Choosing the Right Costing Method in Business Central: FIFO vs. Standard

Choosing the Right Costing Method in Business Central: FIFO vs. Standard

 

Deciding on the optimal costing method for inventory management in Microsoft Dynamics 365 Business Central can significantly impact your company's financial health and operational efficiency. The choice becomes especially pivotal when dealing with products that have varying purchase costs and expiration dates, such as medicines. In this blog, we delve into a scenario where a business must choose between FIFO (First In, First Out) and Standard costing methods for managing medicine inventory.

 

 The Scenario at Hand

A company procures medicine in batches, with each batch purchased at different costs ($20 and $23 per bottle for the first and second batches, respectively). Occasionally, the business donates medicines during charity events, sometimes opting to distribute items from the newer batch before the older one is fully dispensed. This practice raises a crucial question: Should the company implement FIFO or Standard costing to optimally track and value its inventory?

 

 FIFO Costing: A Closer Look

FIFO is an inventory valuation method where the first items purchased (the first in) are the first to be sold or used (the first out). It's a popular choice for businesses dealing with perishable goods or items that have expiration dates, like medicines. This method ensures that the oldest stock is used first, minimizing the risk of having to write off outdated inventory.

 

In the context of Business Central, FIFO is intuitively aligned with physical product flows, making it straightforward for accounting purposes. When you sell or use inventory, Business Central automatically deducts from the earliest batch, ensuring that your financial statements reflect the most accurate cost of goods sold and inventory valuation.

 

 Standard Costing: An Overview

Standard costing involves assigning a fixed cost to inventory items, irrespective of the actual purchase price variations. This method is beneficial for budgeting and cost control, as it provides a consistent cost figure for accounting purposes. However, it might not always reflect the true cost of inventory, especially when prices fluctuate significantly.

 

For businesses dealing with items like medicine, where each batch can have a different purchase price and a definite shelf life, Standard costing might not be the most effective. It could lead to discrepancies between the book value of the inventory and its actual market value, potentially skewing financial reports and operational insights.

 

 Tailoring the Costing Method to Your Business Needs

Considering the specific scenario where a business might use a newer batch of medicine for charity events before older stocks are depleted, FIFO appears to be the more suitable option. This method aligns with the practical need to use batches based on their expiration dates, ensuring that the accounting records accurately reflect the cost of the items used.

 

With Business Central, users have the flexibility to manually override the FIFO sequence through the "Apply to Item Entry" function. This feature allows for specific batch selection (like choosing the second batch for charitable use) while maintaining FIFO's systematic approach for regular transactions.

 

 Conclusion

 

Choosing the right costing method in Business Central hinges on understanding your inventory's nature and your business's operational practices. For companies dealing with perishable goods or items with expiry dates, FIFO offers a realistic and efficient approach to inventory valuation, ensuring that the oldest stock is utilized first and mirrored accurately in financial records.

 

While Standard costing has its merits, particularly in stable price environments and for streamlined budgeting, it may not suit scenarios with varying batch costs and the need for flexibility in stock usage. Thus, in the presented scenario, FIFO stands out as the more appropriate choice, harmonizing with the operational realities of managing medicine inventory.