The costing method determines whether an actual or a budgeted value is capitalized and used in the cost calculation. Together with the posting date and sequence, it also influences how the cost flow is recorded. All costing methods have one thing in common – when the quantity on inventory is zero, the inventory value must also be zero. They differ in the way that they value inventory decreases.
This example uses a sequence of inventory increases and decreases to show the effect of different costing methods.
|
Posting Date |
Quantity |
Entry No. |
|
01-01-03 |
1 |
1 |
|
01-01-03 |
1 |
2 |
|
01-01-03 |
1 |
3 |
|
02-01-03 |
-1 |
4 |
|
03-01-03 |
-1 |
5 |
|
04-01-03 |
-1 |
6 |
For all costing methods different from the standard, the inventory increases are valued at their acquisition cost.
|
Posting Date |
Quantity |
Cost Amount (Actual) |
Entry No. |
|
01-01-03 |
1 |
10 |
1 |
|
01-01-03 |
1 |
20 |
2 |
|
01-01-03 |
1 |
30 |
3 |
For the standard costing method, the inventory increases are valued at the current standard cost.
|
Posting Date |
Quantity |
Cost Amount (Actual) |
Entry No. |
|
01-01-03 |
1 |
15 |
1 |
|
01-01-03 |
1 |
15 |
2 |
|
01-01-03 |
1 |
15 |
3 |
FIFO means First-in-First-out. With this method, the items that were purchased first are always sold first.
The FIFO costing method values the inventory decrease by taking the value of the first inventory increases on inventory.
|
Posting Date |
Quantity |
Cost Amount (Actual) |
Entry No. |
|
01-02-03 |
-1 |
-10 |
4 |
|
01-03-03 |
-1 |
-20 |
5 |
|
01-04-03 |
-1 |
-30 |
6 |
LIFO means Last-in-First-out. With this method, the items that were purchased most recently are always sold first.
The LIFO costing method values the inventory decrease by taking the value of the last inventory increases on inventory.
|
Posting Date |
Quantity |
Cost Amount (Actual) |
Entry No. |
|
02-01-03 |
-1 |
-30 |
4 |
|
03-01-03 |
-1 |
-20 |
5 |
|
04-01-03 |
-1 |
-10 |
6 |
The average costing method values the inventory decrease by calculating a weighted average of the remaining inventory at the valuation date of the inventory decrease.
|
Posting Date |
Quantity |
Cost Amount (Actual) |
Entry No. |
|
02-01-03 |
-1 |
-20 |
4 |
|
03-01-03 |
-1 |
-20 |
5 |
|
04-01-03 |
-1 |
-20 |
6 |
The standard costing method works almost the same as FIFO, the difference being that the inventory increases are valued at standard cost, which affects the value of the inventory decreases.
|
Posting Date |
Quantity |
Cost Amount (Actual) |
Entry No. |
|
02-01-03 |
-1 |
-15 |
|
|
03-01-03 |
-1 |
-15 |
|
|
04-01-03 |
-1 |
-15 |
|
The costing methods express the assumption that the cost flows from inventory increase to inventory decrease. It is always possible for the user to overrule this assumption if more accurate information about the cost flow exists. This is done by creating a fixed application between entries.
The entries below show how fixed application influences the valuation of the inventory decreases.
|
Posting Date |
Quantity |
Cost Amount (Actual) |
Applies-to Entry |
Entry No. |
|
02-01-03 |
-1 |
-20 |
2 |
4 |
|
03-01-03 |
-1 |
-10 |
1 |
5 |
|
04-01-03 |
-1 |
-30 |
3 |
6 |
Fixed application has the same effect as using the specific costing method.