Average vs. Standard Costing in Business Central for Canadian Food Manufacturers

Estimated reading time: 7 minutes

Most mid-market Canadian food manufacturers made a costing decision with their ERP partner during implementation. That decision may have been right at the time. Since then the business has changed, with more SKUs, more volatile ingredient costs and more complex production. The costing method usually hasn’t been revisited. In my years working across manufacturing ERP environments, I have watched CFOs struggle to explain product-level margin variances that trace directly back to a costing method that no longer fits their operation.

Three Costing Methods for Food Manufacturers

Average costing blends the cost of each receipt into one unit cost. In Business Central (BC), cost adjustment does the recalculation, per average cost period (one day by default). It runs on a schedule, or at posting if Automatic Cost Adjustment is set to Always. If you buy flour at $0.80/kg in January and $0.95/kg in March, the average moves up once the March receipt has been through cost adjustment. Within the same location and averaging period, every unit carries the same blended cost regardless of when you bought it. By default BC keeps one average per item, location and variant, so the same item can carry a different cost in each warehouse. If you want one blended cost across locations, set Average Cost Calc. Type to Item in Inventory Setup. BC then re-adjusts every average-cost item, so run Adjust Cost – Item Entries straight after.

Standard costing assigns a predetermined cost to each item based on expected material, labour and overhead rates. Actual costs flow in separately and the system records the difference as a variance. You decide what a kilogram of flour should cost. The variance report shows how reality compares.

FIFO (First In, First Out) assigns the actual cost of each receipt to outgoing inventory in the order it arrived, unless lot tracking ties the outgoing entry to a specific lot. Without lot tracking, your oldest flour receipt is costed into production first, at its original purchase cost.

When Average Costing Works

Average costing is straightforward and requires the least maintenance, but it depends entirely on cost adjustment running regularly. For Canadian food manufacturers with stable ingredient costs and limited product complexity, it works well enough. If your primary ingredients come from supply-managed commodities (dairy, poultry, eggs), where marketing boards set producer prices and pricing stays fairly predictable, average costing gives you a reasonable picture.

It also works when your product mix is small. A manufacturer running 10-15 SKUs with similar production processes does not gain much from the additional overhead of standard costing.

When Average Costing Fails

Average costing hides margin problems when ingredient costs are volatile. Canadian food manufacturers sourcing cocoa, coffee, canola oil or imported spices know this volatility firsthand. When your cocoa cost swings 30% over a quarter, average costing smooths that swing across your entire inventory. Your COGS looks stable on paper, but individual batch margins don’t show what each batch cost.

The problem compounds with high product mix complexity. A manufacturer running 80 SKUs with different ingredient profiles and production complexities needs to know which products make money. Average costing blends everything together and makes that question nearly impossible to answer at the product level.

Seasonal ingredients create a similar problem. For example, if you buy strawberries at $2.50/kg in July and $5.80/kg in January, average costing spreads that cost across all your strawberry-containing products. Your summer batches look less profitable than they are and your winter batches look more profitable than they are.

The Case for Standard Costing in Food Manufacturing

Standard costing gives you variance visibility, which average costing can’t. When you set standard costs for your ingredients, labour operations and overhead, every finished production order of a standard-cost item posts variance entries you can report on. The Inventory – Cost Variance report shows where actual costs moved away from the standard.

For a Canadian food manufacturer, that means:

• Purchase price variance: Tells you if standard-cost ingredients are bought above or below plan.
• Material variance: Compares what production consumed with the recipe standard. If your ingredients are also on standard cost, this is effectively your usage variance. Ingredients on FIFO or Average carry their price differences into it too.
• Capacity variance: Covers labour and machine time against the routing. It shows whether production runs take more or less time than expected.
• Overhead variances: BC posts Capacity Overhead and Manufacturing Overhead variances, which flag absorption gaps.

This variance data feeds directly into pricing decisions. If your purchase price variance on dairy ingredients runs consistently unfavourable (costs above standard), you know your product pricing needs to adjust before your margins erode further.

The trade-off is maintenance. You need to review and update standards periodically, typically annually or when commodity prices shift significantly. In BC you do this in the Standard Cost Worksheet, which can suggest new standards, roll them up through your production BOMs and implement the change. If your standards go stale, your variances stop telling you anything useful.

FIFO and Lot-Controlled Production

FIFO keeps the actual cost of each receipt and passes it to the stock that goes out. With lot tracking, BC carries the cost of the lot you used, which suits SFCR lot traceability records. Physical rotation (FIFO or FEFO) is a warehouse setting, not a costing setting, for example Pick According to FEFO on the Location card.

The practical challenge is discipline. FIFO needs careful receiving and consumption processes. For manufacturers already doing lot tracking rigorously, the incremental effort is small. For those with loose lot control, FIFO adds a layer of precision they may not be ready to manage.

FIFO is worth evaluating if your operation relies on high-cost, volatile ingredients where you need to trace the actual purchase cost through to the finished good. It matters less when ingredient costs stay stable and lot-level cost precision does not drive meaningful decisions.

What Switching Costing Methods Actually Involves

In BC you can’t change the costing method on an item once it has any ledger entries, even after its stock is back to zero. An open purchase order for the item blocks the change too. The route Microsoft documents is a new item number set up with the new method. An assembly order moves the stock from the old item to the new one. Then you block the old item.

If the new method is Standard, the gap between the old cost and the new standard posts as a variance on the assembly order. For FIFO or Average the cost carries across unchanged. Vendor invoices that arrive late for the old stock still flow through to the new item.

A costing method transition requires:

• New items: One for each item you’re switching, set up with the new costing method.
• Stock moved by assembly order: On-hand quantity moves from each old item to its new one.
• Updated standard costs: For every new item, if you’re moving to standard costing.
• Clean-up: Block the old items and update BOMs, routings and price lists to the new item numbers.
• Staff training: How variance reports work and how to interpret them.
• Process changes: Receiving, production and month-end close.
• Coordination with your accountant: The accounting treatment and any disclosure.

The operational disruption is real but manageable with planning. Plan the switch for a low-production period or for fiscal year-end to keep it simple.

ASPE Reporting Considerations

Canadian private food manufacturers reporting under Accounting Standards for Private Enterprises (ASPE) should know that a change in cost formula is generally a change in accounting policy under Section 1506. It is usually applied retrospectively, with disclosure of the change and its financial impact. Confirm the treatment with your accountant.

No regulatory body mandates a specific costing method. CRA does not prescribe one. But your costing method choice affects inventory valuation on your balance sheet and COGS on your income statement, both of which feed into your tax filings.

For manufacturers claiming SR&ED (Scientific Research and Experimental Development) tax credits, accurate production costing matters. The eligible expenditure calculation can include costs incurred during experimental production runs. Your production costing setup (separate production orders, dimensions) determines how those costs are separated from routine production. Rough allocations invite CRA scrutiny during the review process.

The Decision Framework

Ask three questions:

1. Can you explain your product-level margins with confidence today?
2. Do your ingredient costs fluctuate more than 10-15% within a fiscal year?
3. Do you need variance visibility to make pricing or production decisions?

If you answered no, yes, yes, average costing is probably not giving you what you need.

The costing method you inherited may have made sense five years ago. Check whether it still fits the business you are running today.