Parallel accounting according to the “Cost of Sales” and “Nature of Expense” accounting method (2)

24 Friday Jun 2016

Posted by Ludwig Reinhard in Accounts Payable, Accounts Receivable, Fixed Assets, General Ledger, Inventory

Tags

Cost of Sales Method, Nature of Expense Method, Posting setup, Profit & Loss Statement

Posting 01 January: Packing slip raw material 1
The packing slip transaction for the purchase of the first raw material results in the following voucher.

This voucher debits a product receipt account for the purchased material (account no. 13110) and credits the purchase accrual account (no. 22550). As both accounts are Balance Sheet accounts, no effect on the company’s Income Statement can be identified.
The following illustration summarizes the company’s Balance Sheet and its Income Statements according to the COS and NOE method and demonstrates that the packing slip transaction does not affect the company’s profit.

Outcome – after packing slip posting

Posting 02 January: Vendor invoice raw material 1
The next step in the purchase process is related to recording the vendor invoice. The invoice voucher created does first reverse the previous packing slip transactions. At the same time a stock increase (on account no. 13120) and an increase in vendor liabilities (on account no. 22500) is recorded.
Because of the automatic charge code that has been setup, an additional transaction equivalent to the item purchase amount is recorded on the raw material expense and stock variation accounts no. 53130 and 53140. The next two screen-prints summarize the voucher created and show its influence on the company’s financial statements according to the different accounting methods.

Outcome – after invoice posting

Note: As the raw material expense and stock variation account are both assigned to the cost of sales section of the company’s Income Statement that follows the COS method, no effect on the company’s profitability, KPI’s, etc. results.

Posting 03 January: Packing slip raw material 2
The voucher generated with the packing slip posting for the second raw materials purchase is identical to the one created for the first raw material. For that reason, everything that has been mentioned before for the first raw material purchase also applies here. The next screen-prints detail the resulting packing slip voucher and financial statements.

Outcome – after packing slip posting

Posting 04 January: Vendor invoice raw material 2
As also the invoice voucher for the second raw material debits and credits the same ledger accounts that have been used when the posting the vendor invoice for the first raw material, reference can be made to what has been mentioned above.
The only major difference between the first and second raw material purchase is reflected in the invoice voucher. That is, for the purchase of the second raw material the slightly higher purchase price of 12 EUR / pcs. results in a stock increase of 12000 EUR that is recorded on the respective ledger account no. 13120.
In line with this stock increase, an equivalent transaction on the raw material expense and stock variation accounts can be identified. For details, please see the postings on accounts no. 53130 and 53140 and the resulting financial statements shown next.

Outcome – after invoice posting

Posting 05 January: Packing slip vendor return raw material 1
The return of the first raw materials that did not pass our quality tests results in vouchers that are – except for the sign – identical to the one’s recorded before. For that reason, reference is made to the previous explanations.

Outcome – after packing slip posting

Posting 06 January: Vendor invoice vendor return raw material 1
What has been mentioned for the packing slip voucher generated also applies for the credit note “invoice” voucher. In this respect I would especially like to draw your attention on the parallel raw material and stock variation posting created for the vendor credit note shown in the following screen-print.

The overall result from all of the transactions recorded within this subsection can be identified in the next screen-print that summarizes the effects of the postings on the company’s financial statements according to the COS and NOE accounting method.

Outcome – after invoice posting

Note:
Dynamics AX uses the so-called running average cost price when issuing goods. With the recording of the vendor return transaction such an issuance occurs. As the running average cost price cannot directly be influenced by users and regularly differs from the price that our vendor credits for the item return, a temporary difference between the stock and stock variation accounts might result.
In the long-term this (temporary) variance will be offset through the transactions recorded when closing the company’s inventory. However, in the short-term an additional transaction on the “purchase expenditure, un-invoiced” resp. “purchase expenditure for product” accounts might occur.
The next screen-prints exemplify such a situation, where the amount credited by the vendor (10 EUR) differs from the running average cost price (11,83 EUR).

