Costing methods and inventory value

The costing method decides what value an item gets when it leaves the warehouse, and therefore what your cost of goods shows in the income statement. Many choose the default setting without thinking about it and notice the difference at the close. Here we go through the five costing methods, why the cost can change after the fact, and what the cost adjustment run does. You also get an overview of when inventory value reaches the general ledger. That gives you a good basis for the conversation with your auditor.

The five methods

Business Central supports FIFO, LIFO, Average, Specific and Standard. The method is chosen in the Costing Method field on the item card, and a default can be set in Inventory Setup. Microsoft Learn describes them like this:

FIFO: first in, first out. Suitable when the cost price is stable, and for items with a shelf life.
Average: the cost price is calculated as an average after each purchase. Suits goods that are mixed and cannot be told apart.
Standard: a fixed cost price, where variances are posted when the actual price is known. Requires someone to maintain the standard prices.
Specific: the exact price of each individual unit. Requires item tracking on both inbound and outbound, typically for serial numbers.
LIFO: last in, first out. It is prohibited in many countries, so check with your auditor.

You cannot switch freely

You cannot change the costing method on an item that already has item ledger entries. The decision must therefore be made before stock starts moving. It should be made together with your auditor, because the method affects both the balance sheet and tax.

Average requires two choices

If you use Average, Inventory Setup decides the period the average is calculated over (Average Cost Period), and whether it is calculated per item or per item, location and variant (Average Cost Calc. Type). If you backdate an inventory increase or decrease, the average is calculated again, and the affected entries are adjusted.

Adjust the cost

The cost can change after the sale, for example because the freight is invoiced later. That is why the cost adjustment run Adjust Cost - Item Entries exists. It forwards changed inbound costs to the related outbound entries and creates new adjustment value entries. The adjustment uses the original posting date, unless it falls in a closed inventory period.

Microsoft Learn says that costs are adjusted automatically with inventory transactions, but that you can also run it manually. The Inventory Cost Adjustment follow-up page shows which items still need adjustment. How the automation is set up in your environment, you must check yourself in Inventory Setup, because the field names depend on version and localization.

From inventory to general ledger

Inventory value only reaches the accounts when the costs are posted to the general ledger. The Automatic Cost Posting field in Inventory Setup controls whether this happens with every transaction. Expected costs can also be posted, so interim accounts show an estimate before the invoice is posted. Reconcile inventory value to the general ledger at every period close, and plan the cost adjustment run and the posting as a fixed task, preferably through the job queue.

Corrections and revaluation

If you need to change the value of items that are in stock, you use a Revaluation Journal. It posts the item's current calculated value and is separate from the cost adjustment run. For Standard costing, the prices are updated periodically in a standard cost worksheet, and Microsoft Learn notes that there is no history of standard prices.

Additions such as freight and customs duty that arrive after the sale are posted as item charges and assigned to the relevant entries. That way the cost follows the item, and the margin is correct even when the invoice comes late.

Also ask who in the company owns the figures. Inventory value affects accounts, tax and loan terms, so the decision should not be made by whoever created the item. Document the choice, so it is the same for all item groups that belong together.

Next steps

Addverk builds its own apps for Business Central, but they are not on Microsoft AppSource yet. On the apps page you can see what we are working on. If you want help with the setup in standard BC, you will find the services and the open prices on the prices page.