For Clarity, Costing Methodology Explained (And Why Cetec ERP Offers the Best Costing Approach)
Why do we need to define costing methods?
The nature of ERP technology today, with its wide-ranging capacities, is such that a “standard” definition for concepts like various costing methods can be hard to come by. Because there are many ERP systems running off of decades-old technology, it’s hard to compare how they might define something like “actual costing” versus how we define it in the Cetec ERP platform. For many ERP companies running off of outdated (and outrageously expensive) technology, what they call “actual costing” is not really actual at all.
In order to demonstrate in reality what Cetec ERP’s cost accounting program is actually capable of (wink, wink!), we must properly define the costing methods most likely to be employed by Cetec ERP companies. In order to do that, let’s first start with some terms.
Part Receipt Cost
In Cetec, this field represents the cost at which product is received. This cost is defaulted to the cost indicated on the PO received against, but can be overridden if needed.
Part Standard Cost
This (optional) field represents a predetermined, fixed price manually defined on the part master.
Part Average Cost
This field represents the average cost for the part based on all receipts of stock to inventory. Average Cost = [ Bin1 (receipt cost x qty) + Bin2 + Bin3 + … + BinN ] / [ Total QOH (Quantity on Hand) ]
Now, what are the costing methods?
Average Costing
Under this method, general ledger COGS transactions write cost per the “part average cost” defined above. E.g. an invoice for a BOM containing a component that was received at $5.00, but has a current average cost of $6.00, will drive an inventory COGS transaction at $6.00, effectively overriding the actual cost of the transaction. Most manufacturers do not find the average costing method sufficient due to potential time lags between was the cost “was” versus truly seeing the actual cost variances throughout manufacturing.
Standard Costing
Under this method, general ledger COGS transactions write cost per the “part standard cost” defined above. E.g. an invoice for a BOM containing a component that was received at $5.00, but has a standard cost of $6.00 defined on the item master, will drive an inventory COGS transaction at $6.00, effectively overriding the actual cost of the transaction. Note that the “standard costs”, i.e. the predetermined fixed prices, are defined in an attempt to approximate actual costs (per GAAP requirement). Standard cost definitions require constant care/feeding/adjustment to do achieve this accurately.
Actual Costing (also: FIFO or LIFO Costing)
Under this method, general ledger COGS transactions write cost per the “part receipt cost” defined above. E.g. – an invoice for a BOM containing a component that was received at $5.00 (and then “picked” for an order) will drive an inventory COGS transaction at $5.00. Cetec can track source PO receipt cost all the way through the build process to the invoice to the corresponding ledger entries if Actual costing is enabled. Note that this method is often referred to as “FIFO/LIFO” costing.
Why does Cetec ERP stand out among other ERP options when it comes to costing methodology?
Cetec ERP enforces process in the operational areas of sales, warehousing, and order fulfillment to facilitate the tracking of absolutely “real” cost. By default, Cetec ERP posts these actual costs in COGS transactions, per “actual costing method” definition above. Given that GAAP requires that cost be stated as actual, and because Cetec ERP consists of modern technology that can truly achieve actual costing, we believe that this is the ideal costing methodology.
Standard costing and average costing mostly exist as alternatives to actual costing in systems that are not capable of true actual costing. Though there are some reasons businesses might opt for standard costing over true actual costing (noted below), actual costing is the ideal in nearly every way. And with Cetec ERP, it is not only ideal but completely accessible!
Note: Because some may choose to pursue a standard costing methodology in order to track how material prices vary throughout a given period of time, we offer this option as well. If the config setting for standard costing is turned on (“post_variance_to_standard”), Cetec will still post COGS as actual cost, but will also post any variance from actual to standard to a variance account in the G/L, which will tie directly to your P/L.
Cetec ERP ensures true and visible actual costs, rendering the standard costing methodology fully dispensable if the aim is solely for better adjustment of standard to actual. Many ERP systems promise to operate on “actual costing” methodology, but fall short in reality of true actual costing because the technology to facilitate it is just not there. If you’re interested in exploring Cetec ERP’s costing methodology, contact us!