To ensure an always consistent and correct illustration of the company’s Income Statement according to the COS and NOE method it is thus recommendable to setup…

the same ledger accounts in the “cost of purchased materials received” and “purchase expenditure, un-invoiced” section and to setup…
the same ledger accounts in the “cost of purchased materials invoiced” and “purchase expenditure for product” section.

Please note that this setup is not obligatory but can make the analysis and interpretation of transactions recorded in Dynamics AX easier. The following screen-print shows the setup just described for the first two account sections mentioned.

Intermediate result
The following illustration summarizes all ledger postings created within this subsection.

Notes:

Transactions that offset each other are highlighted in grey color. Transactions that do only affect the company’s Balance Sheet are highlighted in green color and the Income Statement related transactions required for the NOE accounting method are highlighted in yellow color.
In order to follow up the different transactions, the posting types used have been entered in square brackets just below the ledger accounts used.
Tax related transactions are disregarded in order to keep things as simple as possible.

Based on the transaction summary shown in the previous illustration it can be concluded that the COS and NOE accounting methods can be applied in parallel in standard Dynamics AX. In this respect is has been shown that the shortcoming of the standard AP parameter “post to charge account in ledger” can be overcome by using an automatic charge code.

To be continued in part (3)

Parallel accounting according to the “Cost of Sales” and “Nature of Expense” accounting method (1)

18 Saturday Jun 2016

Posted by Ludwig Reinhard in Accounts Payable, Accounts Receivable, Fixed Assets, General Ledger, Inventory

≈ 2 Comments

Tags

Cost of Sales Method, Nature of Expense Method, Posting setup, Profit & Loss Statement

International operating companies are often required to prepare financial statements that follow different accounting methods/regulations.

Especially local units of international business conglomerates that operate in a foreign country regularly have to prepare financial statement in one format for local accounting standard setters and in a different format for corporate headquarters.

In the European Union you will often face situations where companies have to prepare financial statements according to the so-called “Cost of Sales” (COS) Method for corporate headquarters and according to the “Nature of Expense Method” (NOE) for local accounting bodies / tax offices.

Within the following subsections I will illustrate how both methods – the COS and the NOE method – can be setup in parallel in Standard Dynamics AX.

Before digging into details, let’s have a look at the major differences between the COS and NOE accounting method.

A. Overview major differences between the COS and NOE accounting method
In the European Union (EU) different regulations are applicable when it comes to the use of COS and the NOE accounting method. As an example, the EU directive 2013/34 specifically describes both methods in detail by referring to the “Function of Expense” (COS) and “Nature of Expense” (NOE) method. Similar regulations can be found e.g. in Germany and Austria where legal regulations detail the differences and requirements of both methods. Irrespective of differences in the nomenclature, the major differences between the COS and NOE method can be recognized in the structure of a company’s Income Statement. The next screen-print compares those structures by showing the COS method on the left and the NOE method on the right.

Despite the summarized comparison of the different Income Statement formats, major differences can be identified in the inventory, human resource and fixed asset sections.

From a finance & controlling perspective, an important difference between the COS and NOE method is related to the data sources required for generating both financial statement formats. That is, while the NOE method does only require data from the accounting department, the COS method also requires cost / management accounting information in order to break down the costs by functions.

The next subsection details the sample data used for the illustrations shown in this post. This section is followed by a in depth specification of setups required in Dynamics AX and their effects on corporate financial statements.

B. Sample data
To illustrate you the differences between the COS and NOE method, a number of transactions have been recorded that are based on the following process flow:

The process flow that you can identify from above starts with the purchase of raw materials, which are later on partly returned to the vendor (due to quality problems). The next transactions are related to inventory adjustments in the warehouse. Thereafter, several transactions originating from the non-operating/administrative areas will be illustrated before the differences in the production process of finished goods will be explained in detail. The process flow finally ends with the investigation of the differences in regards to the sale of the produced goods.

C. Process illustrations
In the following, each of the different colored elements shown in the prior process flow diagram will be analyzed and explained in separate sub-chapters.

