Inventory Valuation & Physical Inventory

Inventory Valuation & Physical InventoryNitin Gupta

Table of ContentsInventory Valuation3Inventory Accounting Systems3Net Realizable Value (NRV)4SAP Inventory Valuation5Valuation category5Valuation type5Types of Valuation6Joint Valuation6Split Valuation6Types of Split Valuation6Split Valuation by Procurement Type6Split Valuation by Country of Origin6Split Valuation by Quality7SAP Standard Customization8Physical Inventory9Phases on Physical Inventory Process91. Physical inventory preparation92. Physical inventory count93. Physical inventory check9Physical Inventory Procedures in SAP10Periodic inventory:10Continuous inventory:10Cycle counting:10Inventory sampling:10Physical Inventory Processes101.Create physical inventory document102.Entering the Physical Inventory Count113.Post inventory differences11Reference Transactions12Cycle Counting12Inventory Sampling13Inventory sampling processes141)Select stock management level142)Stock population143)Stratification144)Random selection145)Creation of PI documents146)Update147)Extrapolation14

Inventory ValuationAninventory valuationallows a company to provide amonetary valuefor items that make up theirinventory. Inventories are usually the largest currentassetof a business, and proper measurement of them is necessary to assure accuratefinancial statements. If inventory is not properly measured,expensesandrevenuescannot be properly matched and a company could make poor business decisions.Inventory Accounting Systems Perpetual:Theperpetual inventorysystem requires accounting records to show the amount of inventory on hand at all times. It maintains a separate account in thesubsidiary ledgerfor each good in stock, and the account is updated each time a quantity is added or taken out. Periodic:In theperiodic inventorysystem, sales are recorded as they occur but the inventory is not updated. Aphysical inventorymust be taken at the end of the year to determine the cost of goodsRegardless of what inventory accounting system is used, it is good practice to perform a physical inventory at least once a year.The perpetual system records revenue each time a sale is made. Determining the cost of goods sold requires taking inventory. The most commonly used inventory valuation methods under a perpetual system are:1. First-In First-Out(FIFO)2. Last-In First-Out (LIFO)3. Average CostorWeighted Average Cost These methods produce different results because their flows of costs are based upon different assumptions. The FIFO method bases its cost flow on thechronological orderpurchases are made, while the LIFO method bases it cost flow in a reverse chronological order. The average cost method produces a cost flow based on a weighted average of goods.

Net Realizable Value (NRV)Net realizable value (NRV) is a method of evaluating an asset's worth when held in inventory, in the field of accounting. NRV is part of the Generally Accepted Accounting Principles and International Financial Reporting Standards (IFRS) that apply to valuing inventory, so as to not overstate or understate the value of inventory goods. Net realizable value is generally equal to the selling price of the inventory goods less the selling costs (completion and disposal).It is expected sales price less selling costs (e.g. repair and disposal costs).Under IFRS, companies need to record the cost of their Ending Inventory at the lower of cost and NRV, to ensure that their inventory and income statement are not overstated (under ASPE, companies record the lower of cost and market value). For example:Under IFRS, at a company's year-end, if an unfinished good that already cost $25 is expected to sell for $100 to a customer, but it will take an additional $20 to complete and $10 to advertise to the customer, its NRV will be $100-$20-$10=$70. In this year's income statement, since the cost of the good ($25) is less than its NRV ($70), the cost of the good will get recorded as the cost of inventory. In next year's income statement after the good was sold, this company will record a revenue of $100, Cost of Goods Sold of $25, and Cost of Completion and Disposal of $20+$10=$30. This leads to a profit of $100-$25-$30=$45 on this transaction.Suppose we changed the example so that it costs $60 to advertise to the customer. Now the good's NRV will be $100-$20-$60=$20. In this year's income statement, since the NRV ($20) is less than the cost of the good ($25), the NRV will get recorded as the Cost of Ending Inventory. To do so, an inventory write down of $25-$20=$5 is done, and hence a decrease of $5 in this year's income statement. In the next year's income statement after the good was sold, this company will record a revenue of $100, Cost of Goods Sold of $20, and Cost of Completion and Disposal of $20+$60=$80. This leads to the company breaking even on this transaction ($100-$20-$80=$0).Inventory can be valued at either its historical cost or its market value. Because the market value of an inventory is not always available, NRV is sometimes used as a substitute for this value.

SAP Inventory Valuation

SAP allows valuating stocks of a material either together or separately, that is, according to different valuation criteria.

The way the stocks of a material are valuated depends on how you define the following:

Valuation categoryThis defines whether the stocks are valuated jointly or separately. If stocks are to be managed separately, it also specifies the criteria used to valuate the stocks, that is, whether they are valuated by origin, in-house production/external procurement, or individual batches.Valuation typeThis is a further subdivision of the valuation category. For example, if the valuation category isorigin, a company may want to define the valuation typesstock from Los Angelesandstock from Detroit.This data is stored in the material master record.

PrerequisitesIt has to be defined in system whether valuation is at company code level or plant level and whether split valuation is allowed.

