To ensure that a business is profitable, the business must be able to effectively measure and control its costs. To evaluate the available inventory and cost of goods sold, many businesses use the weighted average cost (WAC) method as a reliable measuring of costs and for inventory valuation. Proper valuation of costs is the base for proper determination of profit or loss.
In FirstBIT ERP, the costs of inventory, costs of goods sold, costs of services are calculated automatically by the Month-End Closing service tool.
The options available for cost calculation on the Accounting > Service Tools > Month-End Closing form define the stages of cost calculation:
- Calculate Direct Costs: This option enables calculation of weighted average costs of the ending inventory and cost of goods sold.
- Allocate costs: Generally, this option is used if your company enabled the Production module to account for production of the goods. The option enables allocation of the overheads and work in process to finished goods by using the Cost Allocation Methods with Cost of Goods / Services selected as allocation type. Also, this stage can be used if your company defined custom allocations to allocate some specific expenses to work in progress or cost of goods sold or any other allocations specific to your business.
- Calculate Actual Costs: If selected, this option enables calculation of actual costs of finished goods. Also, it enables updating of costs of inventories, sold goods and services based on the direct costs and the allocated costs.
If needed, you can manually allocate specific costs by creating Manual Cost Allocations. You must perform manual cost allocations before you run the period closing process. The accounts involved in manual allocations, will not be processed by the automatic allocations.
Cost estimations during the period
If you need to estimate costs during the current month, you can select the Calculate Costs in Credit Notes, or Show Costs in Sales Documents, or both options on the Administration > Settings > Sales form. Then, for particular items listed in a document (Credit Note, Invoice) the average weighted costs will be calculated based on the data available on the date of the document, that is, beginning costs and purchases of this item incurred before the transaction date.
Direct Cost Calculation
The period closing process performs calculation of direct costs if the Calculate Direct Costs option is selected on the Month-End Closing form. The process includes calculation of the average costs for inventory for sale and cost calculation for finished goods produced during this financial period.
Inventory for Sale
When ordering goods and materials from different suppliers, the company receives the same items with different costs. Sometimes, items are packed differently and measured in different UOMs. The weighted average cost method assigns the same unit cost to items from different supplies, with larger or smaller quantities, with higher or lower prices, and originally measured in different UOMs.
The cost calculation is performed for the base UOM of the item with specific characteristic or included in a specific batch, recorded to a specific GL account, stored in a specific warehouse, owned by specific entity, that is, for a unique set of the following parameters: Item / Characteristic / Batch / Warehouse / Entity.
Using this method, to find the average cost of specific item, you need to calculate the sum of all costs (including the additional expenses) and divide by the quantity of base units available for sale. The weighted average method is also used as a method for inventory valuation, see Inventory Valuation.
Each item with a serial number may have unique cost based on purchase price with additional expenses (if specified so) allocated in the basis invoice and history of transactions.
Once the average cost are calculated, the application adjusts the costs of sold goods for each transaction recorded and posted during the period including customer returns.
Finished Goods
If the Production module is enabled (on the Administration > Settings > Production form), the average costs of finished goods are also calculated. Generally, direct costs of finished goods are recorded by using the following documents:
- Production Orders
- Productions
- Goods Receipt Notes
- Inventory Transfers
- Bills of Materials
Depending on production processes established in your company, only some of these documents can be involved. Once the direct costs are calculated, the application adjusts the costs of finished goods in sales and return documents.
Allocation of Indirect Costs
Allocation of costs is the next stage of cost calculation. Allocation of indirect costs is performed by the Month-End Closing service tool if the Allocate Costs option is selected on the Accounting > Service Tools > Month-End Closing form.
Default (out-of-the-box) cost allocations are intended for distributing the indirect costs and overheads such as administrative costs over finished goods or the goods produced during the current period. Also, work in progress can be allocated to costs of finished goods.
Allocations are executed in accordance with allocation settings and allocation methods available in the system:
- Accounting > See also > Allocation Settings: Using this form, you can define multiple sources of expense amounts and specify whether they should be transferred to some target accounts or allocated by specified allocation method.
- Accounting > Master Data > Allocation Methods: Using this form, you can review the available allocation methods and add new ones. Each allocation method defines how exactly an amount should be allocated. Generally the method refers to specific data which is used as the base to calculate the proportion for allocation. For more information refer to The Bases for Allocations.
By default, at this stage of costs calculation, allocation methods of the Cost of Goods/Services allocation type are used. As the bases for allocation, the following predefined bases can be used:
- To the Product Cost GL Accounts based on actual production costs: The allocation source amounts will be distributed between GL accounts intended for recording the production costs of specific finished goods proportionally to direct production costs of these goods.
- To the Product Cost GL Accounts based on production volumes: The allocation source amounts will be distributed between GL accounts intended for recording the production costs of specific finished goods proportionally to the manufactured quantities of these goods.
If your business needs more specific allocations, other allocation settings and methods can be added by the implementation team or upon request.
For more details on allocations refer to Overview of Cost Allocations.
Calculation of Actual Costs
Actual costs refer to the costs that actually incurred; they comprise the direct costs and the allocated costs. Once the indirect costs are allocated, the application calculates the average costs where applicable, revalues the finished goods that are available for sale, and adjusts the costs of finished goods in sales documents and return documents.