C.1. Purchase & return of materials
For purchase related material transactions, the major difference between the COS and NOE method is that the COS method does not affect a company’s Income Statement and thus its profit whereas the NOE method initially expenses the complete purchase of the materials. As a result, the company’s profit instantly decreases when the NOE method is applied.

If nothing else happens with the materials (that have been purchased) over the period, the profit reduction is subsequently offset by an adjustment (so-called “stock variation”) transaction. The next screen-print illustrates the differences between both methods just described in an accounting like format.

What can be identified from the COS method transactions shown on the left-hand side of the prior illustration is that the purchase of materials does only affect the company’s Balance Sheet (BS). The NOE method related transactions do on the other hand side – at least temporarily and depending on changes that occurred to stock levels over the month – also influence a company’s Income Statement (IS).

From what has been said so far, two major disadvantages of the NOE method can be identified.

The first disadvantage is that you cannot control and analyze your inventory values within a financial period as the financial inventory values are only correct after the adjustments (“stock adjustment/variation transactions”) have been recorded at the end of the month.
The second major disadvantage of the NOE method is that the stock variation postings at the end of the month are typically done on a summarized basis, which prevents you from running detailed item related product Analysis out of the box.

Irrespective of the disadvantages mentioned and against the background of the accounting transactions illustrated in the prior screen-prints, the question arises how the COS and NOE method can be aligned with each other in a way to get both Income Statement formats out of Dynamics AX in parallel?

The following illustration tries answering this question by showing you that both accounting methods can be aligned with each other through an additional and parallel expense and stock variation transaction (highlighted in yellow color). Please see the lower part in the next illustration.

Given that our company creates two purchase orders – one for 2 TEUR and a second one for 3 TEUR – two additional “stock variation transactions” are recorded. The major difference to what has been explained before is thus the number of stock variations recorded. That is, rather than posting a single “large” stock variation transaction at the end of the month, several “small” stock variation transactions are recorded with each and every purchase.

A major advantage of this procedure is that there is no need for a (manual) analysis and recording of stock variations at the end of the month, which frees up some time for doing other things during the often busy month end closing period.

Note: The ledger accounts used for the additional material expense and stock variation postings debit and credit Income Statement accounts. As a result, no effect on a company’s profit arises. For the preparation of an Income Statement according to the COS method this result thus implies that assigning both accounts to the same Income Statement section will not influence a company’s profitability, KPI’s, etc.

After investigating how the COS and NOE method can be aligned with each other in a way to generate the transactions required for both accounting methods, the questions arises how to setup Dynamics AX in order to get those additional material expense and stock variation postings automatically recorded? From a “technical” Dynamics AX perspective, the following two options might help getting those additional postings recorded.

Option 1: Activate the “post to charge account in ledger” AP parameter
The first option makes use of the “post to charge account in ledger” parameter that can be found in the Accounts Payable parameters form. Activating this parameter results in an additional charge (expense) and stock variation posting on the ledger accounts specified in the respective sections of the inventory posting matrix illustrated below.

On first sight, this seems to be exactly what is needed for a parallel use of the COS and NOE method. Yet, a detailed investigation of this functionality shows that the additional posting triggered through the activation of this parameter only applies to ordinary purchase related transactions but not to vendor return transactions. Because of this shortcoming, this first setup option won’t be used in the following.

Option 2: Make use of automatic charge codes
Due to the limitations of the first option, an automatic charge code is used instead. The next screen-prints illustrates the setup of this charge code that debits an expense account and credits a stock variation account.

Once the charge code is setup, it is linked to an automatic charge in order to generate an additional posting equivalent to the one created for the materials purchased. This requires that an automatic charge percentage of 100% is applied, as illustrated in the next screen-print.