Types of ValuationJoint ValuationIf you want to valuate all stocks of a material at the same price, you specify neither a valuation category nor a valuation type.

Split ValuationIf you want to valuate stocks of a material separately, you must create a material master record with the appropriate valuation category. This record is called the valuation header record. Each material always has only one such record for each company code or plant (depending on whether the material is valuated at company code level or plant level).Once you have specified the valuation category, you can create a material master record for each quantity of the material you want to valuate separately, with the appropriate valuation type and accounting data. Split valuation is necessary if, for example: Stock from in-house production has a different valuation price than externally procured stock. Stock obtained from one manufacturer is valuated at a different price than stock obtained from another manufacturer. Different batch stocks of a material have different valuation prices.

Types of Split Valuation:Split Valuation by Procurement TypeProcurement types accepted by SAP are In-house Production and/or External Procurement. Under the accounting perspective you can valuate your stock material based on the procurement type. Therefore, you should define the valuation category B in-house/ext.procurement combined with the valuation type (internal/external).Possible combination:Valuation CategoryValuation TypeProcurement Type

BInternalIn-house Production

BExternalExternal Procured

Split Valuation by Country of OriginIt is possible to define a split valuation based on the country of origin of material. Basically, the idea is to identify in your stock material which quantity was supplied by each country. Therefore, you should define the valuation category H origin combined with the valuation type determined by the name of country of origin.Possible combination:Valuation CategoryValuation TypeCountry of Origin

HItalyItaly

HFranceFrance

Split Valuation by QualityIt is possible to define a split valuation based on the quality management. This way you can identify in your stock material which quantity was passed by your quality procedures. Therefore, you should define the valuation category Q quality combined with the valuation type.Example:An enterprise manages its stocks of a material using the valuation category "Quality", comprising the following valuation types: A - High quality B - Average quality C - Inferior quality D Bad qualityPossible combination (for example):Valuation CategoryValuation TypeQuality Status

QAHigh quality

QBAverage quality

QCInferior quality

QDBad quality

SAP Standard Customization OMWC

Create Valuation Type: Create Valuation Categories:

Local Definitions:

Physical InventoryIn the R/3 System, you can carry out a physical inventory for special stocks as well as your own stocks. However, you have to inventory your own stock and each type of special stock (e.g. consignment stock at customer, or external consignment stock from vendor) separately, using different physical inventory documents. Physical inventory is linked with the Logistics Information System (LIS). When inventory differences are updated in the LIS, they are shown both in terms of quantity and value. The physical inventory items are aggregated to physical inventory number, plant, storage location, and material. Independent of the physical inventory procedure, the physical inventory process can be divided into three phases:Phases on Physical Inventory Process1. Physical inventory preparationThis includes creating a physical inventory document, blocking materials for posting, as well as printing and distributing the physical inventory document.2. Physical inventory countFirstly, the stocks in the warehouse are counted and the count results are entered in the count list. These are then transferred from the count list to the system in the step enter physical inventory count.3. Physical inventory checkUsing the list of inventory differences, you can check variances in the stocks. You should check whether the transferred count result is correct (change count) or whether you want to initiate a recount. If the difference is accepted, it is posted and stock is corrected.The physical inventory number was created as an additional hierarchy above the physical inventory document number. You can use it to group together different physical inventory documents that belong together organizationally. You assign physical inventory numbers when you create and change physical inventory documents, and you can use them as an extra selection criterion for physical inventory reports. This enables you to directly display the physical inventory documents per storage location, customer, or vendor.

The Physical Inventory (PI) as a whole is divided into three parts, from which one includes the main PI process thecycle-countingprocess theinventory sampling process

The cycle-counting and the inventory sampling processes are only special ways to create PI documents, afterwards the main PI processes are used.

Every company must carry out a physical inventory of its warehouse stocks at least once per fiscal year to balance its inventory. Various procedures can be implemented for this.Physical Inventory Procedures in SAPPeriodic inventory:In a periodic inventory, all stocks of the company are physically counted on the balance sheet key date. In this case, every material must be counted.Continuous inventory:With the continuous inventory procedure, stocks are counted continuously during the entire fiscal year. In this case, it is important to ensure that every material is physically counted at least once during the year. You can use the same transactions for 'continuous inventory' as for 'periodic inventory'. The only difference is, that you count a material more than one time per fiscal year.Cycle counting:Cycle counting is a method of physical inventory where inventory is counted at regular intervals within a fiscal year. These intervals (or cycles) depend on the cycle counting indicator set for the materialsInventory sampling:In inventory sampling, randomly selected stocks of the company are physically counted on the balance sheet key date. If the variances between the result of the count and the book inventory balance are small enough, it is presumed that the book inventory balances for the other stocks are correct.

