Set Up Inventory Valuation to Help Prepare Financial Statements in Compliance with Accounting Standards

  • by Sanjay Wagh, Vice President, Elephanta Technology, Inc.
  • August 28, 2014
Learn how to implement the material inventory valuation process to meet the requirements of different accounting principles, including International Financial Reporting Standards (IFRS) and US Generally Accepted Accounting Principles (GAAP). Implementing this process enables you to automate the process of inventory valuation based on commonly used valuation methods.
Learning Objectives

By reading this article, you will learn how to:

  • Configure LIFO/FIFO based inventory valuation in your system
  • Run a process to activate material masters for inventory valuation
  • Run a process to create initial valuation relevant dataset
  • Configure and run inventory valuation 
Key Concept
Some of the most commonly used methods for material inventory valuation are Last In First Out (LIFO) and First In First Out (FIFO). Of these methods, FIFO is more commonly used and is also acceptable to both the International Financials Reporting Standards (IRFS) and Generally Accepted Accounting Principles (GAAP). Inventory valuation based on LIFO is acceptable to US GAAP only.

All publicly listed companies need to state their material inventory values on the balance sheet in compliance with one or more accounting standards such as US Generally Accepted Accounting Principles (GAAP) or International Financials Reporting Standards (IFRS). Accounting standards generally require companies to follow either a Last In First Out (LIFO) or First In First Out (FIFO) method of inventory valuation. Many privately listed companies also valuate their inventories as it allows inventory values to be stated consistently.

In the absence of implementation of the SAP functionality for inventory valuation, business users are required to use an external database to store valuation relevant data and set up inventory valuation rules outside the SAP system to carry out inventory valuation. This process is inherently cumbersome, error prone, and, more importantly, not auditor friendly.

By contrast, in an SAP system-based process, rules for inventory valuation are set up in the system. The system uses SAP tables to prepare and store inventory valuation data. Finally, the inventory valuation process provides detailed data that explains the basis valuation for each material. This makes the entire process more transparent and thereby easier to audit.   

Accounting standards, namely US GAAP and IFRS, require that organizations record the values of receipts and issues of material inventory using certain acceptable methods. For example, IFRS requires that goods receipts be valuated using a lower of cost or market (LCM) rule (i.e., goods receipts are valuated at cost or market, whichever is lower) and goods issues be valuated using a FIFO method.  

However, in most accounting systems, to keep accounting simpler, both goods receipts and goods issues are valuated based on a notional price such as standard price or a moving average price (MAP), depending on the price control indicator specified in the material master record. Because this valuation is different from the requirements of the accounting standards, it is necessary to re-valuate material inventory so that an organization’s financial statements meet the requirements of the accounting standards.

SAP provides a functionality that automates the process of inventory valuation. Using this functionality, you can set up inventory valuation using various methods, including LIFO and FIFO. However, because FIFO is used widely by companies and also because it is the only method allowed by IFRS, I discuss setting up inventory valuation using a FIFO method.

Sanjay Wagh

Sanjay Wagh has 28 years of professional experience in manufacturing, banking, and consulting in global companies. Sanjay started as a product engineer and corporate finance specialist and seamlessly transitioned to a consultant, assisting other companies in implementing software systems. Sanjay combines his experience in manufacturing and finance with consulting experience to help clients design and implement business processes using best practices in a cost-efficient, risk-free manner with a long-term perspective. Sanjay has 16 years of SAP software implementation experience in the areas of FI and CO along with several end-to-end SAP project life cycles. He has participated in conducting requirements gathering and business blueprinting workshops, realization, testing, end-user training preparation and delivery, and post-implementation support. He is a certified SAP solution consultant.

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Comments

10/3/2014 3:14:13 PM
Vishwa

Very useful article, first of its kind on the subject.
Thanks.

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