Dynamics AX General Ledger Module

Parallel inventory valuation – an alternative approach (Part 5)

17 Monday Apr 2017

Posted by Ludwig Reinhard in General Ledger, Inventory

Tags

Inventory, parallel, price variance, quantity variance, standard costs, substitution variance, valuation

As the other remaining production related standard cost variances are treated in a similar way as the previously analyzed lot size variance, they are analyzed together in this post. In order to get a price, quantity and substitution variance posted, the following modifications have been made to the standard production process for the item that has already been used in the prior post.

Instead of consuming one raw material, two pieces of the raw material are consumed, which results in a quantity variance of $500.
The standard cost price of the raw material has been increased from $500 to $515 prior to the start of the production order. This gave rise to a price variance of
2 pcs x ($515-$500) = $30
The route card was posted with a different route version, which had a different (more expensive) cost category price setup ($600 instead of $490). This change resulted in a substitution variance of $110.

Other common sources of standard cost variances are described on the following website: https://technet.microsoft.com/en-us/library/gg213654.aspx

The next screen print illustrates the total production costs of $1640 and the different standard cost variances for the sample production order processed.

As before, the next accounting overview summarizes the generated ledger transactions.

The grey highlighted lines offset each other and can thus be ignored for the analysis of the production costs.

For those readers who are not very familiar with ledger postings, the following financial statement overview has been prepared.

The financial statement overview presented above shows that the total inventory balance of the produced item ($1000) is too low from an actual costing perspective ($1640). For that reason, an allocation of the price, quantity and substitution variance similar to what has been shown in the previous post for the lot size variance is required.

Applied to the example shown above, the complete price, quantity and substitution variance amounts would have to be shifted to the company’s balance sheet by making use of an allocation rule. That is because only a single receipt transaction but not issue transaction has been recorded thus far. If also issue transactions would have been recorded, a separation and allocation of the different variance amounts would be required. The setup and application of this allocation rule is not shown here to conserve space and because it follows the same concept that has been explained in the prior posts.

Summary:
This and the previous posts demonstrated that companies that make use of a standard cost inventory valuation can obtain a parallel inventory value that is based on actual costs by applying general ledger allocation rules for the different standard cost variances.

The next graph summarizes the different standard cost variances and illustrates how they need to be treated to arrive at a parallel inventory value.

The graph above differentiates between the different standard cost variances based on whether they arise internally (cost revaluation and cost change variance) or whether they have an external market relationship.

External market relationship in this context refers to the purchase market, which gives raise to the purchase price variance in case items are purchased and to the sales market, which relates to the produced items once they are sold.

As explained before, the ‘internal’ standard cost variances need to be eliminated, that is, shifted from the company’s income statement to its balance sheet because they relate to receipt transactions only and are eliminated automatically once the items are sold/consumed later on.

The ‘external’ standard cost variances require on the other hand side a separation based on whether they relate to receipt or issue transactions. This separation can be realized by making use of the ledger allocation rules and ensures that an actual cost inventory value can be obtained.

Overall it can be concluded that a parallel inventory valuation can be realized for companies that make use of standard costs by applying general ledger allocation rules. This post concludes this series on the alternative parallel inventory valuation approach. I hope that you found the one or the other useful information. Till next time.

Parallel inventory valuation – an alternative approach (Part 4)

07 Friday Apr 2017

Posted by Ludwig Reinhard in General Ledger, Inventory

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Tags

Inventory, lot size variance, parallel, standard costs, valuation

After the purchase and internal standard cost variances have been analyzed, let’s now have a look at the production related standard cost variances and how to deal with them.

Within this fourth part we will have a look at the lot size variance (LSV) first, which arises for example if the good quantity from a production order differs from the calculation quantity that was used for the standard cost calculation of an item. The following graphic illustrates the composition of the finished item that will be used for the subsequent explanations of the production lot size variance.

The graphic above shows a finished good that is made of a raw material that has a standard cost price of $500 setup. In addition, another $500 route related costs – that consist of $490 assembly cost and $10 setup cost – are necessary to produce the item.

As the setup costs are independent from the quantity produced, the total production costs of an item decrease, as the production quantity increases. The next graphic illustrates this relationship for the sample item used.

To illustrate how the lot size variance arises and how to deal with this kind of variance, a production order for 10 pcs of the finished good is processed. The next screen print shows that a total of $9910 production costs arise for the production of the 10 items [$10 setup costs + 10 x ($500 material costs + $490 assembly costs)]. The illustrated lot size variance of $90 results from the fix cost degression effect shown in the previous graphic.

Similar to what has been shown in the previous post, the next accounting-like overview summarizes the production postings recorded (separated by the different production steps).

The grey highlighted lines offset each other and can thus be ignored for the analysis of the production costs.

For those readers who are not very familiar with ledger postings, the following financial statement overview has been prepared.

