for special orders, etc.), a significant benefit to salespeople whose commissions are based on margin.
With any method except Standard, items are tracked at their actual costs and inventory values are always accurate, however, it becomes difficult to identify where the real cost variances originated (Were there higher labor costs for this period? More materials? Other?).
For distribution companies, finding such variances is typically straightforward to calculate compared to manufacturing companies.
Manufacturing companies often have several stages of sub-assemblies, labor and material cost fluctuations, and varying costs for overhead and transportation. Here management often chooses to use Standard costing, where the Cost of Goods is a fixed amount and material, labor, and other cost variances are easier to identify and track. In addition, Sales and Marketing have a fixed number to use when establishing sales prices.
Cost accounting can be viewed as an art as much as a science, and the “best” costing method to use will vary from company to company. Understanding how each method is treated in Dynamics NAV, however, will help users make informed choices.
by ArcherPoint LLC