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Auto Reorder Selection, Auto Generate from Sales Orders, Purchase Order Entry, Receipt of Goods Entry, Return of Goods Entry, and Material Requisition Issue Entry use a hierarchy to define how cost types are used.

Note For standard and average cost items in Purchase Order Entry, Receipt of Goods Entry, 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.

Hierarchy of Costs for Purchase Order Entry, Receipt of Goods Entry, Return of Goods Entry (one-step), Material Requisition Issue Entry (with a Purchase Order number assigned), and Auto Reorder Selection:

• The Vendor’s price level is used; however, if a vendor’s price level does not exist, then the primary vendor's last cost specified in the Item Vendors Maintenance window is used. If this value is zero, the item's last cost is used. If the last cost is zero, then the valuation methods listed below are used.

Hierarchy of Costs for Auto Generate from Sales Orders:

• In Auto Generate from Sales Orders, when Costing Hierarchy or Last Unit Cost is selected in the Update Unit Cost With field, the primary vendor's last cost is used from the Item Vendors Maintenance window. When Standard Unit Cost is selected at the Update Unit Cost With field, the item's standard cost is used. When Average Unit Cost is selected in the Update Unit Cost With field, the item's average cost is used. If any of the costs are zero for the above selections, the unit cost used follows the cost hierarchy based on the valuation methods listed below.

 

 Valuation Methods

 

Standard Valuation

The standard cost from the Item file is used. If the standard cost is zero, the unit cost defaults to the last cost. If the last cost is zero, the unit cost defaults to the warehouse average cost. If the warehouse average cost is zero, the unit cost defaults to the item average cost.

Standard cost is the simplest inventory valuation method. When this method is used, the cost is determined by the value assigned for the item in the Standard Cost field in Item Maintenance. The standard cost does not change unless you manually enter a new cost for the item. The total inventory value of each item equals the quantity on hand multiplied by the standard cost. As items are sold, the standard cost is used to determine the cost of goods sold, unless the standard cost value is zero, then the cost hierarchy is used.

This method is appropriate only if you do not track changes in cost as you purchase additional units, and if the standard cost for each item does not change frequently.

When the standard cost value for an item is changed in Item Maintenance, no automatic general ledger postings are made to reflect the change in the total inventory value. These adjustments must be made manually using General Journal Entry.

When items are received into inventory using Transaction Entry or the Purchase Order module, the difference between the cost received and the standard cost is posted to the adjustment account.

 Average Valuation

The warehouse average cost from the Item file is used. If the warehouse average cost is zero, the unit cost defaults to the item average cost. If the item average cost is zero, the unit cost defaults to the last cost. If the last cost is zero, the unit cost defaults to the standard cost.

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.

Average cost is the most commonly used method of costing inventory. Each time new units of an item are purchased (received), a new average cost is calculated. The total inventory value of an item is the quantity on hand multiplied by the average cost. The cost of items shipped (issued or sold) equals the quantity multiplied by the average cost. As items are sold, the warehouse cost is used to determine the cost of goods sold.

The calculation performed during a receipt update is:

(Total cost of the warehouse quantity on hand + total cost of the quantity to be received) / (Total warehouse quantity on hand + total quantity to be received)

The following table illustrates how the average cost changes as receipts and issued are entered.

Transactions	Qty on Hand	Total Cost $	Avg Cost $
Opening Inventory	0	0.00	0.00
Receive 100 @ $5.00 each	100	500.00	5.00
Receive 200 @ $6.50 each	300	1800.00	6.00
Issue 50 @ $6.00 each	250	1500.00	6.00
Receive 250 @ $7.00 each	500	3250.00	6.50
Issue 100 @ $6.50 each	400	2600.00

 

 LIFO/Lot/Serial Valuation

The last cost from the Item file is used. If the last cost is zero, the unit cost defaults to the standard cost. If the standard cost is zero, the unit cost defaults to the warehouse average cost. If the warehouse average cost is zero, the unit cost defaults to the item average cost.

• The Last-In, First-Out method assumes that the last units purchased (last in) are the first units issued (first out). This method is most appropriate for businesses that value inventory based on the oldest purchases.

Like the FIFO method, the actual cost associated with each unit received into inventory is recorded for each item. The receipt date, quantity received, and unit cost are recorded as a cost tier for the item. As items are sold, the most recent cost tier (with the latest receipt date) is used to determine the cost of goods sold, thereby matching the most current cost to the current revenue.

When all units associated with the most recent cost tier are sold, the next most recent cost tier is used. During period-end processing, all cost tiers with a zero balance are removed. There are no limits to the number of cost tiers that can be maintained for an item.