The financial statement overview shows a total inventory value of $10000 for the finished product on ledger account 140670. To produce those finished goods, raw materials with a total value of $5000 and $4910 labor costs have been consumed. The remaining difference to the standard cost value of the finished goods is assigned to the lot size variance that is recorded on ledger account 540630.

Further above, a realized cost amount of $9910 has been identified. Against the background of this actual cost amount, it can be concluded that the inventory value of the finished goods is overstated by $90 from an actual costing perspective.

If one of the produced items is sold later on, the inventory value is decreased by $1000 – the standard costs of the item. The financial statements illustrated below exemplifies this situation.

From an actual costing perspective, the decrease in the inventory value from the sale of the produced item is comparatively too high. The same holds for the cost of sales, which are recorded on ledger account 640650.

In order to arrive at an actual cost valuation, the lot size variance (LSV) needs consequently be adjusted and split up in a similar way that has been shown for the purchase price variance before. The next graphic exemplifies the necessary separation of the total lot size variance if one out of the ten produced items is sold.

To conserve space, the setup of the necessary ledger allocation rule is left as an exercise for the reader. If the allocation rule is later on processed, the following financial statements result:

The financial statement overview shows a total inventory value that is $81 lower than before. This reduction takes care of the difference between the actual and the standard cost price [9 pcs x ($1000 – $991)]. As the allocated lot size variance amount is recorded on a separate ledger account, a parallel standard cost and actual cost inventory valuation can be achieved.

Please note that this also applies for the COGS amount of $1000 that has been adjusted through a corresponding adjustment on ledger account 640651 to arrive at an actual cost value of $991.

Within the next post we will take a look at the other production related standard cost variances and how to deal with them from a parallel valuation perspective. Till then.

Parallel inventory valuation – an alternative approach (Part 3)

28 Tuesday Mar 2017

Posted by Ludwig Reinhard in General Ledger, Inventory

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Tags

cost change variance, Inventory, parallel, standard costs, valuation

The next standard cost variance type that has an influence on the parallel valuation approach concerns cost change variances, which can result from two different sources that will be explained in the following.

Source 1: Standard cost price differences between sites
Standard costs can be setup in a way that different standard cost prices are defined per site in order to incorporate cost price differences resulting for example from transportation costs, etc. The next screen print exemplifies an item that has different cost prices setup for site 1 and site 2.

In order to illustrate what influence these different cost prices have on the parallel inventory valuation approach, 100 pcs of the item have initially been acquired through an inventory adjustment journal for site 1. The resulting financial data can be identified in the following screen print.

After the items have been acquired, an inventory transfer from site 1 to site 2 for a single item is posted through an inventory transfer journal.

The outcome of this transfer is an adjustment voucher that results in a corresponding increase in the inventory value. The adjustment voucher and the resulting inventory value increase can be identified in the following figures.

What one can identify from the financial statement reports exemplified above is that the total inventory value increased by $25 because of the item transfer from site 1 to site 2.

Before analyzing how to deal with that variance for the parallel inventory valuation approach, let’s have a look at the second possible source of cost change variances.

Source 2: Customer item return after standard cost price change

A second possible source for cost change variances are situations where standard cost items are sold to customers and returned after a cost price adjustment has been completed.

The following example illustrates this scenario where initially 100 pcs of a standard cost item with a cost price of $100/pcs are acquired – for reasons of simplicity – through an inventory adjustment journal. The next screen print shows the resulting financial statements.

After the items have been acquired, 5 pcs are sold for a sales price of $200/pcs. With a standard cost price of $100/pcs, the company’s inventory value is consequently reduced by $500, which can be identified from the next financial statement illustration.

Shortly after the items have been sold, the standard cost price of the remaining inventory items is adjusted from $100 to $130. The resulting accounting voucher and financial statements are shown in the next screen prints.

The screen prints above illustrate that the change in the standard cost price resulted in a $2850 higher inventory value [95 pieces x ($130-$100)].

After the standard cost price has been increased from $100 to $130, the customer decided to return 3 out of the 5 pcs sold. Posting the return order packing slip and invoice results in a number of transaction vouchers that are summarized in the next accounting-like overview.

The grey highlighted lines offset each other and can thus be ignored for the analysis of the production costs.

The transaction vouchers summarized above demonstrate that the item return resulted in a corresponding adjustment of the sales revenue and the receivables amount (3 pcs x $200 sales price / pcs = $600). At the same time, an adjustment of the COGS and inventory value was recorded. Yet, because of the cost price change, a $90 higher inventory value remains.

Expressed differently, selling and returning the 3 items resulted in a $90 higher inventory value, which can be identified in the following financial statement overview.

After having analyzed the sources of cost change variances, the question arises, how to deal with them in order to arrive at a parallel actual cost based inventory value?

As mentioned in the previous post, standard cost price changes resp. differences typically do not reflect actual (market) price differences but rather cost/transportation/handling cost differences.

Moreover, in an actual inventory costing environment, internal movements of goods between different sites do not affect the company’s profit. That is, a company does not get richer or poorer by the mere fact that an item has been shifted from one location to the other, as it might be the case for standard cost items.

