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Include Actual Costs in COGS with Material Ledger in Release 4.7

by Janet Salmon, SAP AG

Does your cost of goods sold (COGS) figure match your actual costs? Learn how to use new functionality in the material ledger to complete the value flow through R/3 and assign price differences to the cost of sales accounts to ensure that the COGS reflects the actual costs.

Key Concept
SAP uses the term "actual costs" in various ways. For the material ledger, the actual costs are calculated at period close, taking into account all material movements and invoices associated with the raw materials and the actual cost of the confirmations to the production orders. R/3 determines these actual costs using a multi-level costing process that takes account of all goods movements within a plant. This article refers only to the material ledger definition of actual costs.

When manufactured goods are issued from stock to sales, the posting to the cost of sales account is usually based on an estimate of the cost of goods sold (COGS). This estimate commonly known as the standard cost is calculated by looking at the bill of material (BOM) and routing for the product and creating a cost estimate for each semi-finished and finished product to calculate the cost of the material shipped to the customer. While this valuation at standard costs is perfectly acceptable in the United States and Europe, Latin America and Asia legally require companies to value COGS with a price that reflects the actual costs for the product. For more information on this subject, refer to Qian (Sharon) Tang's article "Statutory Requirements Compliance: Are You Ready for China?" in the January 2005 issue of SAP Financials Expert. I'll show you how to use new functions available with the material ledger (CO-PC-ACT) in R/3 Release 4.7 to adjust the cost of sales accounts to reflect the actual costs for the period. Also, if you are working in a make-to- order environment, I'll show you how to use the same functions to update the sales order or project with the actual costs. (See the sidebar, "What Are Actual Costs?") First, let's look at how the standard costs for the manufactured product are set. The Product Cost Planning (CO-PC-PCP) functions are used to create a multi-level cost estimate to determine the costs for each material at the start of the year or period. This explodes the BOM and calculates the costs of the raw materials and each semi- finished and finished product in turn to arrive at a standard cost for the product sold to the customer. Usually, a costing run is used to calculate and update the standard costs for all materials centrally. In principle, the standard costs represent a true and fair view of the material costs. In practice, however, variances can occur at any stage of the manufacturing process, resulting in price differences on the associated purchase orders and production orders. In a standard costing environment, these variances are posted to a price difference account. Clearly, if these variances are significant, the standard costs do not reflect the true costs of manufacturing the product sold. It is the task of the material ledger to unravel the postings to price differences. Variances are collected with respect to the relevant material in an additional set of tables, instead of being subsumed in a single account. At the end of the period, a second costing run calculates the variances for each procurement alternative and material and then applies these differences either to the goods in stock or to the goods consumed in the next manufacturing level, thus rolling the actual costs through the production structure in a way that mirrors the process in Product Cost Planning. The result is inventory values for each product that include all the variances. If you are new to this area, you might find it useful to refer to Kurt Goldsmith's article, "Hard-to-Get Inventory Analyses Become Easy Via the Material Ledger 4.6," published the July/August 2002 issue of FI/CO Expert. Prior to Release 4.7, the value flow captured by the material ledger stopped as the final goods were delivered to inventory and ignored the goods issue to the sales order or project that completes the process from a logistics point of view. In make-to-stock production, the goods issue resulted in an FI posting only, whereas in make-to- order production, the posting was additionally reflected on the cost collector for the sales order or project.

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I'll show you how the "revaluation of consumption" functions in the material ledger extend the value flow to include the goods issue to the sales order in Release 4.7, allowing you to update the cost of sales account and, if necessary, the sales order or project.

Example
Let's say that you need to produce and sell a demo CD in Mexico. Figure 1 shows the material master (transaction MM03) for the demo CD together with its valuation parameters on the Accounting 1 tab. Experts recognize this subscreen as the MBEW tables. You are manufacturing demo CDs to stock, instead of to order, which means that the fields VC:Sale Ord. Stk and Project Stock VC are blank. In a make-to-order environment, either sales order stock or project stock would also be active. Full details on valuated sales order stock are beyond the scope of this article. If you want to know more, refer to the FI/CO Expert article on valuated sales order stock by John Jordan, "Make-to-Order WIP and Cost of Sales: You Have Three (Not Two) Options," in the October 2003 issue.

