Can you have both FIFO & Standard costing methods?

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Posted on by lmai

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Hi All,

We are not exactly a manufacturer. We purchase raw material, then we subcontract. After we received the finished goods from our subcontractors, we ship them to our customers. In terms of material, we use FIFO. The different between the purchase price and the invoice price, we post to variance. In what situation would you need to use standard cost? Is standard cost applicable to manufacturing?

Please share your thoughts. Thanks so much!

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Konrad U 804 on at

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Standard cost in AX works performance wise if you handle lots of stuff and do many transactions. Variances to standard are similar to your purchase price invoice price variance. Average costs can skew wildly depending on purchase lot size. Outside this and impacting both methods are currency variations.

FIFO can impact cost but mainly serves to ensure inventory age is minimized assuming you are tracking lot cost. The lot cost impacts average cost or creates purchase price variances to standard cost.

Given our experience I would almost always recommend standard cost unless there are few items and manageable transaction volumes. Standard involves more work in setting up and maintaining costs but pays it back in being more understandable.

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lmai 2,438 on at

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Hi Konrad,

Thank you for taking the time to response. I appreciate that.

With our current FIFO when it comes to pulling inventory, do you suggest us to use Standard Costing. So just ignore FIFO and use one cost method? Thanks, Konrad.

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Ludwig Reinhard Microsoft Employee on at

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Hi Kim,

If your question has been answered, please be so kind and verify the answer to let also other community members know what helped you.

Many thanks and best regards,

Ludwig

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guk1964 10,888 on at

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Standard cost needs relatively stable costs, which implies long term price agreements, consistent order quantities etc.

If you use standard for some components and FIFO for others then FIFO for a parent makes sense.

It does not make lot of sense to have FIFO or Average for standard cost parents.

Standard allows sales to enter into long term price agreements and to quote knowing the cogs is not going to change by the time the sales order comes in. Basically SCM side ahs to hit the cost standard and sales does not get hit with either higher cost nor benefit from lower. There will be some variances order to order but why penalise one order/sales because that was the day the machine broke down and created lot of scrap..

An allowance for the variance can be built into the standard e.g as part of overheads.

For quote and make to order items, or widely varying price commodity items FIFO makes sense.

If you turn around orders and inventory within a period then it makes little practical difference.

I prefer standard especially for manufacturing. Accountants don't like

I do.

They let me see what is happening and there a lot less issues with month end close, or negative, inventory values, when trying to adjust a late invoice costs to inventory that no longer exists.

Standard cost encourages SCM to beat standard.

This promotes a healthy debate on the most efficient way to run the business, and whether savings should go to the bottom line or be passed onto sales to grow volumes

The basic question are:

Does the costing method selected help you make better business decisions?

How does it impact administrative work and system performance (how many items and boms do you have?).

How stable is your supply and demand?

What are the statutory /IFRS requirement if any?

How will it impact the timing of tax payments?

Before you change, then discuss with your auditors and understand how it will impact your balance sheet and P@L for the period. ( not much if you hold little stock).

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lally 8 on at

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[quote user="magic1949"] prefer standard especially for manufacturing. Accountants don't like[/quote]

Hi Magic,

Could you share more insights about why the Accountants does not like Standard cost?

You also mentioned that there are some challenges, if we use standard cost in the application. Could throw some light on this also?

Many thanks in advance.

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Konrad U 804 on at

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Hi Kim

It would be nice to have both methods available at once but AX forces the choice of FIFO (a version of average cost) and standard cost. In AX 2009 our weighted average cost was a problem since average costing requires an inventory close and that close had lengthened to a day. We changed to standard for AX 2012 R3 and now there are no inventory closes. Yeah!

However the strictness of AX mandates that at standard all inventory is the same, certain features stop working or change how they work such as marking and reservations. With some minor code tweaks you can bring some of the function back, we had uses for marking beyond inventory valuation so we made a minor code change to bring it back.

So standard is the best way for us and depending on your need for FIFO you can probably find workarounds to simulate it. Either one should work but in a high transaction environment standard performs far better.