The same holds for the second source of the identified cost price changes; i.e. in an actual costing environment, a company does not get richer or poorer by shipping and returning goods to and from a customer, as it might be the case in a standard cost environment.

For those reasons and because cost change variances affect receipt transactions only, it can be argued that the complete cost change variance amount needs to be shifted from the company’s income statement to it’s balance sheet in order to arrive at an approximate actual cost valuation. This shifting can once again be realized by making use on an allocation rule similar to the one that has been introduced in the prior posts.

The next posts will deal with the production related standard cost variances and how to incorporate them in the parallel inventory valuation approach. Till then.

Parallel inventory valuation – an alternative approach (Part 2)

15 Wednesday Mar 2017

Posted by Ludwig Reinhard in General Ledger, Inventory

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Inventory, inventory cost revaluation, parallel, standard costs, valuation

After having analyzed how to deal with purchase price variances in order to arrive at a second (parallel) inventory value, let’s have a look at the second standard cost variance type – the inventory cost revaluation – and how to deal with those variances to obtain a second (parallel) inventory value for standard cost items.

Scenario:
At the end of a fiscal year, the standard costs of a first item are adjusted from $100 to $109. For a second standard cost item, the standard costs are adjusted from $100 to $95. As there are currently 100 pcs from each of the items on stock, a total inventory value of $20000 can be identified (before adjusting the standard cost prices) in the financial statements illustrated in the next figure.

For reasons of simplicity the inventory values/balances have been created by posting an inventory adjustment journal that resulted in an inventory receipt & profit transaction.

The aforementioned revaluation of the standard cost item is realized by recording and activating the new standard cost prices in the standard cost costing version, as exemplified in the next screen print.

Once the new standard cost prices are activated, the financial statements show a $400 higher inventory value. This can be identified from the next figure.

The overall increase in the inventory value can be explained by the value increase of the first standard cost item [($109-$100) x 100 pcs] and the value decrease of the second standard cost item [($95-$100) x 100 pcs]. If the revalued items will be sold subsequently, the newly activated standard cost prices will be used for posting the issue transactions.

At this point the question arises whether the inventory cost revaluation amount can remain in the income statement as illustrated in the previous screen print or whether an adjustment similar to the one that has been shown in the first part for the purchase price variance (PPV) is required in order to get a second (parallel) inventory value?

This question can be answered by stating that no split and allocation of the cost revaluation is required, if the cost revaluation is done in a way to adjust the standard cost prices to an ‘actual’ market price. If this is the case, any previously recorded adjustment and allocation of the PPV needs to be reversed in order to avoid an over-adjustment of inventory values towards actual market prices/values.

In practice, most companies do not adjust their standard cost prices in a way to reflect ‘actual’ (market) cost prices. Otherwise, they would have chosen an alternative actual cost price valuation model right from the beginning. Against the background of this common adjustment behavior, it can be argued that an adjustment of the recorded standard cost revaluation amount is necessary in order to arrive at an approximated actual inventory cost price. The main question in this context is then how such an adjustment can be realized?

From the authors’ perspective, the complete cost revaluation amount needs to be shifted (allocated) from the income statement to the balance sheet in order to arrive at an actual cost valuation amount. That is because only those items that are currently on stock (or in process) – that is receipt transactions – are affected by the cost change variance. If those items are sold or consumed later on the adjusted higher/lower standard cost price will ensure that the cost revaluation amount that has been allocated to the balance sheet is successively eliminated. For that reason no split up and allocation of the cost revaluation amount is necessary.

The next part of this series continues with analyzing cost change variances and how they need to be incorporated into this parallel inventory valuation approach.

Parallel inventory valuation – an alternative approach (Part 1)

05 Sunday Mar 2017

Posted by Ludwig Reinhard in General Ledger, Inventory

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Inventory, parallel, purchase price variance, standard costs, valuation

In one of my prior posts I already had a look at the parallel inventory valuation issue. For details, please see this site.

While the prior post focused on the Russian dual warehouse functionality, this post focuses on an alternative parallel valuation approach I recently came across. A major advantage of this alternative approach compared to the Russian dual warehouse functionality is that it does not depend on country-specific features but rather makes use of generally available functionalities that can be applied in every Dynamics AX/365 for Operations environment.

Let’s get started by having a look at the underlying business scenario for this parallel inventory valuation approach.

Scenario:
The following illustrations and explanations are based on a company that makes use of standard costs but requires an ‘actual cost’ evaluation for external reporting & tax purposes.

In order to explain the underlying parallel inventory valuation approach, the following sample transactions have been recorded for a trading item; that is, an item which is not used in the production process.

(DOM = Day Of the Month)

The sample transactions illustrated in the previous figure start with the purchase of 50 pcs of the trading item for a price of $110. As the item is set up with a standard cost price of $100, a purchase price variance (PPV) of $500 results.

