Inventory Costing & Ledger Flow
How does Business Central calculate item costs? Learn the five costing methods, understand the item ledger entry chain, and see how inventory transactions flow to the General Ledger.
How Business Central tracks costs
Think of inventory costing like a petrol station tracking fuel prices.
You buy petrol at different prices throughout the week — Monday at $2.10, Wednesday at $2.15, Friday at $2.20. When a customer fills up, which cost do you use? The oldest batch? The newest? An average? That choice is your costing method.
At Summit Distribution, Raj’s team receives shipments of steel bolts at varying prices. Business Central needs a rule to decide: when Raj sells 100 bolts, what did those bolts actually cost? The costing method answers that question — and it affects profit margins, tax calculations, and balance sheet values.
The five costing methods
| Method | How Cost Flows | Best For | Exam Tip |
|---|---|---|---|
| FIFO (First In, First Out) | Oldest purchases are consumed first. Sale picks up the cost of the earliest remaining receipt. | Products with a shelf life, stable pricing environments. Shows higher balance sheet values when prices rise. | Default costing method. Most common in the exam. |
| LIFO (Last In, First Out) | Newest purchases are consumed first. Sale picks up the cost of the most recent receipt. | Rarely used — not permitted in many countries because it can artificially lower profits. | Know it exists but remember it is disallowed in many regions. |
| Average | Costs are pooled and averaged across all stock. Every unit has the same cost at any point in time. | Bulk commodities, chemicals, mixed inventory where individual units are indistinguishable. | Average cost recalculates after every purchase. The Average Cost Period setting (Day, Week, Month, Accounting Period) matters. |
| Specific | Each unit carries its exact purchase cost. You must link each sale to a specific receipt using item tracking (serial/lot numbers). | High-value serialised goods — vehicles, heavy machinery, jewellery. | Requires item tracking on both inbound and outbound. Most precise but most effort. |
| Standard | A pre-set cost is used regardless of actual purchase price. Differences post as variances. | Manufacturing with repetitive production. Enables tight cost control and variance analysis. | Variances (purchase price variance, material variance) post to separate GL accounts. |
When to use each method — a quick decision guide
| Question | Answer points to… |
|---|---|
| ”We just want something simple and fair” | FIFO — the default and most straightforward |
| ”Our raw materials fluctuate in price and we mix them together” | Average — no need to track individual batches |
| ”We sell high-value items with serial numbers” | Specific — exact cost per unit |
| ”We’re a manufacturer and want to measure efficiency against a target cost” | Standard — enables variance analysis |
| ”We want to minimise taxable income when prices rise” | LIFO — but check if your country allows it |
Important: You cannot change the costing method once entries exist
The costing method is locked once you post item ledger entries for an item. If you set up an item as Average and start posting transactions, you cannot switch it to FIFO later. Plan your costing method before you go live.
To change a costing method on an item with entries, Microsoft provides a guided process through the Change Costing Method page — but it creates a new item and re-maps entries. This is a complex operation, not a simple settings change.
The item ledger entry chain
Every inventory transaction in Business Central creates a chain of connected entries. Understanding this chain is critical for the exam.
Item Card
└── Item Ledger Entry (ILE) ← quantity change (+1, -1)
└── Value Entry (VE) ← cost/value of that change
└── G/L Entry ← debit/credit in the General Ledger| Entry Type | What It Records | Key Fields |
|---|---|---|
| Item Ledger Entry | Quantity in or out. One entry per inventory movement. | Entry Type (Purchase, Sale, Positive Adj., Negative Adj., Transfer, Consumption, Output), Quantity, Remaining Quantity |
| Value Entry | The monetary value of the quantity change. Can have multiple value entries per ILE (e.g. direct cost + revaluation). | Cost Amount (Actual), Cost Amount (Expected), Cost per Unit, Entry Type (Direct Cost, Revaluation, Rounding, Indirect Cost, Variance) |
| G/L Entry | The double-entry bookkeeping record in the General Ledger. | Debit Amount, Credit Amount, G/L Account No. |
Why multiple value entries per item ledger entry?
A single purchase receipt might generate:
- Expected cost value entry — when you receive but haven’t invoiced yet
- Direct cost value entry — when the invoice arrives
- Cost adjustment value entry — if the cost is adjusted later (e.g. item charges added)
Each value entry can generate its own pair of G/L entries.
How a purchase flows through the chain
Let’s follow a real transaction at Summit Distribution. Raj receives 100 steel bolts at $5.00 each from a vendor.