Hope this hasn't made it too muddy for you.

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Konrad U 804 on at

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It depends on the department tasked with managing standard cost. If accounting does it standard requires each item have a cost before it is touched. For manufactured items this involves doing cost rollups and then activating the new standard. If manufacturing does it accounting is probably happier.

In average cost the main issue is correcting bad transactions before month end closes. Depending on what process you use this can either be a big or a small problem.

A side issue is how sales prices are determined since they can be based on cost (markup) if you use that function.

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lally 8 on at

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[quote user="Konrad U"]However the strictness of AX mandates that at standard all inventory is the same, certain features stop working or change how they work such as marking and reservations. With some minor code tweaks you can bring some of the function back, we had uses for marking beyond inventory valuation so we made a minor code change to bring it back. [/quote]

Did you mean that standard cost stop some features ?

What about those features which does not work ?

Any document is available ?

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guk1964 10,888 on at

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Many accountants with whom I discuss seem to have only have book knowledge of costing and have often only  been trained on, or had experience with, average costing. They then write the accounting standards so it becomes a loop. I say that because they say stupid thing like your get different profit margin with average and standard. However, profit is sell price - buy price so how you cost in between has no impact.

Costing has to satisfy many stakeholders- the tax man has a major say the costing method can affect the timing of profit - as do the auditors on behalf of shareholders-but that does not help the business to make decisions - the salesman who is quoting with average costs that were last updated a year ago find his actual margin on which his commission is paid bears no relation to his actual margin, or how does he decide based on his costs whether to take a large order at a much lower order at a lower price has different expectation of a costing system. (this ir elrevant for when was the BOM cost last rolled.).

A major factor in costing is how variable is the sale /purchase /manufacturing order quantity, and cost, and how long does it stay in inventory. The answer is probably different for every item and every company but auditors blindly insist on one method, because its what they understand.

From an accounting perspective if standard cost is not suitable then neither is average. They both require relatively stable costs, which also often means stable order sizes (IFRS if I remember correctly requires that they should be within 3% of each other). Average needs marking to take out the highs and lows. Averaging 49.9 with 50.1 makes sense averaging 40 with 60 does not. From my perspective, when these factors are not stable you get variances - the case in many companies, and I would prefer to be aware of those rather than just push them into inventory value. FIFO suffers from having to use average cost as an estimated cost until month end close.

In most companies some real world challenges are: that all inventory is not consumed in the same month - hence the need for inventory costing (as opposed to just bom costing), all orders and invoices related to receipts are not posted/closed  before the month end close so there are adjustments the next month and those can be confusing when there is little inventory on which to post the adjustments. Those can be difficult to understand and are more complex to analyse than separately posted variances,

If costs are stable and inventory is largely consumed and accounted in the same month then any costing methods work ok in general you might as well use the one that you understand and that has the least performance hit. How many items and orders you have, and the complexity of your boms , how seasonal and erratic is demand, exchange rates etc may force a pragmatic decision of what is most workable.

Think of it this way if you expensed everything on receipt your purchase price is that same and you make a loss. when you sell you make 10)% profit on those materials so that offset the stock write off you just had a smaller profit initially and a larger one later.

Put  the inventory into stock at sale price and you make an immediate profit and when you sell make none.

The other costing method are a compromise between those two extremes, Think about he business decisions you face with regard to inventory costs and that will help you decide.

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Sten Baumgarten 12 on at

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Hi Kim

I use to work at at company where we bought raw materials in different countries. The raw materials where repacked and the finished goods were sold in different countries. Before we changed to using standard cost for our finished goods, we used FIFO.

The sales people responsible for sales in different markets used to spend a lot of time convincing the people that planned production of finished goods to use the cheapest raw materials in their products and thereby ensuring that their profit would be bigger than if a random raw material were used.

To get rid of this sub optimization we changed inventory cost principle from FIFO to Standard cost. The sales people then did not spend time trying to convince the production planner to use the cheapest raw material but could spend their time optimizing sales and the production planners could spend their time optimizing production planning.

Kind regards

Sten

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