The second sample transaction also relates to a purchase order where another 150 pcs of the item are purchased for a price of $95. The major difference between the first and this second transaction is that the second one is only packing slip updated whereas the first one is packing slip and invoice updated.

The third and fourth sample transactions represent (internal) inventory adjustment postings for which no purchase price variance arises.

Those internal transactions are followed by a third purchase order related transaction where another 250 pcs of the item are purchased for a cost price of $105.

Finally, 50 pcs of the trading item are sold to a customer. As the item is set up with standard costs of $100, the inventory value is reduced by a total of $5000.

After all sample transactions are recorded, an inventory value of $45000 remains in the balance sheet (BS) and a PPV of $1000 in the income statement (IS). The next figure illustrates the respective financial statement reports.

My next step was making a manual inventory value calculation for the sample transactions in order to get an impression of the theoretically correct actual cost inventory value. To achieve this, an average cost price has been calculated before recording the different (internal and external) issue transactions. This calculation is similar to what one can identify in Dynamics AX for a weighted average cost price valuation and is exemplified in the following figure.

Depending on how the average values are calculated – before each issue transaction or for the whole period – different actual cost inventory values result. As an example, if a single average cost price is calculated and used for the valuation of the issue transactions, a total inventory value of $45849.06 results. Those valuation differences do, however, not matter here because they have only been shown for explanatory purposes.

What matters though is the fact that the issue transactions, which have been recorded with the standard cost prices, require some adjustments in order to arrive at an actual cost value. The way how those adjustments can be calculated is illustrated in the following figure.

What can be identified from the previous figure is that the total PPV is split up based on the relationship between the total receipt and total issue transactions. As an example, the $868.85, which are assigned to the total receipt transactions are calculated as follows: $1000 / ($53000 + $8000) * $53000.

If only external receipt and issue transactions are taken into account; that is, if the inventory adjustment transactions, which did not generate a PPV are excluded from the calculation, the following PPV amounts are calculated and can be assigned to the receipt and issue transactions recorded.

Building upon the last separation of the total PPV, an actual cost inventory value can be approximated by shifting the fraction of the PPV that can be assigned to the receipt transactions from the income statement to the balance sheet. The next illustration exemplifies this.

After having analyzed the theoretical concept how an actual cost inventory value can be approximated for a company that uses standard costs, the question arises how this theoretical concept can be implemented into Dynamics AX/365 for Operations?

The answer to this question are General Ledger (GL) allocation rules that can be used for transferring the part of the PPV, which relates to the receipt transactions, into the company’s balance sheet.

The next screen print shows the allocation rule used. Please note that this rule is set up with the ‘basis’ allocation method.

The ledger account that records the PPV for the trading items – account no. 540400 in the example – is included in the ledger allocation source form and will be used as the basis for the subsequent allocation calculation.

Please note that the allocation basis is defined in combination with the financial dimension ‘item group’, which has been assigned to all trading items. Referring to the item group rather than using separate allocation rules for each individual trading item is a simplification that will not result in an individual but a group-based inventory valuation of the item. From the author’s perspective, this simplification appears to be justifiable, as companies regularly do not report inventory values on an individual item basis in their external financial statements.

The next setup required for using ledger allocation rules concerns the offset account, which should be different from the PPV account that is used in the ledger allocation source form shown above in order to allow users tracking the original and adjusted PPV.

Finally, ledger allocation rule destinations have to be set up that define the account-financial dimension combinations to which the PPV will be allocated.

The next screen prints show that the part of the PPV that relates to the issue transactions is recorded on the income statement account 540401. The part of the PPV that relates to the receipt transactions is, on the other hand side, recorded on the balance sheet account 140499.

Once the ledger allocation rule is setup and activated, it can be processed. Processing the exemplified allocation rule results in the following voucher, which debits the PPV income statement account 540401 for the part of the PPV that remains in the income statement. The remainder of the PPV is consequently shifted to the balance sheet account 140499. In order to avoid a double counting of the PPV, the credit transactions on the income statement account 540409 offsets the posted PPV.

The following screen print summarizes the resulting balance sheet and income statement reports after the allocation rule is processed and posted.

Assessment:
The parallel inventory valuation approach illustrated in this post requires that all items are set up with an ‘item group’ or ‘item’ financial dimension. In addition, separate issue and receipt accounts need to be set up for the different inventory transaction types.

Apart from those setup considerations, major disadvantages of the approach demonstrated here comprise:

That the ‘actual’ inventory cost value can be identified at the General Ledger level only, and
That the approach illustrated requires the use of standard costs.

Despite those disadvantages, the inventory valuation approach demonstrated here seems to be much better suited than alternative approaches the author came across, such as creating specialized and complex inventory transactions reports that are used for recording manual adjustment postings at the General Ledger level or doing some ‘creative’ Excel calculations in order to arrive at an actual cost value amount which is subsequently posted in the system. What is more, the approach illustrated here is in line with the ‘specific identification’ valuation methods that are allowed to be used by IFRS and US-GAAP.

