Hierarchy of Costs

The valuation method of an item determines how the cost of an item is calculated in the Sales Order, Purchase Order, and Inventory Management modules.

The following information describes the costing hierarchy that is followed when relieving inventory for an item and during data entry.

In the Inventory Management module, the valuation method of an item determines what cost is used when relieving inventory. Register and update tasks calculate the cost of an item being relieved from inventory based on the valuation method defined for the item. Some of the methods use a common default cost hierarchy at some point in the calculation steps. The methods used to calculate the cost are described below.

The default cost hierarchy begins with the last cost in Item Maintenance. If that cost is zero, the hierarchy then looks at the standard cost. If that cost is also zero, the hierarchy uses the average cost.
When using Standard Cost, the standard cost is always retrieved from the item, even if this cost is set to zero.
When using Average Cost, if there is a quantity in the warehouse with no value, the cost is always zero. If there is a quantity and a value in the warehouse, the item/warehouse average cost is calculated by taking the total value of the item in the warehouse, divided by the total quantity on hand for the item/warehouse. If there is no quantity or value in the warehouse, the default cost hierarchy is used.

The cost hierarchy for an item valued at average cost is as follows: Item/Warehouse Average Cost, Last Cost, Standard Cost, Item Average Cost.

Note For average cost items, if the quantity on hand is negative, the cost hierarchy will be used to determine the cost and the average cost will be an estimate because the actual cost is not yet known. If an item's quantity is expected to perpetually remain negative, use the FIFO, LIFO, or standard cost valuation method instead. When a transaction is processed to replenish inventory, an adjustment will be made for any difference between the new known cost and the current average cost.

Average Cost Example

Item #1 has 10 on hand and an average cost of $7.50 with a last cost of $8.00.

Sale transaction #1 has quantity of 10 at $7.50 that leaves the on hand quantity and total warehouse value of zero.
Sale transaction #2 has quantity of 10 at $8.00 (using the last known cost), the on hand quantity is -10 and the inventory value is $80.00-, and the average cost is now $8.00 (estimated average cost).
Receipt transaction of 20 with a cost of $8.25 will bring inventory on hand quantity back to 10 and a resulting adjustment transaction will correct the average cost.

The following calculation is made.

Quantity on Hand	Total Inventory Value	Calculation	Average Cost
10	75.00	75 / 10	7.50
-10	0.00	N/A	0.00
-10	-80.00	80 / 10	8.00
20	85.00	(165.00 - 80.00) / 10	8.50
Adjusted Est. Avg. Cost	-82.50	(80.00 / 10) - (82.50 / 10) = -2.50	8.25

In this example, the unit cost of the receipt $8.25 was higher than the last cost of $8.00 used when inventory went negative, so an adjustment transaction is made to bring average cost to actual. If the receipt cost had been lower than the estimated cost, the adjustment would have been positive. These transactions can be seen in Transaction Entry and will also update to the general ledger. The transaction code is the initiating module code followed by a Z. For instance, if the transaction was originated in the Purchase Order module, the transaction code would be PZ.

When using FIFO or LIFO, the cost tier file is used in ascending date order for FIFO, or descending date order for LIFO items. The quantity sold, issued, etc. is distributed across as many tiers as necessary to reach the required quantity. The total value is accumulated from each tier, and a total cost is created for the quantity being removed from inventory. The total value is then divided by the quantity to obtain the unit cost. If there is still a quantity to distribute after all tiers are relieved, the remaining quantity is distributed using the default cost hierarchy and assigned to a default cost tier.
When using Lot or Serial, the lot or serial along with the quantity are entered during data entry. The value used from each lot or serial item is accumulated and then divided by the line quantity to obtain the unit cost for the line. Each individual tier will still be relieved at its actual cost.

In the Purchase Order module, the valuation method of an item determines what cost is used in Auto Reorder Selection, P/O Auto Generate from Sales Orders, Purchase Order Entry, Receipt of Goods Entry, Return of Goods Entry, and Material Requisition Issue Entry.

The hierarchy begins with vendor price levels. If vendor price levels do not exist, then the vendor last cost in Inventory Management is used. If the vendor last cost is zero or no vendor is assigned to the item, then the last cost is used. If the last cost is zero, then the cost hierarchy specified for each valuation method is followed.

Note For standard and average cost items in Purchase Order Entry, Receipt of Goods Entry, and Return of Goods Entry (no purchase order specified), the cost hierarchy for each valuation method is followed. In Material Requisition Issue Entry (one-step) and material requisitions entered in Purchase Order Entry, the cost hierarchy for each valuation method is followed.

When using Standard Cost, the cost is always calculated from the item. If the standard cost is set to zero, the last total unit cost is used. If the last total unit cost is set to zero, the average unit cost from the item's warehouse is used. If the average unit cost from the item's warehouse is set to zero, then the average unit cost of the item is used.
When using Average Cost, the cost is always calculated from the item's warehouse. As long as there is a quantity in the warehouse and the warehouse value is zero, the cost will remain zero; however, if the quantity on hand is zero and the item is oversold or over-issued, the cost hierarchy will be used.

Note For average cost items, if the quantity on hand is negative, the average cost will be an estimate because the actual cost is not yet known. If an item's quantity is expected to perpetually remain negative, use the FIFO, LIFO, or standard cost valuation method instead.

When using LIFO, FIFO, Lot, or Serial, the cost is always calculated from the item's vendor last unit cost. If the Include Allocated Cost in Default Unit Cost check box is cleared in Purchase Order Options, the last allocated unit cost is subtracted from the item's vendor last unit cost. If the item's vendor last unit cost is set to zero, the last total unit cost from the item is used. If the Include Allocated Cost in Default Unit Cost check box is cleared in Purchase Order Options, the last allocated unit cost from the item's last total unit cost is used. If the item's last allocated unit cost is set to zero, the standard unit cost is used. If the standard unit cost is set to zero, the item's warehouse average unit cost is used. If the item's warehouse average cost is set to zero, then the average unit cost of the item is used.
If the purchase unit of measure does not match the standard unit of measure, the unit price is converted to the purchase unit of measure.

In the Sales Order module, the valuation method of an item determines what cost is used during data entry.

The hierarchy begins with pricing methods. When using a pricing method that is a markup percentage or a markup amount and the standard cost is zero, then the cost hierarchy specified for each valuation method is followed to determine the unit price.
When using Standard Cost, the cost is always calculated from the item. If the standard cost is set to zero, the last total unit cost is used. If the last total unit cost is set to zero, the average unit cost from the item's warehouse is used. If the average unit cost from the item's warehouse is set to zero, then the average unit cost of the item is used.
When using Average Cost, the cost is always calculated from the item's warehouse. If the average unit cost from the item’s warehouse is set to zero and there is quantity on hand (positive or negative), the cost will be zero. If the quantity on hand in the warehouse is zero, then the cost hierarchy will be used, starting with the item’s last cost. If the last cost is zero, then the standard cost will be used, and if the standard cost is zero, the item’s average cost will be used. If the item’s average cost is zero, then having exhausted the cost hierarchy, the cost will be zero..
When using LIFO, FIFO, Lot, or Serial, the cost is always calculated from the item's last total unit cost. If the last total unit cost is set to zero, the standard unit cost is used. If the standard unit cost is set to zero, the item's warehouse average unit cost is used. If the item's warehouse average cost is set to zero, then the average unit cost of the item is used.
The unit cost is multiplied by the unit of measure conversion factor in Common Information.

Note If this is a sales order from a RMA return and the original sales invoice had the cost overridden, it will use that cost.