Inventory cost methodologies
The inventory costing method that you select for a product has an impact on the value of inventory, the profits that you record on the manufacture and sale of products, and the process that you use to change and manage prices. Selecting your inventory costing method is one of the first decisions that you 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 you use to manufacture, and inventory that you sell to customers. The standard cost method changes 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 start using items in transactions can be difficult.
Close process
The inventory close process matches issues (outbound inventory) against receipts (inbound inventory) to decide the cost to assign to inventory that you use in manufacturing or sell to a customer. The system bases the match process on the costing method that you choose.
Available cost methods
The method that the system uses to source any specific product comes from the Item model group that you specify for the released product. Go to the General FastTab of the Released product page to view the item model group. Released products are 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 Microsoft Dynamics 365 Finance and Microsoft 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 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 you can settle issues against the receipts. Standard cost and moving average don't require a monthly close.
FIFO
The first-in, first out (FIFO) method uses inventory that you receive first to satisfy outbound requirements. When an inventory close process runs, the system processes outbound transactions in order. Then, it matches each transaction 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 for each unit. You receive more inventory in November at USD 100.00 for each unit. A transaction that occurs in December uses items from the original batch that customers purchase at USD 75.00 each unit (if inventory is available). If no units from that batch are available, the system uses items from the November batch (USD 100.00 each unit). The net revenue for this order is different based on available inventory.
LIFO
The last-in, first-out (LIFO) method uses inventory that you receive last to satisfy outbound requirements. When the inventory close process runs, the system processes outbound transactions in order. Then, it matches each transaction against the last inventory that you receive at the time of the transaction.
LIFO date
The last-in, first-out date (LIFO date) method acts like LIFO, if inventory is available. If no inventory is available to settle against, the system matches/settles inventory that you receive after the outbound transaction against the outbound transaction. The order that the system uses is last-issue, last-receipt. The settling process runs in reverse from LIFO, which settles outbound transactions with earliest first. The LIFO date method acts similarly, unless you receive no inventory prior to the outbound transaction, at which point, the system processes the remaining, unmatched, outbound transactions in reverse order.
Weighted average
The weighted average cost method sums the receipt cost times quantity for all inventory receipts during the current period. The system values the remaining inventory from the prior period the same way and then adds it. Then, it sums these two values and divides them by the total quantity received this period plus remaining quantity from the prior period. This value becomes the weighted average cost that the system assigns to all outbound issue transactions during the period.
Weighted average date
Weighted average date is like weighted average. The difference is that the system calculates each day of the current period's weighted average 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 someone posts a new purchase receipt. The system uses the average cost at the time of an issue transaction. No settlement/inventory close process occurs because the system values all inventory 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 assigns a cost to raw materials and components that you use in manufacturing and sell 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
When manufactured lot size is constant; if the lot size is variable, setup costs and material scrap affect the cost of any lot
The system records variances 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 use 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 you're reserving a specific batch/lot. Selecting a batch overrides the normal FIFO calculations and uses 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, whereas FIFO produces the largest profits and therefore the largest tax. Often, companies choose the method based on whether they want to show larger profits or minimize their taxes.
Moving average and standard cost methods don't require the monthly close, a time-consuming process that can hold up the financial period close.
Frequently, companies use standard cost in manufacturing or raw materials/components with little price variability. Using standard cost where it doesn't apply causes excessive cost variances that aren't easily explained.