In any business, especially those that manage products and inventories, figuring out how to calculate the cost of goods is super important. How accurately you value your inventory and report profitability really hinges on how those costs are figured and assigned. This is where costing methods and costing levels come in — they’re key components in accounting and ERP-based inventory management. Whether you’re a manufacturing company keeping track of raw materials and finished products or a trading firm managing stock across various warehouses, picking the right costing method and level can really influence your performance measurements, profit reporting, and operational decisions.
What Is a Costing Method?
A costing method is basically a structured way to figure out how much each unit of product or inventory item costs. So, it’s all about how costs get assigned to products when they’re bought, made, or sold. These numbers don’t just sit there; they impact crucial financial metrics like:
- Inventory valuation on the balance sheet
- Cost of Goods Sold (COGS) on the income statement
- Gross profit margins and overall profitability
Since various costing methods assume different things about how inventory moves, your choice can subtly or drastically affect your financials. For example, during inflation, one method might show higher profits while another paints a more conservative picture. So, picking the right costing method isn’t just an accounting choice — it’s a strategic one too.
Common Costing Methods in Business
There are quite a few costing methods out there, each fitting different industries and business goals. Here are some of the most commonly used:
1. First-In, First-Out (FIFO)
The FIFO method operates on the idea that the first items purchased or produced are the first to be sold. This means the oldest stock is sold off first, leaving the newer stuff in inventory.
Example:
If your company bought 100 units of raw material at $10 each, and later bought another 100 at $12 each, FIFO assumes the first batch ($10) gets sold first.
Impact:
- When inflation hits, FIFO usually leads to lower COGS (because older, cheaper inventory sells first) and higher profit margins.
- The remaining inventory reflects current market prices, giving a more realistic view on the balance sheet.
Industries Using FIFO:
Retail, electronics, and consumer goods — where products are perishable, move quickly, or older stock needs to clear out first.
2. Last-In, First-Out (LIFO)
With the LIFO method, the most recently acquired or produced items are sold first. This means that the COGS reflects newer and typically higher prices, while the older inventory stays on the books.
Example:
Using the same scenario as above — if prices are going up, the second batch ($12) would get sold first.
Impact:
- Leads to higher COGS and lower profits during times of inflation.
- Results in lower taxable income, which can be a bonus in certain tax settings.
- Ending inventory shows older prices, which might not match up with current market conditions.
Industries Using LIFO:
Some manufacturing and industrial sectors, especially where LIFO is allowed by tax rules (just a note: it’s not permitted under IFRS).
3. Weighted Average Cost (WAC)
The Weighted Average Cost method balances out price changes by averaging the total cost of inventory items over the total quantity available. Each unit, no matter when it was bought, carries the same average cost.
Formula:
Weighted Average Cost per Unit = (Total Cost of Inventory Available for Sale ÷ Total Units Available for Sale)
Impact:
- Reduces the effect of price swings.
- Makes accounting simpler for businesses that deal with a high volume of similar items.
- Provides a steady view of costs over time, although it might not always reflect the latest market trends.
Industries Using WAC:
Great for businesses like food processing, chemicals, or bulk materials where goods are similar and prices change often.
4. Standard Cost
The Standard Costing method sets a predetermined cost for each product based on expected expenses like materials, labor, and overhead. Actual costs are then compared to these standard costs to assess variances — which can highlight efficiency gains or losses in production.
Impact:
- Streamlines budgeting and performance assessment.
- Promotes cost control and efficiency checks.
- Variances (whether good or bad) need to be looked at regularly.
Industries Using Standard Costing:
Common in discrete and process manufacturing where production costs are predictable and manageable, like automotive, electronics, or pharmaceuticals.
Choosing the Right Costing Method
Deciding on the right costing method depends on a few factors:
- Nature of the business: Are you making unique products or generic ones?
- Market conditions: Are input costs stable or all over the place?
- Accounting standards: Are you following IFRS, GAAP, or local rules?
- Tax implications: Some costing methods might bring tax benefits in particular regions.
In the end, the best costing method is the one that syncs up with your operational realities and financial reporting aims while complying with relevant accounting standards.
