Selecting the right costing method is critical when implementing NetSuite for manufacturing firms.
Once the costing method for an item is set, it cannot be changed. To change the costing method, you must delete and recreate the item, which is challenging if transaction history already exists.
The primary costing methods are:
- Average Costs
- Standard Costs
- LIFO
- FIFO
- Specific (for serialized items)
Each method has its own advantages and disadvantages.
Average Costs
Average costing calculates the cost based on a moving average of inventory currently in stock. When new inventory is added, the average cost updates proportionally.
For example:
- Buy 100 items at $100 each: Average cost = $100.
- Buy an additional 50 items at $75 each: Average cost = \(\frac{100 \times 100 + 50 \times 75}{150} = $91.67\).
If 20 items are used or sold, each is valued at $91.67, totaling $1,833.40. Remaining inventory: 130 items at $91.67 each.
Adding another 50 items at $80 each recalculates the average: \(\frac{130 \times 91.67 + 50 \times 80}{180} = $88.43\).
The costing engine updates average costs hourly or based on a custom schedule.
Standard Costs
Standard costing assigns a fixed cost to each item, manually set or calculated using NetSuite’s cost rollup tools.
When posting transactions, items are valued at their standard cost, and differences from actual costs are recorded in a variance account specified on the item record.
If inventory is revalued (changing the standard cost), the variance is posted as the difference multiplied by current inventory quantity. For example, changing from $100 to $120 per item with 100 items results in a $2,000 variance.
LIFO and FIFO
LIFO (Last-In, First-Out) and FIFO (First-In, First-Out) methods depend on the sequence of inventory additions:
Consider:
- Initially buying 100 items at $100 each
- Then buying 50 items at $120 each
When using 20 items:
- LIFO values them at $120 each, total $2,400 (last purchased items are used first).
- FIFO values them at $100 each, total $2,000 (first purchased items are used first).
Using another 40 items:
- LIFO: 30 items at $120 ($3,600), then 10 items at $100 ($1,000), total $4,600.
- FIFO: All 40 items at $100, total $4,000.
Full Example
Suppose:
- Monday: Buy 20 items at $100 each.
- Tuesday: Buy 10 items at $120 each.
- Wednesday: Sell 15 items at $110 each.
Inventory valuation on Thursday:
| Method | Value |
|---|---|
| Average | \(\frac{20 \times 100 + 10 \times 120}{30} = $106.67\)1 |
| LIFO | $100 (all $120 items sold first) |
| FIFO | $120 (all $100 items sold first) |
| Standard | $105 (set standard cost)2 |
Specific Costing
For serialized items, specific costing tracks the exact cost of each item:
| Date | Serial | Value |
|---|---|---|
| 1/1/2025 | ABC |
$10 |
| 1/2/2025 | DEF |
$15 |
| 1/3/2025 | GHI |
$17 |
Selling serial DEF on 1/4/2025 leaves inventory valued at
ABC + GHI= $10 + $17 = $27
Drawbacks of Costing Methods
- Standard costs: High maintenance; managing standard costs and multiple variance accounts can be complex.
- Average costs: Simpler, but errors in transaction rates can cause cascading inaccuracies and difficulties in future transactions.
- LIFO and FIFO: Straightforward but must align with business processes. With LIFO, older inventory may persist indefinitely if maintained minimum inventory levels aren’t reduced.
Conclusion
While consultants may not directly choose the costing method, understanding each method’s nuances ensures accurate implementation and simplifies explaining financial results to clients.
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