In order to enable you tracking what has been mentioned above, the following purchase order related transactions are recorded in a Dynamics AX demo environment:

First, on 1^st and 2^nd January, the packing slip and vendor invoice for the purchase of a first raw material. In total 1000 pcs of the material are purchased for a price of 10 EUR / pcs.
Second, on 3^rd and 4^th January, another 1000 pcs of a second raw material item are purchased. This time the purchase order packing slip is posted with the price the materials were ordered for (10 EUR / pcs) whereas the vendor invoice is recorded with a slightly higher price of 12 EUR / pcs.
Finally, on 5^th and 6^th January, a vendor return order is created for 50 pcs of the first raw material that did not pass quality tests.

The following illustration chronologically summarizes the transactions that will be illustrated and analyzed next.

To be continued in part (2)

Duplicate vendor invoices

08 Wednesday Jun 2016

Posted by Ludwig Reinhard in Accounts Payable

≈ 2 Comments

Tags

Avoid double payments, Vendor invoice recording, Vendor payments

A general problem when recording and paying vendor invoices is the question how to ensure that invoices are not entered and paid more than once. What sounds like common sense can involve a lot of practical problems especially when it comes to recording and paying expense related vendor invoices that are not linked and tracked through purchase orders.

Imagine the following scenario where an employee orders some advertising material (brochures) for the next trade fair. As the total order value is quite small and given that the costs for the brochures are going to be expensed directly, the advertising material is ordered straightaway via Email without making use of the purchase requisition / purchase order process.

If the vendor sends a copy of the invoice together with the shipped advertising material and the original invoice via Email, an invoice – and copies thereof – arrives several times in a company.

For the sake of this demonstration let’s further assume that the invoice copy is forwarded from the warehouse agent to the employee who ordered the goods. After checking and approving the invoice it is then forwarded to the Accounts Payable department where it is recorded by an AP clerk for the first time in the ERP system with invoice no. “INV1234”.

Let’s continue the scenario by assuming that the original invoice is sent to the Accounts Payable department where another AP clerk forwards the invoice to the marketing manager for approval. If the marketing manager does not coordinate with his employee who placed the order, the invoice might get approved and recorded a second time in the system e.g. with invoice no. “INV 1234”. Please note that this time the invoice is recorded with a blank before the number and as a result, the invoice is not identified as a duplicate invoice by the ERP system, as the invoice numbers “INV1234” and “INV 1234” differ from a technical perspective.

At this point three questions arise:

How to identify that an invoice has been recorded more than once in the system?
How to avoid paying the vendor twice? and
How to avoid double entries of invoices altogether?

Within the following subsections I will try answering those questions by referring to Dynamics AX standard features.

Q1: How to identify that an invoice has been recorded more than once in the system?
In order to answer the first question, I will slightly modify the scenario portrayed in the beginning of this post. To understand and follow up the example, it has to be noted that the AP parameter “reject duplicate” invoices is activated. Please see the next screen-print.

Next, two invoices are recorded in a vendor invoice journal. The first invoice is entered with invoice number “INV1234” and the second one with invoice number “INV 1234”. That is, the second invoice is recorded with a blank between the term “INV” and the invoice number. Because of that blank, Dynamics AX treats both invoices as distinct records.

Referring back to our scenario introduced above – and different from the illustration in the previous screen-print – the first and the second invoice would have been entered by different AP clerks in different vendor invoice journals. Because of a (“human”) typing error, Dynamics AX cannot identify that the same invoice has been entered twice.

Now let’s extend the scenario by recording another two invoices with invoice numbers “INV.1234” and “INV1234.” in the vendor invoice workbench. That is the invoices are entered with a dot in between respectively behind the invoice number. Please see the next screen-print.

Due to the blank and dot characters used, the invoice was finally recorded four times in Dynamics AX. This can be identified from the vendor invoice journal form illustrated next.

After entering those four invoices we will now try identifying the duplicate invoices by making use of the audit policy feature available in the audit workbench module. (In AX2012 the same functionality can be found in the compliance and internal controls module).

The first thing that needs to be setup in this module is a policy rule type that makes use of a predefined query (“vendor invoice”) that is incorporated into standard Dynamics AX. The query type used is “duplicate” as we want to search for invoices that have been entered more than once. (Additional information on the available query types can be found on the following TechNet site).