The next post will extend the approach exemplified here to the other standard cost price variances. Till then.

Automatic posting of journals

17 Wednesday Aug 2016

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

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periodic/mass posting of journals, post journals

The previous post dealt primarily with the question how the selection and posting of journals can be restricted. Within this post I would like to change the perspective and take a look at a function that allows a periodic posting of a number of journals that have been created.

The “post journals” functionality I refer to here can be found in the General Ledger module in the journal entries section. (In prior Dynamics AX versions it can be found in the periodic General Ledger module section).

As the information that has been provided e.g. on TechNet for the “post journals” functionality is a bit sparse and as several questions in regards to this function have been brought forward recently, I decided summarizing the different setup and processing options in this post.

Note: Please note that the following illustrations and explanations will only refer to posting General Ledger journals. The post journals function is, however, not limited to those kind of journals but can be applied to other journals as well. Please see the following summary.

In order to explain the different setup options of the post journals feature, I started setting up some daily General Ledger journals that included either no error (“OK”), some journal lines with errors (“Partly ok”) or only erroneous lines (“Error”). The next screenshot exemplifies the setup of some of those journals used.

Option 1: Select the journals, and post them
Once all demo journals have been prepared, I opened the post journals window and selected them through the identic button.

After all journals have been selected, the posting process was initiated by hitting OK button in the post journal form.

Result:
The result of this first posting test was that all journals except the ones that contained errors were posted.

Newly created journals that did not contain any error remained, however, unposted.

Option 2: Select the journals and post them by using a batch job
To get also those journals automatically posted that have been created later on, I deleted all unposted previously generated journals, setup some new ones and selected them as before in the post journals form.

This time I changed the posting process by making use of a batch process that runs every some minutes and that does the posting for me.

Result:
As before, all journals have been posted except the ones that contained errors.

My next step was setting up a new journal (No. 188) that did not contain any error.

Because of my posting setup I expected that the batch process will pick up the newly generated journal and post it. Yet, as nothing happened, I finally checked the batch job history window and noticed that the batch job stopped because it could not process the first two journals that contained erroneous lines. Please see the next screen-print.

Option 3: As option 2 & select the transfer errors checkbox
As processing newly created journals did not work with the previous approach, I repeated the earlier setup steps and created a number of new journals. This time I tried processing them by selecting the ‘transfer errors’ checkboxes (please see below).

Result:
As expected, all journals except the ones that contained errors were posted. After setting up a new journal that contained no error I expected that this time the newly created journal will be posted.

Yet, unfortunately nothing happened to the newly created journal as the batch job stopped as before after detecting errors.

Note: The difference between the 2^nd and 3^rd setup option is related to the journal that was partly ok. That is, this time all journal lines that did not include an error in the original (partly correct) journal No. 189 were posted and the journal lines that contained errors were transferred to a new journal No. 191 that contains only the erroneous lines.

Option 4: As option 3 but with the late selection and transfer errors checkbox activated
Since none of the prior setup options successfully posted the journals that I created subsequently, I changed the setup in the post journals form once again. This time – after selecting the journals that I want to post – the “late selection” and “transfer error” parameters were activated as shown in the next screen-print.

Result:
This time all erroneous journals/journal lines remained unposted as before but the journal that I created later on – in my case journal No. 196 – was finally picked up by the batch process and posted automatically as the following screen-prints prove.

Note: Despite the fact that the newly generated journal was successfully posted, the batch job still continued running (and ending) with errors because of the two journals that contained lines with errors.

Even though this issue in not directly related to the journal posting process itself, it can become quite cumbersome, as it might flood your mailbox with error messages / Emails if alerts and/or Email notifications have been setup that control the processing of batch jobs.

Journal restrictions

01 Monday Aug 2016

Posted by Ludwig Reinhard in General Ledger

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General Ledger, Journal names, Journal setup

Over the last couple of months I noticed that people often get confused about the setup of journals and posting restrictions. Within this post I aim to shed some light on the following questions that I often came across:

Question 1:
How to ensure that only specific users can select their journals? Example: Only the chief accountant shall be able to create a new General Ledger journal?
Question 2:
How can you prevent others from posting your journal?

In order to answer the first question I setup the following new General Ledger Journal. Please note that this journal is linked to the user group “DOC” that only has a single user assigned to it.

After setting up the new journal, I logged into Dynamics AX with the respective user account (“DOC”) and created a new journal.
After logging into Dynamics AX with a different user account I tried to identify the journal that has been created by the chief accountant “DOC”. Yet, after opening the General Ledger journal form I could not identify (and post) the journal because it was setup for the users included in the user group “DOC” only.

Please note that I also could not create a new “DOC” journal, as the “PROF” user account was not included in the respective user group linked to the journal.

For answering the second question, I setup a new journal that I did not link to a user group. Rather than that, I specified that all of my users can only post the journal they created.

