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Mar 30, 2013

Which costing method is best in an ERP implementation?

I am a member of Linkedin, and I participate a lot in the discussions. They are fun and also gives you different perspectives.

One of the discussions that is ongoing is "Which costing method is suitable in ERP Implementations?"

For those of you who do not know, I am kind of an expert in Costing Implementations in ERP. I have implemented (was the first one in the world, I think) Lot Costing, Periodic Moving Average Costing, Transaction weighted average costing and Standard costing. Only the ones missing are Fifo and Lifo.

I gave a response to that mail. For your benefit, I am giving my response below.

There are mainly two reasons why organizations do costing. One, to load the costs into the items so that your margins can be accurately calculated. There are many variants to this theme. This is termed as actual costing, average costing, FIFO etc.Organizations normally use this in two kinds of scenario. One, if the costs are volatile, like for example if your ingredient is gold and two, if you are in a traditionally low margin industry, in which case, more than analysis, you use costing information for product pricing decisions and profitability analysis.

There may be another reason to use actual costing, If you are in a sellers market and if you cannot control the prices, you will benefit by using average or actual costing.

On the other hand, if you are in a kind of stable industry and environment, your supply chain is very predictable and you have some control on the supply chain, you are better off using Standard costing. In this case, analysis is more important for you than loading all the costs into inventory.

Whichever is the costing method you are using, you have to be aware of the disadvantages of that method. While actual costing cannot give you any analytical inputs, a major drawback of Standard Costing is that analysis reports are used as a tool to punish those who are responsible for the actions.

Normally, organizations use actual costing in the initial phase of the business, average costing during the growth phase and standard costing during the mature, steady state phase.

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