Figure 1

Material master showing settlement control

Two fields in this screen are specific to the material ledger the flag showing that the material ledger is active (ML act. check box) and the price determination method (Single-/Multilevel in this case). I'll return to these later when I talk about configuration. Just as you can access the standard cost estimate used to set the standard costs from the material master, you can use the Mat. Price Analysis button to access details of how the actual material costs were determined from the material master. This takes you to the screen shown in Figure 2. You set up my example as follows:

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Figure 2

Result of revaluation of consumption

Use a production order to manufacture 50 demo CDs and deliver them to stock. You can see this posting under Receipts>Production>Production Version 1 the goods receipt is document 1000000182 in the material ledger. Next, run an order settlement for the variance of 574.70 Mexican pesos that occurred during manufacturing. You can see this posting under Receipts>Production>Production Version 1 the order settlement is document 1000000183 in the material ledger. Issue 40 demo CDs to a sales order. You can see this posting under Consumption> Consumption>Account 893015 the goods issue is document 1000000184 in the material ledger. Ten demo CDs remain in stock (ending inventory). When you carry out the costing run, the price differences from production (574.70 Mexican pesos) are assigned as follows: 459.76 Mexican pesos to the cost of sales account 893015. You can see this posting under Consumption> Consumption>Account 893015 the revaluation of consumption is document 4000000398 in the material ledger. 114.94 Mexican pesos to the ending inventory. You can see this posting under Ending Inventory the price differences are in document 4000000399 in the material ledger. Now I will walk you through the customizing steps in the material ledger and the changes to the costing run required to revaluate consumption postings. (If you are new to the material ledger or need a review of what happens prior to revaluation of consumption, see the sidebar, "Steps in the Costing Run for the Material Ledger.")

Material Ledger General Settings

If you are setting up the material ledger for the first time, start in the accounting view of the material master (Figure 1). On the Accounting 1 tab of the material master, you can see that the material price is stored in three currencies, Mexican pesos, Euros, and US dollars, and that the price control remains S (standard costs) in all currencies to ensure that the preliminary valuation uses standard costs. The ML act. check box indicates that the material ledger is active, so price differences will be collected for the material. As shown in the Price determination field in Figure 1, the settlement control has been set to 3 for multi-level settlement. This means that the R/3 system uses a costing run to assign these differences to each level of production (and ultimately to sales) at the end of the period. To generate these fields in the material master, you need to activate the material ledger for the plant by following the IMG menu path Controlling>Product Cost Controlling> Actual Costing/Material Ledger>Activate Valuation Areas. For multi-level actual costing, check that the automatic update of the quantity structure is activated by following the IMG menu path Controlling>Product Cost Controlling>Actual Costing/Material Ledger>Actual Costing>Activate Actual Costing. This ensures that all goods movements that affect inventory valuation are tracked to construct a multi-level quantity structure for each product. You might be familiar with the term "quantity structure," referring to the BOM and routing used as the basis for standard costing. To arrive at the standard costs, individual BOM and routing items can be deactivated at numerous places. Because actual costing uses the goods movements in the Materials Management (MM) module, you don't need to revisit the BOMs and routings to get to your actual

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costs.

Material Movements
To revalue goods issued to sales orders and projects with the actual costs, you need to determine which movement types are used in the MM module to issue materials to sales orders/projects or reverse such postings and activate the revaluation of consumption for these goods movements. Note that if you activate revaluation of consumption, you should also create an account for any goods issues that are not to be updated to cost objects, using the posting key COC (cost of other consumption) in MM to ensure that an account assignment exists for all variances to consumption. To define movement groups for the relevant postings, follow the IMG menu path Controlling>Product Cost Controlling> Actual Costing/Material Ledger> Material Update>Define Movement Type Groups of Material Ledger. In this example, movement type group CF updates the COGS account and movement type group CC updates both the COGS account and the sales order/project. The group names are mine. At a live installation, you will probably work with one or the other, entering either 1 Revaluation of G/L Account or 2 Revaluation of G/L Account and CO Account Assignment in the Revaluation of Consumption field for the movement type group (Figure 3).

Figure 3

Movement type groups

If you choose 1, then only the FI account for the cost of sales is updated. This makes sense in a make-to-stock environment, when the sales order or project is not a cost collector and sales controlling takes place primarily in Profitability Analysis (CO-PA). If you choose 2, then both the FI account and the sales order/project are updated. This works in a make-to-order environment. Option 2 also is a good choice for goods issues to cost centers. However, you should be careful if goods are issued to production cost centers. Generally, cost center closing and order settlement should be complete before you run the costing run in the material ledger. If you were to subsequently revalue the production cost centers, then a cyclical structure would be created that cannot be resolved by the material ledger. The revaluation to the cost center can only be posted to Profitability Analysis (CO-PA) as a variance. Then you need to assign the movement type groups to the movement types by following the IMG menu path Controlling>Product Cost Controlling>Actual Costing/Material Ledger>Material Update>Assign Movement Type Groups of Material Ledger. I use movement type 251 to issue goods to sales and 252 to reverse such postings, as shown in Figure 4. Depending on your configuration in the MM module, you may need to create multiple entries here if you are using special stock types, such as consignment (the K shown here) or sales order stock (special stock type E) in a make-to-order environment.

