Costing Method Best Practices for Dynamics NAV
There are a variety of costing methods to choose from in Microsoft Dynamics NAV. Depending on the chosen procedure, a costing practice will determine if a budgeted or actual value is used in the cost calculation and it will impact how the cost flow is recorded.
Dynamics NAV features integrated inventory management and costing through perpetual inventory. NAV allows the specification of a Costing Method per Item master record. This makes it possible for businesses to select a “mixed model” of costing. For example, a manufacturing firm may choose FIFO for Items it purchases (i.e. raw materials), but use a Standard Cost for the goods it manufactures.
Inventory Value in Dynamics NAV is maintained in the Value Entries table. Items coming into inventory (Purchase Receipts, Sales Returns, and Positive Adjustments) have their direct acquisition costs determined either as Actual (FIFO, LIFO, Specific, and Average) or an assigned Standard cost. The cost assigned to items going out (Sales Shipments, Purchase Returns, and Negative Adjustments) is determined by the costing method chosen for that Item.
Outbound transactions represent inventory value flowing from the balance sheet to the income statement, where it becomes cost. COGS is the most common endpoint of these transactions, but Negative Adjustments also cause this value flow to the Inventory Adjustment account. When these outbound entries are posted, they are applied in the Item Ledger to positive entries based on the Costing Method criteria below. The Value Entries for the positive quantity entries show where the value came from that was used in the applied negative quantity entries, except for an Average Cost Item.
The Costing Method options [per Item] are:
- FIFO (First In First Out) – this method uses the actual value of the earliest (by Posting Date) open positive entries with Remaining Quantity to move costs for outbound transactions.
- Standard – this method uses the Standard Cost specified for that Item to move costs for outbound transactions.
- Specific – this method uses the exact cost of that unit which was recorded upon the inbound transaction to move costs for outbound transactions of that unit. This method requires both inbound and outbound item tracking and is most frequently used for Serialized Items.
- LIFO (Last In First Out) – this method uses the actual value of the latest (by Posting Date) open positive entries with Remaining Quantity to move costs for outbound transactions.
Note: In the US, this method is only acceptable to the IRS if your company has been granted an exemption to the prohibition on this valuation method.
- Average – this method uses the weighted average of the remaining units of an Item at the time of posting to move costs for outbound transactions.
Note: This method is typically not recommended due to the difficulty of traceability and complication of correction if data entry errors are made. However, there are certain industries and cases where average cost is used and accepted.
The costing methods above are used for valuing inventory on the balance sheet. NAV also calculates and displays the average cost on the item card, regardless of which costing method is used for inventory valuation. This average cost can be used for other reports such as sales analysis or commissions calculation.
Dynamics NAV also offers several options for adding indirect costs to inventory value. Item Charges may be used to pass through additional costs in a landed cost model. There are two fields at the individual Item master record level, one for Overhead Rate and one for Indirect Cost %. Overhead Rate is specified as dollars and cents to add to the inbound value. Indirect Cost is specified as a percentage to add to the inbound value. Both are calculated per the base Unit of Measure of the Item. All three of these options result in additional Value Entries when they’re applied to inbound transactions, establishing a higher valuation on the balance sheet.
These varying costing methods differ in the way that they calculate inventory changes and which type of cost they use as the valuation base. Factors such the cost stability, unit costs, and cost control requirements of a business allow Dynamics users to determine which practice best meets their needs. Which method does your company use? Comment below to get the conversation started.
About the Author: Teresa Peitsmeyer
Teresa Peitsmeyer, Western Computer’s NAV Senior Project Manager and Solution Architect, has over 21 years of experience in identifying customer issues to provide proactive solutions to optimize ERP functionality. With her exposure to Western Computer’s diverse client case, Teresa has refined her expertise in complex operations such as pricing structures, credit card processing, international tax processing, multi-company consolidation, and royalty reporting.