Understanding Costing Levels
While costing methods define how costs are assigned, costing levels clarify where and at what point in the organization those costs are tracked. Costing levels help businesses break down profitability more accurately — whether by product, location, organization, or batch. In modern ERP setups, nailing down costing levels helps produce better reporting and tighter control over cost behaviors. Here are some typical costing levels:
1. Client Level
This is the highest organizational tier in a multi-company framework. Each client (or group of companies) manages expenses independently, so cost data isn’t mixed up between entities.
Use Case:
Large corporate groups with several subsidiaries that operate separately but under the same ERP system.
2. Organization Level
An organization level refers to a specific business unit within a client. Each unit tracks its cost of production, sales, and inventory changes separately.
Use Case:
A firm with different divisions — like manufacturing, distribution, and retail — may need to monitor profitability for each separately.
3. Batch or Lot Level
At this level, costs are tracked for a specific batch or production lot. Each batch has its own cost profile, which is crucial when raw material prices or production efficiencies vary.
Use Case:
Industries like pharmaceuticals, chemicals, and food processing, where traceability and compliance are essential.
4. Warehouse Level
This level zeroes in on the physical location of inventory. Costs are monitored per warehouse, helping businesses gauge performance by location and manage logistics effectively.
Use Case:
A trading company with stock in several regional warehouses, each having its own handling and freight costs.
5. Warehouse + Batch Level
Combining both warehouse and batch levels offers even deeper insights. Each inventory batch is costed individually within each warehouse.
Use Case:
Helpful for manufacturers producing batches at different times and storing them across various locations.
6. Organization + Batch Level
This level brings together organizational control with batch tracking. Costs are tracked per batch in each organization, providing detailed visibility into production performance.
Use Case:
Best for multi-plant manufacturing setups where each plant needs to keep costs separate while ensuring full traceability.
Why Costing Levels Matter
Getting the right costing level right is key for:
- Accurate profitability analysis across plants, products, and locations
- Better decision-making about pricing and production planning
- Tighter control over cost variances and resources
- Improved audit readiness thanks to clear cost tracing
When implemented properly in an ERP system, costing levels lay down a transparent financial structure that boosts both operational efficiency and strategic growth.
Conclusion: Making Costing Work for You
Costing methods and levels are more than just accounting techniques — they’re vital tools for controlling your business, planning, and driving profitability. Whether you go with FIFO for transparency, Standard Costing for control, or Weighted Average for stability, your costing strategy should align with your overall business goals. In today’s digital age, ERP solutions like Cyprus ERP make managing these complex costing systems a breeze. With features that support various costing methods and adaptable costing levels, Cyprus ERP helps organizations keep tabs on real-time inventory costs, analyze profitability at all levels, and make informed decisions — all from one integrated platform. By setting up the right costing framework, businesses can go beyond just compliance and turn costing into a strategic advantage — achieving efficiency, precision, and sustainable growth.
Cyprus ERP & Onfinity ERP: ERP Solutions for Modern Businesses
BRS Infotek offers two powerful ERP platforms—Cyprus ERP and Onfinity ERP—designed to support businesses at different stages of growth and complexity.
Cyprus ERP, developed by BRS Infotek and based on the Adempiere framework, is a robust yet cost-effective ERP solution for SMEs and growing organizations.
Key Highlights
- Fully web-based and user-friendly
- Cloud and on-premise deployment options
- Modular and flexible customization
- Strong manufacturing and costing capabilities
- Advanced reporting and business analytics
- Low implementation and maintenance cost
Cyprus ERP is widely used across manufacturing, distribution, construction, healthcare, and professional services.
Onfinity ERP is an enterprise-grade ERP platform built for organizations with complex processes and scalability requirements. BRS Infotek is the legal partner of Onfinity ERP, providing implementation expertise, localization, and ongoing support.
With Cyprus ERP or Onfinity ERP, businesses can choose an ERP solution that aligns with their operational needs and long-term growth strategy.
👉 Request a free demo of Cyprus ERP: www.cypruserp.com
👉 Request a free demo of Onfinity ERP: https://onfinity.io/in/demo.php
About the Author
Surya Sagar, Founder and ERP Solution Architect at BRS Infotek, has over 18 years of experience in ERP implementation, solution architecture, and process optimization.
He has led ERP deployments across multiple industries and regions and plays a key role in delivering value through both Cyprus ERP and Onfinity ERP solutions.
