Microsoft Dynamics 365 for Finance and Operations (D365FO) offers a great functionality which helps to control manufacturing costs. This functionality is standard costing. In this post, I’ll guide you through the key points needed to set up standard costing for direct materials.

The guide for AX 2012 is available here.

In case you’re not familiar with standard costing at all, please have a look at Standard costing. Or how to control costs of production first.

In order to follow this guide you need to be familiar with D365FO production control functionality.

The guide for standard labor costs is available here.

Standard Costing Example

To demonstrate how standard costing works in D365FO I use the same example as presented in Standard costing. Or how to control costs of production.

Price of apples = $1.50 per kg
Consumption of apples = 2 kg per 1 liter of juice

Yield of juice = 5,000 liters
Consumption of apples = 12,500 kg
Cost of apples = $18,000

Total variance = $3,000 unfavorable
Direct material quantity variance = $3,750 unfavorable
Direct material cost variance = $750 favorable

1. Basic parameters

1.a. First, let’s set the “Cost breakdown” parameter. D365FO offers two options: “No” and “Sub ledger”. You should specify “Sub ledger”. In this case the system splits costs by cost groups. In turn, this affects how variances are calculated. If you don’t split cost by cost groups, variances won’t be split either.

Next, set the “Variances to standard” option to value “Per cost group”. This means that the system calculates variances per cost group. In most cases you should have at the least variances for cost of materials, costs of labor, and overhead costs. By calculating the variances per groups you are able to set different ledger accounts to post them to ledger.

Inventory accounting policies setup
The “Cost management > Inventory accounting policies setup > Parameters” page.

The details about these parameters can be found here.

1.b. Now let’s set up ledger entries for variances. There you need to at least specify variances for:

  • “Production price variance” – used for price variance of materials or resources.
  • “Production quantity variance” – used for variances which occur because of exceeded or fall behind in quantity consumed of materials or resources.
  • “Production substitution variance” – used for variances because of material or resources were used which were not planned.

If you need to post material/labor/overhead variances on different ledger accounts, then you can use “Cost code” and “Cost relation” fields to set up appropriate ledger codes. Your cost groups or cost types setup must allow you to split variances by accounts you need.

The “Inventory management > Setup > Posting > Posting” page.

More information about variances can be found here.

1.c. You then need an item model group for a finished good. The inventory model must be standard cost there. A finished good item will be linked to this group further in the guide.

Item model group
The “Cost management > Inventory accounting policies setup > Item model groups” page.

1.d. You also need a costing version where costing type is standard cost. If you don’t have one then create it.

Costing version maintenance
The “Cost management > Inventory accounting > Costing versions” page.

More details about costing versions can be found here.

2. Materials setup

2.a. It’s time to create items for materials. Let’s create apples in accordance with the example we are following. Here is how I did that.

The “Product information management > Products > Released products” page, the “New” button.

Please note that I use FIFO item model group for the raw material item. This means that the system determines actual cost of apples by using the first in first out method of inventory valuation.

2.b. Next you need to set a standard cost for the item created.

Item price
The “Product information management > Products > Released products” page, the “Manage costs / Item price” button.

Use the version of the cost you created in step 1.d. Make sure that the price quantity is correct. When the price is inserted in the table, you need to activate it by the “Activate pending prices(s)” button.

3. Finished goods

3.a. What you need now is to create an item for the finished goods – juice.

The “Product information management > Products > Released products” page, the “New” button.

Item model group for the item must be standard cost and production type must be “Formula” or “BOM”. I used a formula item.

Released product - production type
The “Product information management > Products > Released products” page, the “Edit” button.

3.b. Now let’s create a formula for the finished good. A formula is very important for standard costing because it keeps quantities of materials which will be copied to standard.

Formula creation
The “Product information management > Products > Released products” page, the “Engineer / Formula versions” button, the “New / Formula and formula version” button.

3.c. When you create a new formula, D365FO links it to the item. The link is called “Version”. What you need now is to change the formula size on the version. In our example production batch is 5,000 liters, so let’s set the formula size to 5,000.

Formula version
The “Product information management > Products > Released products” page, the “Engineer / Formula versions” button.

3.d. Next you need to add raw materials to the formula. Add apples and set 2 kg per 1 series. This means that 2 kg of apples are consumed per 1 liter of juice.

Formula lines
The “Product information management > Products > Released products” page, the “Engineer / Formula versions” button, the “Formula lines” tab.

Then the formula must be approved and the version must be also approved and then activated.

More information about formula setup can be found here.

3.e. Now you have everything in the system you need to calculate the standard cost of juice we produce. Let’s do it.

Formula calculation
The “Product information management > Products > Released products” page, the “Engineer / Formula versions” button, the “Formula version / Calculation” button.

3.f. When the calculation is done, the system shows the “Item price” page. Go to the “Pending prices” tab and take a look at the complete calculation results by clicking the “View calculation details” button.

Calculation details
The “Item price” page, the “View calculation details” button.

The standard cost for apples is calculated.

Consumption per lot size = 2 kg per liter * 5,000 liters = 10,000 kg
Cost per lot size = 10,000 kg * $1.50 per kg = $15,000

Now you need to activate the cost by clicking the “Activate pending prices(s)” button in the “Item price” as it shown in section 2.b of this guide.

4. Production run and variances

4.a. Before the production can be run, let’s add apples to the stock. I used a movement journal to do the job.

Movement journal
The “Inventory management > Journal entries > Items > Movement” page.

Please pay attention to the cost price. I use $1.44 according the example we follow.

Consumption of apples = 12,500 kg
Cost of apples = $18,000

Actual cost price = $18,000 / 12,500 kg = $1.44 per kg

Don’t forget to post the journal.

4.b. It is time to create a batch. I don’t show you how to run the production order here since it’s no different whether you use standard costing or not. What is important here is to start production for 5,000 liters, register 12,500 kg consumption of the apples as our example specified and post the production picking list.

Production picking list
The “Production control > Production orders > All production orders” page, the “View / Picking list” button.

After that, you need to end the production order. At the stage “Ended” variances are calculated.

4.c. Now, you can go and see the variances calculated.

Production variance
The “Manage costs / Variance” button.

Price variance = ($1.44 – $1.50) * 12,500 kg = ($750) favorable
Quantity variance = (12,500 kg – 10,000 kg) * $1.50 = $3,750 unfavorable

I hope you enjoyed this guide. If you would like to know more or have any questions, please feel free to leave a comment.

4 thoughts on “How to set up standard costs for direct materials in Dynamics 365 for Finance and Operations

  1. Very well written document. However, the setting cost breakdown at ‘subledger’ level potentially creates overheads being calculated on lower level BoM’s when using cost sheet. Unless there is another setting elsewhere, this appears to be an unintended result of this option

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