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Figure 4

Choose movement types for revaluation

Change the Parameters

To calculate actual costs at the end of the period, you need to create a costing run using the IMG menu path Accounting>Controlling>Product Cost Controlling>Actual Costing/Material Ledger>Actual Costing>Edit Costing Run. Before you perform the costing run, you need to change the parameters in the variant for the closing entries report. Go to the Post Closing step, right-click on the execute icon, and select Change Parameters (Figure 5).

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Figure 5

Change parameters in the costing run

Change the variant for the closing entries report by checking the flag for Revaluate Consumption (Figure 6). If you chose 2 for revaluation of consumption in Figure 3, also choose the flag for Set CO Account Assignment to ensure that your sales order or project is updated too.

Figure 6

Parameters for revaluation of consumption

Now you know how to roll price differences through all levels of production to the cost of sales. In a subsequent article, I will show you how to create a cost component split in actual costing to view the factors affecting the price differences and how to include the actual costs in Profitability Analysis (CO-PA).

What Are Actual Costs?

SAP uses the term "actual costs" in different ways. Many reports in the CO and PP modules show "actual costs" as distinct from "planned" or "target" costs. In that case, actual costs refer to a posting such as a goods issue or a confirmation that has resulted in "actual costs" on a cost center or production order. Typically, these costs are based on an actual quantity, such as the amount of material issued to a cost center or the amount of work performed for a production order. The costs are based on a standard price for the material issued or the standard rate for the work performed. The goods receipt to stock when the production order is complete also results with an actual costs credit to the order normally the actual quantity multiplied by the standard price. As far as the material ledger is concerned, these costs are not actual costs at all, but simply a preliminary valuation of the goods movement or confirmation with a standard price because the actual costs are not known at the time of posting.

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In the days before the material ledger, sites that wanted to use actual costs for inventory valuation would value finished and semifinished goods with the moving average price. Unlike the standard price that was updated when the cost estimate was released, the moving average price was updated with every goods movement, invoice receipt, and order settlement. This was particularly dangerous in the case of order settlement, because order settlement would only assign variances to the materials if they were still in stock. If some of the goods had been issued between the time of the goods receipt and order settlement at period close, then part of the moving average price would finish up in price differences, leaving the auditors with a headache and management with a material price that did not take account of all variances. The new functionality of the material ledger adjusts the cost of sales accounts to reflect the actual costs for the period.

Steps in the Costing Run for the Material Ledger

If you are new to the material ledger functions, you might find it helpful to understand what happens in the stages of the costing run prior to revaluation of consumption: Selection specifies which plants, company codes, or controlling areas are included in the multi-level costing run. Because of the multi-level nature of the costing, it is not possible to exclude particular materials from a costing run, as it is in standard costing. Determine sequence checks the material inputs and outputs of each production process and determines the number of levels in the quantity structure. This step is needed to build the quantity structure for actual costing dynamically each period, especially for cyclical production structures and co-products. Single-level settlement calculates the periodic unit price for each material, taking account of price differences, revaluation differences, and exchange rate differences. It also determines the difference to be rolled through the quantity structure during the multi-level settlement. Multi-level settlement takes the difference calculated during the single-level settlement and passes it on to each material and procurement alternative in the quantity structure in turn. Note that this step handles goods movements arising from external procurement, subcontracting, and stock transfers as well as in-house production. After the multi-level settlement, you see a new material price and the cumulated price differences from the subordinate materials (multi-level price difference) for each material. Revaluation of consumption determines which goods have been issued to sales and applies the price differences for these goods to the cost of sales account attached to the material movement. If you activate the CO assignment, it also assigns the price differences to the sales order. This step results in a new period status being set: Revaluation of Consumption Completed (Figure 2). Post closing switches the price control in the material master from S (standard price) to V (periodic unit price) for the period closed, writes the price calculated to the material master as a new V price, and adjusts the balance sheet for the period closed when you create closing entries.

Janet Salmon joined SAP AG in 1992. After six months of training on R/2, she began work as a translator, becoming a technical writer for the Product Costing area in 1993. As English speakers with a grasp of German costing methodologies were rare in the early 1990s, she began to hold classes and became a product manager for the Product Costing area in 1996. She has since helped numerous international organizations set up Product Costing. More recently, she has worked on CO content for the Business Information Warehouse and Financial Analytics, and is currently responsible for user productivity in ERP Financials. She lives in Speyer, Germany, with her husband and two children. You may reach her via email at janet.dorothy.salmon@sap.com.

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