Station 6 of 10
Inventory and costing in Oracle NetSuite
What you leave this station with
Calculating the effect of the valuation methods by hand, choosing a method per item with an argument, and reading the count entry and explaining its differences.
This question has been deferred twice: at the item card in station three, and at cost of goods sold in station five.
It is answered now — by calculation rather than by definition.
The measurement first: the difference in numbers
Valuation methods are not understood from their definitions; they are understood by calculating them. Take one movement on one item:
| Movement | Quantity | Unit price |
|---|---|---|
| Opening balance | 300 | 20 |
| Purchase | 200 | 30 |
| Sale | 400 | — |
| Method | The cost calculation | Cost of sales | Remaining stock |
|---|---|---|---|
| First in, first out | (300 × 20) + (100 × 30) | 9,000 | 100 × 30 = 3,000 |
| Average | 400 × 24 | 9,600 | 100 × 24 = 2,400 |
| Standard at 26 | 400 × 26 | 10,400 | 100 × 26 = 2,600 |
The gap between the highest figure and the lowest is 1,400 on one item and one movement — around 15 per cent of cost of sales. Multiply it by a thousand items and a full year, then read again any income statement you have ever seen.
Anybody choosing the method without that calculation chooses out of habit, and is asked a year later why the margin is not what was expected.
The method named for its due and warned against
The product also offers last in, first out.
Naming it is obligatory, and warning against it equally so: it is not accepted under the international financial reporting standards. Its presence in the list is not permission to use it, and any company reporting under those standards does not choose it.
That is a point a consultant is expected to know and a user is not — and it is one of the cheapest questions there is for showing the difference between them in an interview.
And there is a fifth method worth naming: specific identification, where each unit is tracked in itself by its serial number or its lot. It is the only correct method for anything tracked individually — pharmaceuticals, vehicles, and anything with an expiry date.
The method is chosen on the item, not on the company
Here is a point many people do not know: the choice is not one decision for the whole company.
Every item carries its own method. Which means a single company may value its raw materials at average, its serial-tracked products at specific identification, and its spare parts at standard — and all of it is right, because every item has its own nature.
That is a freedom whose price is discipline. Anything left at the default while a thousand items are created produces a company that valued everything by a method nobody chose.
The rule: the method is written into a policy by item category, a default is set per category, and it is never left to whoever is keying the record.
Costing at location level
The second question after the method: at what level is it calculated?
One item in two warehouses may have two costs, because the cost of getting it to each differs — inland freight, or customs, or a different supply route.
| The level | When it fits |
|---|---|
| The item alone | One warehouse, or identical delivered costs |
| The item by location | Distant warehouses with different delivered costs |
Anybody choosing the first level and then opening a warehouse in another country reads an average blending two costs with nothing in common — and reads one branch’s margin against another branch’s cost.
Transfers between locations — a movement that looks neutral and is not
Moving goods between two warehouses changes neither ownership nor total quantity.
But it changes the cost at both ends, and changes what is available at each location, and if the two locations sit in two different entities it is an intercompany sale with everything that implies — with a profit that appears and must be eliminated on consolidation, as was said at station four.
The common error is treating a transfer between entities as a transfer between warehouses. An internal profit then appears inside inventory and lives there until it is sold — one of the hardest things to find in an audit.
The physical count and its entry
A count compares what is in the warehouse against what is in the system, and the difference is posted as an entry — debit or credit to stock, against an inventory variance account.
The difference is usually not a system error; it is damage nobody recorded, or a shipment that left with no document, or a unit-of-measure mistake, or an item posted to the wrong location.
The discipline that separates a serious count from a ceremonial one: closing the period once the count is approved, so nothing is posted into it retrospectively.
A count that is approved and then has movements added to it afterwards is a count with no meaning — and periods actually get closed at station seven.
What you actually do at this station
- Calculate the example above on paper under all three methods, and produce the six figures before reading the table again.
- Repeat it with your own numbers on an item from your work, and write the difference as a percentage.
- Write a valuation-method policy for an imagined company with four item categories, with an argument for each category.
- Write an example of one item in two warehouses with two delivered costs, and calculate the average at both levels and compare.
- Write the difference between a transfer inside an entity and one between entities, and what gets eliminated in the second.
- Write four plausible causes of a count difference, and the adjustment entry for both a surplus and a shortfall.
The three commonest errors
One: choosing the method without calculating. It gets chosen because it is the default, and a year later somebody asks why the margin is not what was expected.
Two: item-level costing with distant warehouses. It works until the second warehouse opens, then blends two costs without anybody noticing.
Three: a transfer between entities treated as a transfer between warehouses. It hides an internal profit inside the inventory value, and it surfaces only in an audit.
What the valuation method does to reading a company’s numbers is set out in the Oracle NetSuite guide, and the general logic of inventory and costing — independent of any product — is in the inventory and costing cycle.
The acceptance test for this station
- Calculate the example under all three methods and produce the six numbers with no system.
- Name a method the product offers and the international standards do not accept, and why.
- Explain why the method is chosen on the item, and the price of leaving that to whoever keys the record.
- Explain when costing is calculated at location level, with an example.
- Explain the difference between the two kinds of transfer, and the error that comes from confusing them.
What comes next
You know where the numbers come from. The next station gathers them and closes them: the close and the reports — containing the capability this product is bought for in the first place, and the skill that gets you hired in your first week.