Demystify Parallel Valuation and Analyze Value Flow of Materials Across Plants or Legal Entities

  • by Muralidharan Sethuraman, Director Enterprise ERP IT Finance, Johnson Controls
  • December 22, 2010
In a product cost controlling implementation, you may consider implementing the material ledger with parallel valuation — the recording of inventory values in a separate valuation view — whenever business requirements related to group and legal cost, transfer pricing, or group and legal valuation are planned. This approach demands a high degree of business process control and integration across various business functions. Understand some of the global settings and fundamental concepts that are key in designing the material ledger with parallel valuation so that you can avoid complex and irreversible system design issues and minimize manual work in product costing.
Key Concept
Group costing enables companies to seamlessly analyze the cost of materials across the borders of legal entities. Organizations also demand visibility into the cost or value flow of a material at the transfer price — the internal price that is charged for the transfer of materials across business units or plants. This triggers business requirements for parallel valuation and transfer pricing.

A global manufacturing enterprise has a very complex supply chain value flow. Raw materials used in manufacturing goods can be sourced from an external supplier or from internal business units or subsidiaries. Different steps in the manufacturing of a finished product can be executed across various logistic plant locations, which in financial and managerial accounting terms can be across various legal entities, business units, or profit centers. The products in the manufacturing value chain (e.g., raw materials, semi-finished goods, and finished goods) can move between these organizational units, thus creating scenarios for intercompany and intracompany stock transfers. To adhere to international accounting principles and guidelines, such transfer of goods and services across borders or entities should happen at the arm’s length price, which in the SAP system is called the transfer price. This principle requires organizations to clearly account for internal revenue and cost of sales, and differentiate it from end customer external sales. This way, you can easily know internal intercompany profits and eliminate them (net them out of internal profits) during consolidation. 

I’ll explain how to implement the material ledger with parallel valuation so you can adhere to this principle and monitor your manufacturing process in your SAP system. In this scenario, the material ledger activation with multiple currencies or valuations enables the capturing of quantity and value information in each of the logistics transactions in the material value flow across different valuation views (e.g., legal, group, and profit center) in real time. Based on this, the enterprise can manage transfer pricing, account for internal revenues and profitability of a specific business unit or profit center, and in parallel manage financial information as required for group consolidation and legal reporting.

If the material ledger is not activated, then the SAP system tracks the value flow of material only in legal valuation. The accounting view of the material master holds the inventory value in one default currency (the company code currency) and the default valuation used by the SAP system is the legal valuation. In this case, you need to make necessary valuation entries for internal management reporting at the end of the period by means of financial adjustments.

As a first step to understanding the design of the material ledger with parallel valuation, you need to understand and evaluate in detail four key design questions:

  1. What does it mean to manage inventory values in parallel currency and parallel valuation and how does it affect other FI settings?
  2. What combination of currency valuation settings in the material ledger should an organization choose to meet its inventory valuation and managerial reporting needs and how does this align with the settings done in FI, CO, and profit center accounting (PCA)?
  3. If an organization wants to implement the material ledger with parallel valuation, what are the key factors that it needs to consider?
  4. If an organization chooses not to implement the material ledger and manage inventory in only one valuation or currency, how can it still meet objectives of viewing group cost and legal cost based on the transfer price?

This article provides practical insights and guiding principles for organizations to understand these questions in detail. Note that many of the concepts I go over are complex and you should not undertake them lightly. There are many points to consider moving forward. For more about that, see the sidebar “Some Notes of Caution.” In the next sections, I’ll explain the meaning and significance of some key terms used with regard to parallel valuation.

Muralidharan Sethuraman

Muralidharan Sethuraman is director enterprise ERP IT finance at Johnson Controls. He has more than 16 years of industry experience leading and managing multiple SAP implementation and business transformation programs across geographies. Muralidharan is currently leading the SAP S/4HANA program at Johnson Controls. He specializes in SAP Financials and has done design lead, solution architect roles in global SAP implementation programs. Muralidharan is a subject matter expert in the areas of product cost analysis and management, inventory and working capital management, management reporting and profitability analysis, financial analytics and reporting, and business planning. He has published multiple articles in Financials Expert in these areas.

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