Dynamics 365 for Finance and Operations Inventory Cost Model, Part 2: Configuration

This is the second instalment in my series of articles explaining the inventory cost model in Dynamics 365 for Finance and Operations (D365FO). The series is expected to include the following parts:

  • Part 1: Core concepts.
  • Part 2: Configuration.
  • Part 3: Cost management.
  • Part 4: Landed cost.
  • Part 5: Cost controlling.

This article will explore the key configuration steps you need to take to set up inventory costing. Since I will not be covering all the details in this article, you can find more information here. Also, I will be focusing on configuring the necessary elements for costing, so I will not be dealing with warehouse management, quality management etc.

Item Groups and the Posting Set Up

Inventory management / Setup / Inventory / Item groups

Inventory management / Setup / Posting / Posting

The most essential part of configuring inventory costing is defining the link between the general ledger and the inventory ledger. This is done through the Posting set up screen:

Posting set up.PNG

In the Posting set up screen you define the general ledger accounts used for each inventory transaction type. You can define this link for each item, groups of items or all items.

Important note: Ideally, you set everything up on item group level.

Doing this means that you need a set of accounts in the chart of accounts for each item group. This creates quite a lot of accounts, but the benefit is that all reports that aggregate on item group level can reconcile directly to an account in the general ledger (if you are lucky).

Important note: It is extremely important that the accounts used in the chart of accounts do not allow manual postings. If you post manually to these accounts they become very difficult to reconcile to the inventory ledger.

If you need to manually adjust the financial value of inventory in the general ledger make sure to create a separate manual adjustment account for each item group.

Generally, I advise my clients to use the Item group field on a product solely for the purpose of linking the inventory ledger and the general ledger. In my experience it should not be used for statistical purposes. You can use other fields for that.

As an example I could have the following item groups in my configuration:

  • Item group 10 = Traded items
  • Item group 20 = Services
  • Item group 30 = Semi-finished items
  • Item group 40 = Manufactured items
  • Item group 50 = Consumables

These would cover most normal scenarios in a small manufacturing company and allow me to reconcile the ledgers on a fairly granular basis.

Item Model Group

Inventory management / Setup / Inventory / Item model groups

Now you have defined how the general ledger and the inventory ledger relate to each other. You have also assigned products to their item group thereby implicitly linking them to the general ledger via the posting set up. Now, it is time to determine how the inventory cost of a product is treated. This is done by assigning the product to an Item model group.

Item model groups are configured in the Item model groups screen:

Item model groups.PNG

In the following, I will explain the main configuration options available on an Item model group:

Stocked product: This determines whether the cost of a product is posted to the balance sheet (ticked) or directly to cost-of-goods-sold (un-ticked) when posting a supplier invoice. If un-ticked, the system will not carry an inventory of this item. You must leave this field un-ticked for products such as stationary and consumables.

Post physical inventory: You must tick this option, if you would like the system to post goods-received-not-invoiced (GRNI) and goods-shipped-not-invoiced (GSNI). Also, this field needs to be ticked for products that are consumed in production, but need to go into work-in-progress (WIP).

Inventory model: This is probably the most important option to select on the Item model group. This determines how the cost of an item lot is calculated when re-calculating inventory on a periodic basis (see the first article in this series).

Physical / Financial negative inventory: These two fields can be tricky. Ideally, you would not allow the business to operate with negative inventory. However, in some cases, for instance when the goods receipt people are slow to update the system, goods may be physically shipped before they are financially updated. However, if possible, avoid allowing negative inventory.

The rest of the fields have limited impact on inventory costing or relate to special scenarios.

Dimension Link

Inventory management / Setup / Posting / Dimension link

If you have a requirement to track the internal ownership of inventory, you can configure this in the Dimension link screen:

Dimension link.PNG

Firstly, you must define which financial dimension is used to create the link. In the above example, I am using the BusinessUnit dimension. As the following example shows, each Site in the inventory breakdown structure must subsequently be associated with a BusinessUnit dimension value:

Site - Financial dimensions.PNG

Now, every time a transaction is made using Site 1, the system will post the cost value to the 001 (Home) BusinessUnit financial dimension.

Product Attributes

In its most simple form, you actually only need to set two attributes on a product namely Item group and Item model group to make inventory costing work. It really is that simple.

Further Reading

If you are interested in some of the theory and general concepts behind inventory costing, I can strongly recommend this book by Steven Bragg.


The basic configuration of the key elements of inventory costing in D365FO consists of item groups, the posting matrix and item model groups. Once you have those in place, you are set to go.

In the next instalment of this series, I will be looking at how to manage costs including

  • Maintaining standard cost prices.
  • Setting up charges.
  • Adjusting the inventory value.
  • The costing sheet.


Published by Henrik Marx Larsen

This blog is my personal contribution to the Microsoft Dynamics 365 for Operations and Finance (D365F&O) community debate. Having worked with Axapta / Dynamics AX / D365F&O for 20 years , I think I may have some interesting insights and views to share. However, I tend to always look forward so I will mostly be writing about current subjects. I have a vain hope that my musings may inspire some of you and provoke some new thoughts in the interest of our community. My day job is to work as a Senior Technical Specialist at Microsoft and help take D365F&O capabilities to new and existing customers. Please note, the views expressed in this blog are mine alone and do not necessarily reflect the views of my employer, Microsoft.

4 thoughts on “Dynamics 365 for Finance and Operations Inventory Cost Model, Part 2: Configuration

  1. Dear Henrik,
    you realy wrote a fine and clear abstract here. The question i’ve is about item group. Above you write to use item group solely. I understand. and you say also “use other fields for statistical pupose”. As we have to use inventory value report the item group is the resource group aggregating values. How and what fileds would you suggest to use for inventory statistics? I’ve an customer with about fifty groups he needs to report periodic inventory values. How should we do this without using as many item groups?
    Thanks, Andreas

    1. Hi Andreas, sorry for the late response, but things have kept me busy. You are absolutely right that if you need to report inventory by item group then you are a bit stuck. The problem is that the item master does not contain a good statistical field for reporting. Normally, my customers add a field to the item master and use it as a slowly changing dimension when loading a data warehouse. The data warehouse then becomes the reporting and analytics hub for non-operational inventory reporting. Hope this answer helps.

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