Step 1: Post the purchase receipt (receive only)
| Entry Created | Details |
|---|---|
| Item Ledger Entry | Entry Type = Purchase, Quantity = +100, Invoiced Quantity = 0 |
| Value Entry | Entry Type = Direct Cost, Cost Amount (Expected) = $500, Cost Amount (Actual) = $0 |
| G/L Entry (if Expected Cost Posting enabled) | Debit: Inventory Accrual (Interim) $500 / Credit: Invt. Accrual Acc. (Interim) $500 |
Step 2: Post the purchase invoice
| Entry Created | Details |
|---|---|
| Item Ledger Entry | Updated — Invoiced Quantity now = 100 |
| Value Entry | Entry Type = Direct Cost, Cost Amount (Expected) reversed to $0, Cost Amount (Actual) = $500 |
| G/L Entry | Debit: Inventory Account $500 / Credit: Direct Cost Applied $500. Plus reversal of interim entries. |
What about Expected Cost Posting to G/L?
In Inventory Setup, the field Expected Cost Posting to G/L controls whether receipt-without-invoice creates G/L entries.
- Enabled: Receipts immediately show in the GL via interim accounts. The balance sheet reflects goods you have but haven’t been invoiced for.
- Disabled: G/L entries only appear when the invoice is posted. The balance sheet doesn’t reflect uninvoiced receipts.
Most businesses enable this for accurate financial reporting. The exam expects you to know this setting exists.
Inventory Posting Setup
The Inventory Posting Setup page controls which GL accounts are used for inventory transactions. It’s a matrix of Inventory Posting Group (from the item) and Location (from the transaction).
| Inventory Posting Group | Location | Inventory Account | Example |
|---|---|---|---|
| FINISHED | MAIN | 2130 - Finished Goods | Finished items at main warehouse |
| FINISHED | SHOWROOM | 2130 - Finished Goods | Finished items at showroom |
| RAW-MAT | MAIN | 2120 - Raw Materials | Steel bolts at main warehouse |
Key GL accounts in the Inventory Posting Setup:
| Account | Debited When… | Credited When… |
|---|---|---|
| Inventory Account | Goods received (purchase receipt) | Goods shipped (sales shipment) |
| Inventory Account (Interim) | Expected receipt posted | Expected receipt reversed at invoice |
| COGS Account | Sale is invoiced | — |
| Direct Cost Applied Account | — | Purchase is invoiced |
| Inventory Adjustment Account | Positive adjustment | Negative adjustment |
Exam tip: Automatic Cost Posting vs Adjust Cost batch job
Automatic Cost Posting (Inventory Setup) pushes value entries to the GL in real time as transactions post.
Even with Automatic Cost Posting enabled, the Adjust Cost - Item Entries batch job is still essential. This job:
- Adjusts costs forward from inbound entries (purchases) to outbound entries (sales)
- Handles item charges applied after the original transaction
- Updates average cost calculations
The exam may test whether Automatic Cost Posting replaces the Adjust Cost batch job. It does not. They serve different purposes — one posts to GL, the other adjusts cost between entries.
What hits the GL — a complete picture
When Raj sells 50 of those steel bolts to a customer at $8.00 each:
| Step | Item Ledger Entry | Value Entry | G/L Impact |
|---|---|---|---|
| Ship the goods | Entry Type = Sale, Qty = -50 | Expected Cost (if enabled): -$250 | Debit: COGS Interim $250 / Credit: Inventory Interim $250 |
| Invoice the sale | Invoiced Qty updated | Actual Cost: -$250 (50 bolts at $5.00 FIFO cost) | Debit: COGS $250 / Credit: Inventory $250. Revenue: Debit Receivables $400 / Credit Sales Revenue $400 |
The profit on this sale: Revenue $400 minus COGS $250 = $150 gross profit.
Notice how the costing method determined the $5.00 per-bolt cost. If Raj had later bought bolts at $6.00, FIFO would still use the $5.00 cost for the first 100 bolts. Average would have blended the two prices.
Knowledge check
Summit Distribution buys chemicals that arrive in bulk tankers and are mixed in storage tanks. Individual batches cannot be distinguished once mixed. Which costing method should Raj configure?
Raj receives 200 bolts at $5.00 each (purchase receipt posted, not yet invoiced). Expected Cost Posting to G/L is enabled. Which GL entries are created at receipt?
Priya is helping a manufacturing client choose a costing method. The client produces the same widget repeatedly and wants to track whether production costs are above or below their target. Which costing method enables this?
🎬 Video coming soon
Next up: Now that you understand how costs flow, let’s look at the master data that drives sales and purchase documents — shipping agents, ship-to addresses, lead times, and vendor order addresses.