After setting up this second journal, I logged into Dynamics AX as chief accountant “DOC” and created a second journal.

After logging off and logging on again with a different user (“PROF”) I could identify the journal that was created by my chief accountant (“DOC”). Yet, once I tried posting the journal I noticed that I could not post it because of the posting restrictions setup.

To sum up, by linking a specific user group in the blocking section of the journal names setup form you can allow only specific people creating and posting specific journals.
The posting restriction feature allows identifying journals that have been created by other users but can prevent other people from posting journals that you created. However, this requires that you specify and select those users that face this restriction as Dynamics AX does by default not restrict any user from posting other people’s journals.

Hope that this post shed some light on the setup of journals and posting restrictions and look forward to seeing you in the next posts again.

Parallel accounting according to the “Cost of Sales” and “Nature of Expense” accounting method (5)

16 Saturday Jul 2016

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

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

C.6. Sale of goods
Within the last part of this series on the COS & NOE accounting method, the item that has been produced before will be sold for 1000 EUR / pcs through a standard customer sales order shown in the next screen-print.

The first sales order related voucher is created when the sales order packing slip is posted. In the example used, Dynamics AX created the following voucher:

As only Balance Sheet accounts are addressed, no influence on the company’s Income Statements can be identified and as a result, no difference between the COS and NOE method arises.

The next and final posting step in my example is related to the sales order invoice. The voucher created when posting the invoice is shown in the next screen-print.

For reasons of clarity and traceability, the vouchers created when posting the sales order packing slip and sales order invoice, have been summarized in the next illustration.

Similar to the previous chapters, all transactions that offset each other have been highlighted in grey color. In the example used, the packing slip voucher is reversed with the posting of the sales order invoice.
All accounts highlighted in green color represent Balance Sheet accounts that debit a receivable account and credit the inventory account that traces the stock reduction due to the sale of the finished item.
The first yellow highlighted Income Statement account no. 40500 records the sales revenue of 1000 EUR. This transaction is self-explanatory. The posting on the second Income Statement account no. 50500 on the other hand requires some explanation, as it is used and interpreted differently from a COS and NOE accounting perspective. That is, from a COS perspective the amount recorded on ledger account no. 50500 is included in the cost of sales section and directly influences (reduces) a company’s profit. The reduction in a company’s profit does also occur when the NOE method is applied. Yet, for the NOE method this account represents a stock variation account and consequently needs to be included in the stock variation section of the company’s income statement.

The following financial statements summarize the sales order related transactions resulting from the sales order invoice posting.

D. Summary
Within this series on the COS and NOE accounting method I demonstrated that Dynamics AX can be setup in a way to generate financial statements that follow both accounting methods in parallel. This also holds for situations where other inventory valuation principles, such as standard costs, moving average costs, etc. are used.

Irrespective of those valuation principles and differences thereof, the key to a successful parallel implementation of both principles is a “correct” setup of your chart of accounts and related account structures.

Parallel accounting according to the “Cost of Sales” and “Nature of Expense” accounting method (4)

10 Sunday Jul 2016

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

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

C.5. Production of goods
Probably the most complex part when it comes to setting up the COS and NOE method in parallel is related to the production of goods. That is mainly because the production posting setup does not only require a setup of the inventory posting matrix but – depending on the parameter setup – also makes use of other accounts that are setup e.g. at the resource level, production category level and in the costing sheet.

Notes:

It is not feasible showing you all possible ways for setting up production related postings. Rather than trying to do that I will exemplify the setup based on a simple production item. You can use this basic setup then and apply it to more complex production scenarios.
To keep things as simple as possible, I do not create transactions that result in production related variances e.g. due to additional raw material consumption, changed execution times and so on.
All production postings illustrated in the following are based on the ledger principle “item and resource” that can be found in the production control parameters form.

Irrespective of the specific ledger setup for production related postings, the basic production process in Dynamics AX follows a three step procedure that begins with the start of a production order, continues with reporting the production order as finished and finally ends with the closing or “costing” of the production order. Those basic production steps and the related postings executed are illustrated in the next diagram, which will be used as a guideline for the subsequent illustration of the production related postings for a production item.

The structure of the production item I referred to above can be identified in the next screen-print.

The cost price calculation screen shown above illustrates that the production item (FG2000) consists of two raw materials (RM300 and RM400) that have a cost price of 10 EUR / pcs each. For the production of this good one piece of the first raw material (RM300) and two pieces of the second raw material (RM400) are required. In addition, for the assembly of the product a worker has to work one hour on a machine that has a total cost price of 270 EUR / hour. Based on those data a total production cost price for the production item of 300 EUR / pcs arises.

C.5.1. Production step 1: Start
For reasons of simplicity, the production parameters used in this example have been setup in a way that the material consumption (BOM) and route consumption are immediately posted when the production is started. The next screen-print shows the vouchers that have been created through the posting of the BOM and route journals.

The effect that these vouchers have on the financial statements of the company can be identified in the next illustration.