Next, an audit policy needs to be setup and linked to an organization. Please see the next screen-print for an example.

The last and most important setup required is the specification of an audit policy rule that identifies the duplicate invoices. Example:

The criteria that the audit policy rule uses to identify (potentially) duplicate invoices are entered in the “group by” filter tab. In my example, I specified that invoices with the same amount and date for the same invoice account are potentially duplicate invoices.

Please note that the invoice number cannot be used as a criteria, as all the invoice numbers that we entered differ.

Once the audit policy rule is established, a batch job needs to be setup which analyzes all vendor invoices for potentially duplicate records based on the criteria that we specified before.

If the invoice batch search process finds duplicate records, it creates a case where it lists the potentially duplicate invoices as illustrated in the next screen-print.

Note: A prerequisite not explicitly mentioned/illustrated here is the setup of an audit type case category in the organization administration module. Details for this setup can be found on the following TechNet site.

If you take a close look at the duplicate vendor invoices identified above, you will notice that Dynamics AX only listed the invoice numbers with the dot characters in the audit case window. On the other hand, the invoices that were entered in the vendor invoice journal are not picked up and identified as duplicates.

The underlying reason for this standard behavior is the Dynamics AX policy framework. That is, only those invoices that do – among others – have a source document header and source document line associated are picked up by the audit policy check. As the invoices recorded through vendor invoice journals do not have this association they are not taken into consideration by the audit policy rule.

This standard behavior of the audit policy rules does have three major implications:

If you want to make use of the audit policy rule functionality, vendor invoices cannot be recorded through vendor invoice journals.
Alternatively, a comprehensive system modification needs to be implemented, and
Given that users are still allowed entering invoices through vendor invoice journals, manual checks for duplicate vendor invoices are required to avoid double payments.

From the authors perspective the first implication that requires entering all vendor invoices through the vendor invoice workbench seems to be superior as it provides one single point of entry for vendor invoices irrespective of whether those invoices are linked to a purchase order or not.

What is more, recording expense related invoices by referring to descriptive categories rather than a multi-digit ledger accounts reduces the risk of typing/posting error especially if temporary employees or trainees are recording vendor invoices in the system. Example:

Please note that users still have the chance to overwrite the ledger account that is linked to the category if necessary, as illustrated in the previous screen-print.

Even if users are familiar and used to entering vendor invoices through the Dynamics AX vendor invoice journals, a process change towards entering all invoices through the vendor invoice workbench might be beneficial. That is not only because of the audit policy functionality mentioned before but also because of the standard Excel-import and workflow processes that can be associated with the invoice workbench resulting in an overall streamlined and simplified invoice recording process.

Q2: How to avoid paying the vendor invoice twice?
Based on what has been said before, you can setup and process an audit policy rule for duplicate vendor invoices before you start making vendor payments to minimize the risk of making double payments. As mentioned previously, this requires that all invoices are entered through the vendor invoice workbench. Otherwise your only option is executing manual checks for potentially duplicate invoices that might require a lot of time and resources.

Q3: How to avoid double entries of invoices altogether?
The audit policy process introduced in this post helps you identifying whether an invoice has been entered more than once. That is, the feature is able to identify with hindsight that something went wrong that needs to be cured.

As prevention is usually better than cure, the question arises how one can prevent similar scenarios as the one described in the introduction of this post?

From the author’s perspective the best and safest way for avoiding duplicate vendor invoice records is a complete and consistent use of the Dynamics AX purchase order process for each and every purchase that is made in your company. This requires that also expense related and often small value purchases are processed through purchase orders. Especially for small- and medium-sized companies this might sound like taking a sledgehammer to crack a nut. However, I made the experience that especially small- and medium-sized companies are the ones that do not have the most stringent organizational business processes in place and as a result are the most likely ones running into the risk of entering and paying invoices double.

I hope you enjoyed reading this post and would be happy if you could share your experience with the AX community on how to prevent duplicate vendor invoices & payments in Standard Dynamics AX. Thank’s and till next time.