A righter way to capitalize vendor processing using transfer orders and item charges
Outside processing is one of those areas where Microsoft Dynamics 365 Business Central quietly gives you everything you need—if the pieces are lined up in the right order.
Powder coating, plating, machining, heat treating. The work happens outside your facility, but the cost belongs in inventory. The challenge is not whether Business Central can handle this. It is deciding how to represent the movement and where to attach the cost so it remains traceable, auditable, and explainable later.
This post walks through a righter way for some users: using a Transfer Order to represent the physical movement and an Item Charge to capitalize the outside processing cost.
When this approach applies
This pattern assumes:
- The Transfer Shipment has already been posted from the sending location
- The Transfer Receipt has already been posted at the receiving location
- A vendor invoice has been received for the outside processing service
At this point, the inventory is physically back in house, but its cost is incomplete. The transfer receipt gives us a clean, standard anchor point to finish the costing story.
Why a transfer order is part of this scenario
A transfer order is used because the item is changing location ownership inside the company while it is away for processing.
Even though the work is performed by a vendor, the inventory itself is not being purchased or sold. It remains company owned the entire time. The transfer order represents:
- Shipment from the sending location to an outside processor or subcontract location
- Receipt back into the location where the item will be stocked, staged, or consumed
Using a transfer order provides three benefits that matter:
- Traceability
The outbound and inbound movement is tied together through a single document trail, making audits and reviews far easier. - Accurate inventory by location
On-hand quantities remain correct while the item is physically off site. - A clear costing target
Once the transfer receipt is posted, Business Central provides a specific Transfer Receipt Line that can receive an Item Charge, which is exactly how the system expects processing and landed costs to be capitalized.
The item number does not change
A critical detail in this flow is that the item retains its original Item No. from start to finish.
The transfer order represents a location change, not a transformation into a new product. Outside processing enhances or finishes the same item. Because the Item No. remains unchanged:
- Quantity and cost history stay continuous
- Item Ledger Entries and Value Entries tell one complete story
- Outside processing costs are capitalized back into the same inventory record
This continuity is one of the reasons Item Charges work so cleanly with transfer receipts.
Why Item Charges are used
Outside processing is not overhead and it is not a period expense. It is a direct cost of the item.
Item Charges allow you to:
- Capitalize vendor service costs into inventory
- Assign costs to specific transfer receipt entries
- Maintain a full audit trail through value entries
- Let standard cost adjustment handle downstream posting
Most importantly, Item Charges fully support Transfer Receipt Lines.
Step by step: applying outside processing costs
Step 1: Create the purchase invoice
Create a standard purchase invoice for the outside processor.
- Open Purchase Invoices
- Create a new invoice
- Select the vendor who performed the processing
This invoice represents the service cost only.
Step 2: Add the Item Charge line
On the invoice lines:
- Set Type to Item Charge
- Select the Item Charge number
- Update the description if helpful
- Enter the quantity, typically 1
- Enter the Direct Unit Cost Excl. Tax from the vendor invoice
At this point, the cost exists but is not yet attached to inventory.
Step 3: Assign the Item Charge to the Transfer Receipt
With the Item Charge line selected:
- Choose Line → Related Information → Item Charge Assignment
On the Item Charge Assignment (Purch) page:
- Select Get Transfer Receipt Lines
- Choose the posted transfer receipt line or lines related to the outside processing
- Confirm the selection
Then:
- Choose Suggest Item Charge Assignment
- Select a distribution method:
- Equally (uses quantity across the selected lines)
- By Amount
- By Weight
- By Volume
- Confirm the assigned total matches the vendor invoice amount
Using Get Transfer Receipt Lines is the step that tells Business Central exactly where the cost belongs.
Step 4: Post the purchase invoice
Post the purchase invoice once everything looks correct.
This creates value entries tied directly to the transfer receipt and capitalizes the processing cost into inventory.
Step 5: Run Adjust Cost – Item Entries
Run Adjust Cost – Item Entries.
This finalizes the cost flow so inventory valuation and future cost of goods sold reflect the updated item cost.
What G/L accounts are posted, and where they come from
Using this method, the outside processing cost is capitalized into inventory, not expensed. The G/L accounts used come from posting setup, not from the purchase invoice line itself.
When the purchase invoice with the applied Item Charge is posted, Business Central:
- Debits Inventory
- Credits Accounts Payable
Inventory account (debit)
The inventory account comes from Inventory Posting Setup, based on:
- The item’s Inventory Posting Group
- The receiving location on the transfer receipt
The Inventory Account defined for that combination is used, which is why the cost lands in inventory at the receiving location.
Accounts Payable account (credit)
The offset comes from Vendor Posting Setup, based on:
- The vendor’s Vendor Posting Group
- The Payables Account defined for that group
This is standard purchase invoice behavior. Item Charges do not change how payables are posted.
What is not used
- No expense account from General Posting Setup
- No Item Charge expense account
- No outside processing clearing account
- No WIP account
Those assumptions are common—and incorrect—for this pattern.
Why Adjust Cost is required
Item Charges post their value through Value Entries, not directly to G/L. Running Adjust Cost – Item Entries ensures those values are fully reflected in inventory and, when applicable, in cost of goods sold.
The result
When completed correctly, the outside processing cost is:
- Capitalized into inventory at the receiving location
- Fully traceable through Item Ledger Entries and Value Entries
- Reflected accurately in inventory valuation and future COGS
- Posted using standard, supportable Business Central functionality
No clearing accounts. No manual reclassification journals. No mystery variances later.
A final note on “a righter way”
This is not the only correct approach. Some organizations model outside processing through production orders or routing based subcontracting. Others expense the service directly when capitalization is not required.
This is a righter way for many teams when the goals are visibility, clean valuation, and strong audit trails.
Created as part of Sharing the Righter Way, this article combines my Business Central experience with AI-supported research and drafting. AI helps explore options and accelerate analysis, while every conclusion and recommendation reflects my own professional judgment.