From a Balance Sheet perspective, the production start related postings are reflected in changes that can be observed on the WIP accounts no. 13430 and 13440. For the raw material consumption another Balance Sheet account (no. 13150) has been used as the offset account and the offset account for the route consumption has been posted on an Income Statement account (no. 60110).

Given that the NOE accounting method typically uses stock variation accounts for each and every change recorded in the company’s stock level, the question arises how the raw material related postings that were executed with the start of the production order can be explained / justified?
I will try answering this question based on the following illustration that shows the recorded accounting transactions in the upper part and the missing “in between” stock variation accounts in pink color in the lower part.

What becomes obvious from this illustration is that the approach followed here is not fully correct in the sense that the pink transactions highlighted above are missing.
An important question at this point is whether those missing transactions result in a critically wrong illustration of a company’s financial position or not.
From the author’s perspective the “missing” pink transactions are not critically important as they do not distort the financial position of a company that follows the NOE accounting method. That is because the NOE Income Statement does on the one hand side summarize all stock variation transactions into a single line. On the other hand side, one has to remember that the pink highlighted lines add up to zero and do thus have no impact on the company’s financial position.

The second transaction I would like to discuss in more detail here is the route related voucher that credits an Income Statement account (no. 60110 “production wages clearing”) and thus affects the profit of the company.
From a NOE accounting perspective this account / transaction can be explained by stating that the clearing account used represents a part of the stock variation of the company. In other words, the increase in semi-finished products for the route consumption part on account no. 13440 is offset by the “stock variation” recorded on account no. 60110. For that reason, the production wage clearing account has been assigned to the stock variation section in the Income Statement that follows the NOE accounting method.
If you take a look at the Income Statement that follows the COS method, you can identify that the very same account no. 60110 has been included in the section that incorporates the production wages recorded before. Irrespective of the whether the name and the section where those accounts have been assigned to is correct, the question that arises how one can justify the assignment of the production wages clearing account there?
From the authors perspective this assignment can be justified by interpreting the transaction recorded on the production wages clearing account as a kind of allocation that shifts a part of the total production wages from the company’s Income Statement into its Balance Sheet.
Stated differently, the production salary / wages posting recorded before immediately reduces a company’s profit. The start of the production on the other hand side creates a tangible value for the company in form of a (semi-) finished product and thus increases its overall wealth. This wealth increase is reflected on account no. 60110 in the company’s Income Statement.

C.5.2. Production step 2: Report as Finished (RAF)
The next production step consists of reporting the production as finished. Executing this production step results in the following voucher that debits and credits a Balance Sheet account with the total production cost amount of the item.

As only Balance Sheet Accounts are used for recording the RAF transaction, no difference between the COS and NOE method arises.

C.5.3. Production step 3: End the production order
The last production step ends the production order and ensures that the realized production costs get posted. Dynamics AX realizes this by reversing and replacing all prior production postings that have been recorded based on planned cost values with postings that are based on realized ones, that is, actual cost values. In the example used, the following costing voucher results.

Note: The lines that have been selected in the prior screen-print reverse the prior postings that have been created during the first two production steps.
The outcome of the production postings generated can be identified in the financial statements illustrated next.

Interpretation of the production costing posting created

Lines highlighted in light green color
* The amount of 300 EUR recorded on ledger account 13470 represents the stock increase resulting from the production of the finished good.
* The negative amount of 30 EUR that Dynamics AX credits on ledger account no. 13160 represents the reduction in raw materials that have been used for producing the finished good.

Lines highlighted in yellow color
* The three ledger accounts no. 53420, 53410 and 53170 are Income Statement accounts that – from an overall perspective – offset each other. That is, the total amount posted on those accounts adds up to 0 EUR.
* A first reason why these accounts were setup this way is to get the production costs – of 270 EUR for the production worker and 30 EUR for the raw materials consumed – transferred into the cost accounting module for subsequent cost analysis.
* A second reason for using this specific production posting setup is related to the NOE method as the accounts highlighted in yellow color represent stock variation accounts. The next illustration exemplifies this in detail by showing that those accounts are used “in between” each and every stock transaction.

Lines highlighted in white resp. orange color
* The lines highlighted in white color in the first screen-print of this section – resp. the orange line in the illustration above – shows the production costing voucher which posts 270 EUR on ledger account 60120 that arose for the assembly of the production item.
* As explained further above, from a NOE perspective, this account represents a stock variation and is consequently included in the cost variation section of the company’s Income Statement following the NOE accounting method.
* For the COS method reference can also be made to the interpretations from production step 1. That is, the amount recorded on ledger account 60120 represents an amount that allocates costs from the company’s Income Statement into its Balance Sheet and offsets the value increase caused by the production of the finished good.

To be continued in part (5)

Parallel accounting according to the “Cost of Sales” and “Nature of Expense” accounting method (3)

01 Friday Jul 2016

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

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

After analyzing purchase related transactions in the previous chapter we will now move on and take a look at the other business areas where differences between the COS and NOE accounting method can be identified.

