What Is a Costing Method?

I’ve been going through a number of inventory management terms for the past few weeks to make sure you’re familiar with them. Last week I defined Cycle Counting. Next up is Costing Method. Costing Method – The way that a final product’s total cost is calculated. That definition is a little vague, so let’s go through the main costing methods so you can see how they work:

• First in, First Out – FIFO applies the cost of the oldest product to newer copies of that product, even if it’s not the same.
• Last in, First Out – LIFO is the opposite of FIFO. It applies the cost of the most recent product to every other copy, no matter when it was purchased.
• Average Cost – Instead of using the amount you spent to get a particular item, you take the average of how much it cost to get every copy of it over time.
• Standard Cost – Manufacturers add up the costs of all the parts in a bill of materials, labor costs, and other costs incurred in the manufacturing process to come up with a final cost for each final product.
• Actual Cost – Similar to Standard Cost, this method compares the actual costs incurred in building a product to what is listed in a work order.
• Landed Cost – This goes beyond the manufacturing of a product and includes costs related to delivery, taxes, duties, and any other applicable fees.

Costing methods let you figure out how much you’re spending on products. This helps with accounting, pricing products, and other parts of running your business. The most important thing isn’t necessarily which one you use but that you’re consistent in using whichever one you choose. Come back next week to learn another inventory management term.