Costing Methods

A costing method is the means by which an item or service’s total cost is calculated. This allows a business to determine their asset valuation for accounting and inventory management purposes. Because not every item or service is manufactured or sold in the same manner or timeframe, there is more than one way to make this calculation.

A costing method is permanent once you go live

Before you go live with your Fishbowl Drive account, you will need to select a costing method. This is a very important step that has huge ramifications. Keep in mind that you won’t be able to change your costing method after you click the Go live button in the Company section of the Settings module under the Setup module group.

If you ever wanted a different costing method in the future, you would have to delete your database and create a completely new one. So choose wisely, and then stick with your choice. If you are unsure which costing method to choose, you should check with your accountant.

To help you make this crucial decision, we have put together the following explanations of the four costing methods found in Fishbowl Drive.

There are four costing methods available in Fishbowl Drive:

• Last In, First Out (LIFO)
• First In, First Out (FIFO)
• Average Cost
• Actual Cost

LIFO

LIFO applies the cost associated with the newest unit of an item you have in stock to a unit being sold. So whichever unit you most recently purchased will be used as the cost of goods sold for a specific item, even if those units sold are older and were purchased at a different cost. As you replenish your stock, you will continue to apply the newest units’ cost to transactions.

Profitability Changes - This affects profitability measurements. Under this setup, units that are sold will always reflect the most recent amount of money paid to obtain that type of item, even if the actual amount paid for it was higher or lower in the past.

Tracking Methods - No tracking method is necessary to make LIFO work in Fishbowl Drive. If there is no lot number, serial number, or expiration date assigned to a unit, it will be organized by its receipt date.

Uses and Applications - Manufacturers and distributors of nonperishable items (e.g., cookware, fasteners, and tools) will most likely want to use LIFO.

FIFO

FIFO is basically the polar opposite of LIFO. FIFO applies the cost associated with the oldest unit of an item you have in stock to a unit being sold. It doesn’t have to be that exact old unit that was sold, but it will be accounted for as if it was. Newer items could have been purchased for more or less than older ones, but their costs won’t be recorded as the cost of goods sold until all of the older ones have been sold.

Profitability Changes - This affects profitability measurements. Under this setup, units that pass their expiration date and can’t be sold are scrapped at the later cost, while units that are sold have earlier costs associated with them. The difference in these costs can vary, depending on inflation and other factors.

Tracking Methods - No tracking method is necessary to make FIFO work in Fishbowl Drive. If there is no lot number, serial number, or expiration date assigned to a unit, it will be organized by its receipt date.

Uses and Applications - Manufacturers and distributors of perishable items (e.g., food, medicine, and fuel) will most likely want to use FIFO.

Average Cost

Average Cost adds up the cost of every unit you have in stock and divides that total cost by the number of units. This calculation is done on a per-item basis. It produces a mean average that gets applied to each unit’s cost of goods sold. This is a compromise between LIFO and FIFO by taking both extremes into account in calculating the unit cost. The average will only change when new units are added at a different cost than the ones currently in stock. It won’t change when units are sold. Please note that the average cost will reset to 0 if an item's on-hand quantity reaches 0.

Profitability Changes - This smooths out the variability in profitability by averaging all costs out to a single number applied to all units, no matter when they were purchased.

Tracking Methods - Since all units are taken into account, there is no need for detailed tracking to distinguish them by age. When new units are received into inventory, they may affect the average cost. But there will be no effect on the average when units are removed from inventory through sale, use, or scrap.

Uses and Applications - Distributors of fast-selling items will most likely want to use Average Cost.

Actual Cost

As its name implies, Actual Cost uses the actual cost of each item. Unlike LIFO and FIFO, which simply ascribe a cost to a specific unit irrespective of how much it truly cost to obtain it, Actual Cost makes sure to pinpoint exactly how much it cost to obtain that unit and then apply its cost when it’s sold or consumed. It does this by using tracking criteria associated with each unit. In a situation where items don’t have any tracking assigned to them, Actual Cost will be replaced by FIFO.

Profitability Changes - Generally, a FIFO picking strategy is used to ensure older items are sold before newer ones. That way, there’s a lower chance of older units expiring or becoming obsolete before they can be sold. And your profitability measurement of each unit that is sold will be accurately recorded.

Tracking Methods - Lot numbers, serial numbers, and/or expiration dates must be tracked on all items for Actual Cost to work in Fishbowl Drive. If an item doesn’t have at least one of these tracking methods activated, FIFO will be used instead of Actual Cost for it. That’s because Actual Cost requires a high degree of visibility and accuracy in order to record each unit’s cost of goods sold. When that isn’t available, it will revert to FIFO.

Uses and Applications - Manufacturers that have a lot of customization and fluctuations in raw-material costs will likely want to use Actual Cost.

NOTE: Only the values from the Costing method in the Settings module will be used across Fishbowl Drive. At any given moment, each costing method is likely to have a different Total Cost. For example, the FIFO/LIFO total cost is the only the sum of the remaining costing layers. Average Cost incorporates previous costs that are not visible in the remaining costing layers. Average Cost is not the same thing as the average of the remaining costing layers. Additionally, values sent to your accounting system may not reflect the physical inventory that you are consuming. You could theoretically be using a FIFO picking method, and a LIFO costing method. Different costing methods will give different values throughout time. If you were to compare the costing methods after selling all your inventory, the total values in your accounting system would be equal. However, while you have inventory, the values displayed in each costing method can be significantly different, so it is important to remember that only the values for the current Costing method will be used.