Manufacturing Costing Methods Available in Microsoft Dynamics 365 Business Central
If you’re a manufacturing company implementing or already using Microsoft Dynamics 365 Business Central, a natural and important question to answer is which costing method you should be using. As with so many decisions you make about setting up your ERP system, it depends on several factors. Let’s look at the different manufacturing costing methods offered in Business Central and how to decide which is best for your company.
Manufacturing Costing Methods in Business Central Defined
Before addressing the question, we need to start with a quick discussion of why costing methods exist, and which ones are supported by Business Central.
As opposed to financial accounting, cost—or managerial—accounting includes providing and having the ability to validate the value of inventory items on the balance sheet. Cost accountants are responsible for providing actionable information to the management team to make adjustments to improve the company’s financial performance. Since there are no GAAP rules to abide by, your company’s cost accounting should be structured to provide management with that information, whatever it might be. Cost accountants are also often asked to provide information around the future cost of items. This is where costing methods come into play. Business Central supports five methods. Following are definitions and benefits of each.
#1: First In, First Out – FIFO
FIFO, or First In First Out, is a method where costing is based on the cost of goods first purchased. It is commonly used by manufacturers with limited or short shelf-life inventory, such as perishable items or those that follow trends or seasons (like fashion). However, many other manufacturers use FIFO because it accommodates for fluctuating prices.
#2: Last In, First Out – LIFO
LIFO, or Last In First Out manufacturing costing method, is like FIFO with the main difference being that assets purchased or received under FIFO are disposed of first, while LIFO disposes of assets first that were received most recently. FIFO is the better accounting method to use when prices are steady, while LIFO is a better option if prices are expected to rise. LIFO is often used by manufacturers with large inventories, such as retailers or automobile dealerships.
#3: Average
With the Average manufacturing costing method, the total cost of inventory is based on the average cost of goods available for sale during a set period. It divides the total cost of goods sold (COGS) by the total units that are available for sale. This method is efficient, easy to use, generally consistent, and especially beneficial for manufacturers with many of the same kinds of items. It is used by all types of manufacturers, from retail to fuel to pharmaceuticals.
An advantage of using Average cost is that COGS is smoothed and does not swing when emergency purchases are made to fulfill a special customer order. When sales commissions are based on margins, salespeople are not penalized when shipments go out using the FIFO or LIFO layer that was procured at an inflated cost.
#4: Standard
The Standard manufacturing costing method is commonly used in slower-paced environments. Some benefits include:
- Quickly build out standard costs
- Identify ways to optimize inventory by implementing feedback via variances
- Easily develop reports for management
- Keep production BOMs consistent, repetitive, and predictable
- Provide marketing and sales teams with a fixed cost number
- With fixed COGS:
- You can provide management with purchase price variance, material usage variance, and labor efficiency variance
- You can provide sales and marketing with a fixed cost number that can used to set sales prices
- Margins will remain the same until new standards are set
Many companies use the standard costing method as it allows them to set predetermined costs to inventory and monitor any differences using variances. While all the methods except Standard let you provide up-front estimates, actual cost and margins will vary from accounting period to accounting period. In a distribution company, identifying the costs is easier because products are purchased at one price and sold at another.
In manufacturing, however, there are often several stages of sub-assemblies, making it nearly impossible to understand why margins are high or low for a specific accounting period. Therefore, manufacturing companies typically use Standard costing when management is interested in tracking variances for process improvement. The only real drawback to Standard is that there is a significant amount of up-front effort to set the standards.
#5: Specific
The Specific costing method is used when selling high-value items one at a time. The major benefit of this method is that the flow of cost will accurately line up with the inventory’s physical flow, making it easy to compare the actual cost against revenues. Although less common, this method can be useful for industries with limited inventory.
Choose the Right Manufacturing Costing Method with ArcherPoint
As you can see, choosing the right costing method can make a huge difference across the organization. ArcherPoint’s team of experts understand manufacturing costing methods, Business Central, and understand the impact different methods will have on your business. We can help you determine the best choice while ensuring your Business Central implementation is set up to support the costing method you choose to deliver maximum cost control and financial stability. Contact ArcherPoint today to start the conversation and determine which costing method makes the most sense for your manufacturing business.