C.2. Inventory adjustments
The next area where such differences can be recognized is related to adjustments of a company’s inventory. Whether or not the COS and NOE accounting method can also be applied in parallel for inventory related adjustment transactions will be investigated next based on the following sample transactions.

Note: Transfer orders within and between sites/warehouses and other item related transactions that do not generate ledger vouchers will not be analyzed in the following.

For reasons of brevity, no Dynamics AX screen-prints of the created inventory adjustment postings will be provided but rather a summarized overview of the ledger postings created when recording those transactions (please see the next illustration).

Note: The main accounts required to be setup for the inventory adjustment transactions recorded can be found in the inventory section of the inventory posting matrix shown in the next screenshot.

Once all four inventory adjustments are posted, the following result can be observed in the company’s financial statements:

In the prior illustration one can see that the Income Statement that follows the COS method incorporates the inventory profit and inventory loss accounts (no. 53150 & 53160) in the cost of sales section. Whether or not those accounts are better assigned to another Income Statement section – such as the other operating expense section – is not important for the general question whether or not the COS and NOE accounting method can be applied in parallel for inventory adjustment transactions.
What is important though is the question where to incorporate the inventory profit and inventory loss accounts according to the NOE method. Against the background of the explanations provided before, this question can be answered by stating that those accounts need to be incorporated into the stock variation section of the company’s Income Statement. That is because those inventory adjustments represent nothing else than “small” stock adjustment transactions that replace the “large” month-end stock variation transaction required for the NOE method.

C.3. Salary/wages & other operating expenses
Within this subchapter I will deal with the question how to record and disclose salary/wage & other operating expense related transactions in the financial statements that follow the COS and NOE accounting method.
The major difference to what has been shown previously is that the separation of the transactions according to their function of expense is now made through referencing the financial cost center dimension as exemplified in the next illustrations.

The financial statements resulting from the transactions recorded can be identified in the next screen-print.

An investigation of the Balance Sheet related transactions does not bring a specific notable outcome to light that deserves special attention. That is because the amounts shown on the other liabilities & accounts payable accounts (no. 22600 and 22500) increase due to the salary/wage & electricity expense transactions recorded.
What is notable though are the account balances shown in the Income Statements for the COS and NOE accounting method. In this respect it can be observed that the COS Income Statement shows the different amounts split up by functions (cost centers) whereas the NOE Income Statement shows those amounts on a summarized basis. Another disadvantage of the NOE method is thus that this method does not provide users with the same level of detailed information as the COS method.

C.4. Fixed asset acquisitions & depreciations
Recording and disclosing fixed asset related transactions does – in principle – not differ from the salary/wage & other operating expense transactions shown in the previous chapter. That is because also for fixed asset related transactions a separation of the different transactions through the use of a financial dimension is necessary in order to generate the Income Statement for the COS method.

Within the example used in this subchapter, several fixed assets have been setup and acquired first (please see the next screen-print) …

… before the related depreciation expense transactions were recorded.

The outcome of those transactions can be identified in the next Management Reporter report that shows the fixed asset acquisition and fixed asset accumulated depreciation accounts in the company’s Balance Sheet on the left-hand side.
In the middle part of the report one can identify the Income Statement that follows the COS method. From there it can be observed that the depreciation expense is split up by corporate functions by making use of the recorded financial (cost center) dimensions.
The Income Statement following the NOE method illustrated on the right-side does – on the other hand – summarize those transactions in a single line and does thus not allow an immediate analysis of the expenses recorded.

Intermediate result
In addition to the purchase related item transactions shown in the previous part, it can be summarized that also transactions related to inventory adjustments, salary/wages and other operating expeses as well as fixed asset related transactions can be posted in a way that allows the parallel generation of Income Statements that follow the COS and NOE method.
Please not that you can of course also use separate “function-related” ledger accounts – rather than financial dimensions – for separating the different corporate functions in the COS Income Statement report.
Yet, irrespective of what approach you chose for separating the different corporate functions (financial dimensions or separate ledger accounts), the most important thing that you have to take care of is that a consistent and integrated approach is followed in your company which ensures that the financial reports according to both accounting methods can be generated out of the box.

To be continued in part (4)

Dynamics AX Finance & Controlling

Category Archives: General Ledger

Parallel inventory valuation – an alternative approach (Part 5)

Parallel inventory valuation – an alternative approach (Part 4)

Parallel inventory valuation – an alternative approach (Part 3)

Parallel inventory valuation – an alternative approach (Part 2)

Parallel inventory valuation – an alternative approach (Part 1)

Automatic posting of journals

Journal restrictions

Parallel accounting according to the “Cost of Sales” and “Nature of Expense” accounting method (5)

Parallel accounting according to the “Cost of Sales” and “Nature of Expense” accounting method (4)

Parallel accounting according to the “Cost of Sales” and “Nature of Expense” accounting method (3)