Using this method for items with low turnover rates (the quantity on hand is high compared to the quantity sold) results in an inventory valuation that differs significantly from the current purchase costs.

• Items can be grouped and identified by lots for costing and tracking purposes. The Lot Number method is appropriate for items that must be identified in groups of units and is often used by food, drug, and chemical manufacturers or distributors.

The quantity and cost associated with each lot is retained for each item. In addition, a lot identification number must be used whenever units are received or issued (sold) out of inventory. If more than one lot is involved in a receipt or issue, each lot number and quantity of the transaction must be entered.

Because the lot number is specified when units are sold, the cost of goods sold matches exactly the purchase cost of the items in the lot.

If the Sales Order module is installed, a detailed sales history of lot numbers can be produced if the Lot Items or Both Lot & Serial is selected in the Retain Lot/Serial Item Sales History field in Sales Order Options. This report includes the invoice number, invoice date, customer, and quantity sold.

• The Serial Number method allows you to identify each item with a unique serial number, and retain the purchase cost of each item separately. This is often required for large-ticket items such as appliances, computers, furniture, and stereo equipment. Because the serial number is specified when units are sold, the cost of goods sold matches exactly the purchase cost of the items in the lot.

Serial number costing differs from lot number costing in that only a single unit can be assigned to each serial number. If the Sales Order module is installed, a detailed sales history by serial number can be produced if Serial Items or Both Lot & Serial is selected in the Retain Lot/Serial Item Sales History field is selected in Sales Order Options. This report includes the invoice number, invoice date, customer, and quantity sold.  

 FIFO Valuation

The last cost from the Item file is used. If the last cost is zero, the unit cost defaults to the standard cost. If the standard cost is zero, the unit cost defaults to the warehouse average cost. If the warehouse average cost is zero, the unit cost defaults to the item average cost.

The First-In, First-Out method assumes the first units purchased (first in) are the first units issued (first out). This method is appropriate for businesses that value inventory based on the most recent purchases.

Unlike the Average Cost method, the FIFO method retains the actual cost associated with each unit received into inventory. The cost information for each receipt consists of the receipt date, quantity received, and unit cost, and is recorded as a cost tier for the item. As items are sold, the oldest cost tier (the cost tier with the oldest receipt date) is used to determine the cost of goods sold, thereby matching the oldest cost to the current revenue.

When all units in the oldest cost tier are sold, the next oldest cost tier is used. During period-end processing, all cost tiers with a zero balance are removed. There are no limits to the number of cost tiers that can be maintained for an item.

The Simple Moving Average method is used to calculate average cost and average cost per warehouse. Utilizing this method, a standard cost inventory item can generate a negative average cost if the actual item cost varies significantly from the standard cost.

A negative average cost or negative warehouse average cost should alert you of the possibility that the standard cost is not reflective of the actual costs. You should consider changing to another inventory costing method that more closely matches the characteristics of the inventory item or updating the item's standard cost to reflect current market costs.

The calculation of the average cost during a receipt update for a standard cost item is:

(Total cost of the warehouse quantity on hand + total cost of the quantity to be received) / (Total warehouse quantity on hand + total quantity to be received)

Note Total cost is figured using the standard cost. The average cost calculation for a standard cost item does not affect general ledger postings.

The simple moving average cost for a standard cost item is calculated as follows:

Item	11-12345
Standard Cost	$10.00
Quantity on Hand	10
Actual Dollar Value of Inventory	$100.00
Average Cost	$10.00
Receipt of 10 Units @	$15.00
Quantity on Hand	20
Actual Dollar Value of Inventory	$250.00
Average Cost	$12.50
Sales of 10 Units	(sale price irrelevant)
Quantity on Hand	10
Actual Dollar Value of Inventory	$150.00
Average Cost	$15.00
Receipt of 10 Units @	$1.00
Quantity on Hand	20
Actual Dollar Value of Inventory	$160.00
Average Cost	$8.00
Sales of 18 Units	(sale price irrelevant)
Quantity on Hand	2
Actual Dollar Value of Inventory	-$20.00
Average Cost	-$10.00
The receipt of 10 items at an actual cost of $1.00 is significantly less than the standard cost of $10.00.

 

LIFO/FIFO/Lot/Serial Valuation

The last cost from the Item Cost file is used. If the last cost is zero, the unit cost defaults to the standard cost. If the standard cost is zero, the unit cost defaults to the warehouse average cost. If the warehouse average cost is zero, the unit cost defaults to the item average cost.

For more information, see:

Calculating Extension Amounts

Vendor Price Level Maintenance