Types of Costing

Summary

 

Oracle Cost Management provides several alternative cost methods.  Generally, each Inventory Organization has its own perpetual cost method.  The available methods are Standard, Average, FIFO, and LIFO Costing.  We will describe these perpetual methods first and provide some guidance on selecting the costing method.  At the end , we will discuss the optional periodic cost methods.

 

Standard Costing

 

Standard Costing is the original costing method that Oracle had for manufacturing and distribution customers.  In Standard Costing, each item has a cost defined for each inventory organization.  Different Inventory Organizations can have either the same or different standard costs.  The costs can be directly defined or rolled up from components and lower level assemblies.

 

Organizations that use Standard Costing control their cost by reviewing variances. 

 

An item that is bought with a purchase order price different from the standard cost generates a Purchase Price Variance (PPV).  If the invoice is different from the purchase order price, it generates an Invoice Price Variance (IPV). 

 

An assembly that is built has a standard cost.  Each job that produces assemblies may create variances.  Oracle separates the variances for material, resources (labor or machines), overhead, and outside processing (OSP).

 

Inventory moves around the organization and is tracked at its standard cost.  When the actual cost is different from the standard cost, a variance is created.

 

 

Actual cost methods

 

Oracle has three perpetual actual cost methods.  They are actual in that they are not based on standards.  Each of the methods is considered as Generally Accepted Accounting Principle (GAAP).  The actual methods are Average Costing, FIFO, and LIFO.  We will compare and contrast these methods.

 

Average Costing

 

Every receipt in Average Costing may change the average cost.  The purchase order receipt is valued at the purchase order price plus the material overhead that may be applied at the time of delivery to inventory.  This cost is included in the pool of costs for that item.  The total cost for the item is divided by the new quantity and a new average cost is calculated.  This new cost will be use for issue transactions of this item.  If an invoice is matched to a receipt, the IPV can be moved to inventory, changing the average cost.

 

Accounting for interorganization transfers is similar to purchase order receipt.  However, the timing of the reaveraging is based on the change in ownership (the FOB point).

 

When an assembly is completed from a job in Oracle Work In Process (WIP), the cost of the completion is relieved from the job and goes into inventory.  As with the receipt above, a new average cost is calculated.

 

Cost can be changed manually with an Average Cost Update transaction.

 

FIFO Costing (First In First Out)

 

Every delivery of a receipt in FIFO Costing creates a new cost layer.  The purchase order receipt is valued at the purchase order price plus the material overhead that may be applied at the time of delivery to inventory.  This cost is the cost for the new layer.  Each layer’s cost is kept separate but we do display a FIFO cost that is a weighted average of all the layers.  Issue transactions (consumption) will use the first layer first.  Issues that require a combination of layers are costed at the weighted average of the appropriate combination.

 

Accounting for interorganization transfers is similar to purchase order receipt.  However, the timing of the creation of layers is based on the change in ownership (the FOB point).

 

When an assembly is completed from a job in Oracle Work In Process (WIP), the cost of the completion is relieved from the job and goes into inventory, creating a new layer for the assembly. 

 

How do I pick the costing method?

 

Usually a company already has a costing method.  They will be reluctant to change their costing method because both the stock holders and the taxing bodies will need a complex explanation of the reasons and the results.  In government terms, this requirement is a Cost Impact Study.  Our job is to tailor our costing methods to help them avoid the dreaded Cost Impact Study.

 

However you may be asked the pros and cons of the different methods.  This question is similar to asking, “Which religion should I join?”  It’s a rhetorical question.  They probably want to know what cost methods we support and how well we support them.

 

 

Attributes of Standard Costing compared to actual costing.

 

Variances place the responsibility very specifically.  Each variance account can be the responsibility of a particular person.  After standards are set, job performance is primarily determined by the person’s variance.

 

Product Managers are responsible for their sales and gross margin based on standard cost.

 

Much of the accounting effort is setting standards and analyzing variances.

 

Since transactions are costed at standard costs, they can be costed before actual cost are collected.

 

Attributes of actual costing compared to standard costing.

 

Since transactions are costed at actual cost, variances are rare.  IPV can be included in the item unit cost.

 

Since items are transacted at actual cost, cost should be collected before issuing the item.  Receipts and issues are costed in the same sequence as the transactions are entered.  Allowing inventory to have a negative quantity balance may introduce variances.

 

Similarly, completions from WIP should be processed after the charges to the job.  The WIP cost processor will cost all those charges before it costs the completion transaction.  If some charges are incomplete, an algorithm provides an approximate cost.

 

Product Managers are responsible for their sales and gross margin based on actual cost.

 

Accounting effort is reduced.  Cost history and trends subtitute for variance analysis

 

 

Attributes of Average Costing

Average Costing is an actual costing method.  Transactions are costed at the average cost of the item in the Inventory Organization.

Each receipt of an item causes the item’s average unit cost to be recalculated.

IPV can be posted automatically or with a review step.

An Average Cost Updated can be used to change the item unit cost.

 

Attributes of FIFO Costing (First In First Out)

 

FIFO costing is an actual costing method.  Each receipt creates a separate layer with a separate cost. 

A Layer Cost Update can be used to change the item unit cost one layer at a time.

The issues are costed based on the assumption that the first layer  created is the first layer consumed.  The physical consumption may or may not be FIFO.

Returns create new layers rather than adjusting existing layers.

Layers of components are held in WIP jobs.

The only times the system will specify a layer are the Return to Vendor (RTV) and Assembly Return transactions.  It uses the appropriate Purchase Order Layer of WIP job.

 

Attributes of LIFO Costing (Last In First Out)

 

LIFO is the same as FIFO except that the consumption rule is opposite.

 

Perpetual versus Periodic Costing Methods

 

Each Inventory Organization must select a perpetual costing method from the four available methods.  These methods are perpetual in that transactions are costed during the accounting period.  Optionally, periodic costing methods can recost the transactions without disturbing the original cost.  Although preliminary periodic costing can be run during the period, the final periodic costing is run after the accounting period close.

 

Periodic Costing

 

Periodic Average Costing (PAC) and Incremental LIFO costing are optional cost methods.

One or both can be cost all the transactions in a period without disturbing the perpetual costs.  Each periodic costing method can create one or more user defined cost types.  The cost types may differ from each other by calendar, rates, or status (open period).

 

Only one cost type should be transferred to General Ledger.  In Brazil, some companies use monthly PAC and do not distribute their perpetual costing method’s transactions.  The system provides strong warning if more than one cost type has a transfer to General Ledger enabled.

 

Incremental LIFO is only used in Italy.

 

Periodic Costing can be the most accurate costing method.

By recosting after the period, you can

·         Match invoices to receipts including additional invoices for freight, duty, and tax.

·         Use fully absorbed resource rates based on the actual costs and actual usage.

·         Use fully absorbed overhead rates.

·         Recost all the jobs based on the just calculated costs of components.

 

You can combine inventory organizations within a Legal Entity to arrive at a periodic average cost for that Organization Cost Group.

 

You can specify periods of a month, quarter, year, or all three.

You can set up cost types with different rates.

 

You can use the PAC cost to set standard costs or compare them to your perpetual actual cost.

 

Remember: Only one cost type should be transferred to General Ledger.  A perpetual costing method must be specified and may be used to provide management information during the period.  If you intend to transfer a PAC cost type to General Ledger, do not transfer the perpetual methods cost type to General Ledger.

 

 

Summary

 

Oracle Cost Management cost all transactions in manufacturing and does the accounting for these transactions.  Costing can occur immediately after the transaction or can be over a year later.  Besides Standard Costing we provide several different actual costing methods.