Inventory cost methodologies
The inventory costing method that you select for a product has an impact on the value of inventory, the profits that are recorded on the manufacture and sale of products, and the process that's used to change and manage prices. It's one of the first decisions that you'll make when defining products. You can't change the costing method for a product when incomplete inventory transactions exist for the product.
The inventory costing method that you select has a direct impact on the value of inventory in stock, inventory that's used to manufacture, and inventory that's sold to customers. The standard cost method will change the way that you manage prices and can affect other processes. Therefore, it's important to understand the methods that exist and to select a method when you set up a product. Changing the costing method after you've started using items in transactions can be difficult.
Close process
The inventory close process will match issues (outbound inventory) against receipts (inbound inventory) to decide the cost to assign to inventory that's used in manufacturing or sold to a customer. The match process is based on the costing method that you choose.
Available cost methods
The method that's used to source any specific product comes from the Item model group that's specified for the released product. Go to the General FastTab of the Released product page to view the item model group. Released products are found in many modules, including the Product information management module. Select the Released products menu item in the Products group to view released products.
You can define item model groups in the Inventory management module. Expand the Setup section and then select the Item model groups menu item in the Inventory group.
Cost methods
The costing methods that are available in Dynamics 365 Finance and Dynamics 365 Supply Chain Management are industry standard costing methods. Different industries and different processes tend to favor one costing method over another.
The cost method is listed on the Costing method & cost recognition FastTab. The field is named Inventory model.
The list of available cost methods includes:
- FIFO
- LIFO
- LIFO date
- Weighted avg.
- Weighted avg. date
- Standard cost
- Moving average
The first four methodologies require an inventory close at the end of each financial period so that issues can be settled against the receipts. Standard cost and moving average don't require a monthly close.
FIFO – First in first out
The FIFO (first in first out) method uses the inventory that you received first to satisfy outbound requirements. When an inventory close process runs, the outbound transactions are processed in order. Then, each transaction is matched against the earliest inventory in the system at the time of the transaction.
Consider the following example. You receive inventory on the first day of October at USD 75.00 each unit. You receive more inventory in November at USD 100.00 each unit. A transaction that occurs in December will use items from the original batch that were purchased at USD 75.00 each unit (if inventory is available). If no units from that batch are available, items from the November batch (USD 100.00 each unit) will be used. The net revenue for this order is different based on available inventory.
LIFO – Last in first out
The LIFO (last in first out) method will use the inventory that you received last to satisfy outbound requirements. When the inventory close process runs, outbound transactions are processed in order. Then, each transaction is matched against the last inventory that's received at the time of the transaction.
LIFO date – Last in first out date
The LIFO date (last in first out date) method acts like LIFO, if inventory is available. If no inventory is available to settle against, inventory that's received after the outbound transaction will be matched/settled against the outbound transaction. The order that's used is last issue, last receipt. The settling process runs in reverse from LIFO, which settles outbound transactions with earliest first. LIFO date acts similarly, unless no inventory is received prior to the outbound transaction, at which point, the remaining, unmatched, outbound transactions are processed in reverse order.
Weighted average
The weighted average cost method will sum the receipt cost times quantity for all inventory receipts during the current period. Remaining inventory from the prior period is valued the same way and then added. These two values are summed and divided by the total quantity received this period plus remaining quantity from the prior period. This value becomes the weighted average cost that's assigned to all outbound issue transactions during the period.
Weighted average date
Weighted average date is like weighted average. The difference is that each day of the current period has its own weighted average calculated based on the value of all remaining inventory, with receipt on dates prior to and including the date of the outbound transaction. All transactions on a specific day during the period use the same weighted average cost. The system calculates a weighted average each day in a period.
Moving average
Moving average is a perpetual costing method that reevaluates the cost whenever a new purchase receipt is posted. The average cost at the time of an issue transaction will be used. No settlement/inventory close process occurs because all inventory is valued at the same average cost regardless of when it's received. You can convert items to use a moving average cost model.
Standard cost
The standard cost method will assign a cost to raw materials and components that are used in manufacturing and sold to customers. This method works under a couple of conditions:
- When little fluctuation occurs in the cost of the items received, such as raw materials and components
- Manufactured lot size is constant; if the lot size is variable, setup costs and material scrap will affect the cost of any lot
Variances are recorded if a calculated cost is different from the standard cost that's recorded in the system. No close process is required for you to use the standard cost method. A price activation process is required for you to set the cost price to be used in transactions. Additionally, you can convert items to a standard cost model.
Complications
Many features can affect the matching of outbound issues to inbound receipts. One of these features is marking. A user can mark an outbound transaction against a specific inbound receipt. This action overrides the normal settlement/matching process that occurs during the close. You can use a modified FIFO method that considers the expiration date of products when reserving a specific batch/lot. Selecting a batch will override the normal FIFO calculations and will use the cost from the selected batch.
How to choose the best costing method
If you assume rising costs, LIFO produces the smallest profits, which can mean the least amount of taxes. FIFO will produce the largest profits and therefore the largest tax. Companies will often choose based on whether they're trying to show larger profits or minimize their taxes.
Moving average and standard cost don't require the monthly close, a time-consuming process that can hold up the financial period close.
Standard cost is often used in manufacturing or raw materials/components with little price variability. Using standard cost where it doesn't apply will cause excessive cost variances that aren't easily explained.