D365 - Understanding inventory costing configurations for FIFO

Introduction

The Inventory parameters and configurations need to be setup properly in order to maintain the inventory cost tracking and the gl in sync. In addition, the modules that integrate with the inventory items need to be setup as well, example of this are parameters from Procurement and Sourcing module, for the purchase orders receipts integration, Accounts payable module for the purchase order invoices integration (for charges, price variances, additional costs, etc.), Accounts receivable and Production parameters as well.

This article focused in the FIFO inventory valuation.

Quick Summary

The below topics are discussed in this article. 

• Inventory and warehouse management parameters
• Procurement and sourcing parameters
• Accounts payable parameters
• Item model groups
• Item groups
• Items
• Charge codes
• Inventory value report ID

Inventory and warehouse management parameters

For the scenarios where sales taxes apply to the inventory items purchased, it is important to activate the parameter ‘Post physical sales tax’ in the Inventory parameters (Inventory management > Setup > Inventory and warehouse management parameters).

This feature will post the estimated sales tax registered in the purchase order to the purchase receipt. The posting will be to the same purchase item cost debit line in the voucher, not a separate line. When the invoice is posted the system will reverse the receipt (as usual) with the sales tax and will post it to a separate sales tax posting type line.

This configuration will help:

• To reduce the discrepancies that may occur during the month between the physical and financial vouchers, for the purchase receipts where the vendor invoice hasn't been posted.
• The Inventory Value report will display the total item cost (including the sales tax), simplifying the inventory sub ledger vs gl reconciliation.

Procurement and sourcing parameters

For the scenarios where charges apply to the inventory items purchased, it is important to activate the parameter ‘Generate charges on product receipt’ in the Procurement parameters (Procurement and sourcing > Setup > Procurement and sourcing parameters).

This feature will post the charges registered in the purchase order to the purchase receipt. The posting will be to the same purchase item cost debit line in the voucher, not a separate line. When the invoice is posted the system will reverse the receipt (as usual) with the charges and will post it to the same item cost line.

This will help:

• To reduce the discrepancies that may occur during the month between the physical and financial vouchers, for the purchase receipts where the vendor invoice hasn't been posted.
• The Inventory Value report will display the total item cost (including the charges), simplifying the inventory sub ledger vs gl reconciliation.

Note – it is important to also activate the ‘Post to charge account in ledger’ in Accounts Payable parameters in order to post the charges to the receipt.

Accounts payable parameters

For the scenarios where charges apply to the inventory items purchased, it is important to activate the parameter ‘Post to charge account in ledger’ in the Accounts Payable parameters (Accounts payable > Setup > Accounts payable parameters).

This parameter works together with the ‘Generate charges on product receipt’ in Procurement parameters in order to post the charges to the receipt. 

Item model groups

Item model groups primarily determines whether the item is stocked or non-stocked, the cost measurement for inventory valuation of stocked items and if the inventory transactions should be posted to the general ledger (Inventory management > Setup > Inventory > Item model groups).

This setup considers two main parameters for the general ledger integration: Post Physical Inventory and Post Financial Inventory:

There's mainly two types of items, the service/non-stocked items and the stocked items. The configuration for both that impacts the inventory costing is discussed below.

Service/non-stocked items – model group configuration

For the service/non-stocked items it is recommended to activate only:

• Financial negative inventory
• Accrue liability on product receipt (if three-way match)

Stocked items – model group configuration

For the stocked items it is recommended to activate:

• Stocked product
• Post physical inventory
• Post financial inventory
• Accrue liability on product receipt (if three-way match)
• Receiving requirements (to require a receipt before an invoice can be posted)

When using FIFO inventory model, the system provides a main option of marking inventory transactions so that a specific receipt is settled against a specific issue instead the system managing the cost settlement. In addition, there’s the option to include physical value that works in combination with the marking inventory to estimate the cost based on the inventory transactions posted for the scenarios where the marking was not completed. For the combination of configuration :

• FIFO without the Include physical value marked – the system uses only the financial receipt transactions to calculate the running average cost price for both the physical and financial vouchers.

For example, for a scenario where four receipts have been posted for the same item with different purchase prices, the system calculates a running average cost based on the financial voucher posted ($20) and uses is as a measurement to settle to a first issue posted for these receipts (assuming no marking inventory is completed).

Later this cost is adjusted to -$10 when the inventory closing process is run.

• FIFO with the Include physical value marked – the system uses both physical and financial receipt transactions to calculate the running average cost price for both the physical and financial vouchers.

For example, for a scenario where four receipts have been posted for the same item with different purchase prices, the system calculates a running average cost based on the physical voucher posted ($21.25) and uses is as a measurement to settle to a first issue posted for these receipts (assuming no marking inventory is completed).

Later this cost is adjusted to -$11.25 when the inventory closing process is run.

Item groups

Inventory sub ledger is integrated to the general ledger based on the item groups configuration. It is important to assign inventory accounts to the item groups that are configured to stocked items, if not discrepancies will be originated between sub ledger and gl (Inventory management > Setup > Inventory > Item groups).

Main accounts can be set for purchases, inventory, sales (and production). The system provides the feature to assign different accounts per posting type. If a detailed main account is not use, it is recommended to assign the same inventory account per posting type, using he account type list in the item groups setup. Below is an example of the minimum accounts that need to be configured for a stocked inventory item.

Note – the Stock variation account type needs to be setup for the posting of purchasing item miscellaneous costs to the receipt.

 Items

There’re three main configurations in the item that impact the inventory costing of the item:

(Product information management > Products > Released products)

• Item model group – defines if the item should be included as inventory value, based on the above discussions.
• Item type – defines if the item is service (non-inventory) or an inventory item. Items with item type not configured as 'Item' will not be treated as inventory items, even have a stocked item model group. 
• Latest cost price – allows the system to assign the latest cost from the purchase order receipt as the cost to assign to the item. The configuration should be inactivated and no cost price should be assigned to the item, in order for the system to assign the FIFO average cost when no marking is completed. 

In scenarios where there’re no multiple concurrent purchases for the same item or the cost never changes, this may be a useful setup, since no multiple costs will exist for the item.

Charge codes

It is recommended to post item miscellaneous charges to the item costs and not only to gl, to maintain Inventory sub ledger and general ledger reconciled (Inventory management > Setup > Charges > Charges code).

The recommended configuration for a purchasing miscellaneous charge codes is to assign Item as Debit and Customer/Vendor as Credit.

The system only posts miscellaneous charges for categories: Pcs, Percent y Proportional, as indicated in the below table:

For the Fixed category no cost will be accounted for at time of posting an item receipt. The cost will still be accounted for at time of invoice.

Inventory value report ID

The Inventory Value Report allows to review any discrepancy between the sub ledger and the gl, as part of the reconciliation process, at transaction level. Details of all inventory transactions is included in this report (if the Summarized setup is not selected). However, details by item number is not included.

It is recommended the following parameters for the Inventory value report (Cost management > Inventory accounting policies setup > Inventory value reports):

• Financial position activated for Inventory and Profit and loss
• Summarize physical and financial value inactivated
• Include not posted to ledger inactivated
• Inventory dimensions selected, if tracking inventory by dimensions

Conclusion

For details of how the inventory cost is adjusted during the inventory closing and reconciliation refer to the article D365 - Understanding Inventory closing and reconciliation processes.