Physical Inventory Processes1. Create physical inventory documenta. Physical inventory can be carried out both for a company's own stock and for special stock. Inventory for a company's stock and for special stocks (such as, consignment stock at customer, external consignment stock from vendor or returnable packaging) must be taken separately (in different physical inventory documents).b. Physical inventory takes place at storage location level. A separate physical inventory document is created for every storage location.c. If no storage location segment exists for a material, this means that no goods movement has ever taken place for the material in the storage location. The material, therefore, has never had any stock at the storage location and does not exist at stock management level in the storage location. It is therefore not possible to carry out a physical inventory for the material in this storage location.d. A material for which a goods movement has taken place and for which the stock balance is currently zero. A physical inventory must be carried out in this case.e. Posting block:Indicates that no goods movements involving the materials listed in the physical inventory document can be posted until the count results are posted.f. Freeze book inventory:This indicator has the effect that the current book inventory balance is recorded in the physical inventory document. The system compares the counted stock with the frozen book inventory balance to determine any inventory differences.The program reads the actual warehouse stock (table MARD, MCHB, MSKU, ...) and writes this in ISEG-BUCHM.g. a physical inventory can be carried out for the following stock types:h. 1 unrestricted-use stock in the warehousei. 2 quality inspection stockj. 4 blocked stockk. If you want to create a physical inventory document for a material, the system checks the PI indicators.Example:Physical inventory for a (non batch management) material--> system analysis storage location data in table MARD.--> No physical inventory possible, if 'X' 'XX_' '_XX' or 'XXX'.2. Entering the Physical Inventory CountYou have to enter the count results for each item in a physical inventory document.a. The posting block is automatically cancelled when you post the counting results for the physical inventory document.b. If there was no 'Freeze book inventory' before, the systemcalculates thecurrent book quantity and updates ISEG-BUCHMwith this quantity.--> Physical inventory difference = ISEG-MENGE - ISEG-BUCHMc. Physical inventory indicator will be updated==>After entering the count results: You are able to post goods movements for this material. (no posting block)Determination of the PI difference-->note 202834 Determ. of book quantity within physical inventory3. Post inventory differencesa. When you post the physical inventory difference, the system creates a material document that records the adjusted stock balances and an accounting document that contains the necessary account activities.b. Movement types in material document:c. 701: GR phys.inv.: unrestricted stock (stock type 1) (positive phys.inv. dif. for unrestricted stock)702: GI phys.inv.: unrestricted stock (stock type 1) (negative phys.inv. dif. for unrestricted stock)703: GR phys.inv.: quality insp. (stock type 2) (positive phys.inv. dif. for quality insp.)704: GI phys.inv.: quality insp. (stock type 2) (negative phys.inv. diff. for quality insp.)707: GR phys.inv.: blocked stock (stock type 4)(positive phys.inv. diff. for blocked stock)708: GI phys.inv.: blocked stock (stock type 4)(negative phys.inv. diff. for blocked stock)d. Physical inventory indicator will be updated

Reference Transactions T-CodeDetails

MI01Create physical inventory document

MI02Change physical inventory document

MI03Display physical inventory document

MI04Entering the Physical Inventory Count

MI05Change count

MI06Display count

MI07Post inventory differences

MI08Post Count and differences (MI04 + MI07)

MI09Enter count without reference to a document (MI01 + MI04)

MI10Post document, Count and Differences(MI01 + MI04 + MI07)

MI11Recount

MI08Post Count and differences

MI09Enter count without reference to a document

MI10Post document, Count and Differences

MI20List of Inventory Difference

MI24Physical Inventory Difference List

MI21Print Physical Inventory Document

MI22Physical Inventory Document for Material

MI23Physical Inventory Data for Material

MIDOPhysical Inventory Overview

MI12Changes to Physical Inventory Document

Cycle CountingMark all materials that are to be included in cycle counting with a cycle counting indicator in the material master record (storage data). The cycle counting indicator is used to group the materials together into various cycle counting categories (for example,A,B,C, andD). The time intervals at which the materials are counted are defined for each category.You can mark the materials as follows:a. manually in the material master record (storage data)b. automatically using ABC analysisTo perform an ABC analysis, use program RMCBIN00. In this analysis, the system assigns the materials to the individual categories according to consumption or requirements. You can also specify whether this analysis is to consider only the materials with cycle counting indicator or all materials. The cycle counting indicator can be updated automatically while the ABC analysis is run.For the planning of cycle counting, run program RM07ICN1 at regular intervals. This program checks all cycle counting materials to determine whether a physical inventory is due to be carried out.If a material needs to be counted, use the program to create a batch input session for creating physical inventory documents.

Inventory SamplingThis component reduces the time and cost of a physical inventory considerably by counting only the stock of individual materials and carrying out an extrapolation to arrive at an estimated count result for all units of stock managed in theERP System (stock management units).The more materials a company has, the more costly it is to carry out a physical inventory by counting all stocks. The principle of extrapolation during sample taking is also used in quality inspection in theERP System: only one particular sample is inspected. The result is then applied to the entire quantity.To infer the counts for all stock management units by extrapolating the count results for individual units, the following prerequisites must be fulfilled:The size of the stock management units included in the physical inventory must be large enough.The selection of stock management units to be counted must be "representative".Statistical procedures are used for carrying out inventory sampling:A sample to be counted is randomly selected from the stock management units subject to physical inventory. The size of the sample depends on the degree of probability (probable degree of confidence) with which the extrapolated value inferred from individual counts is expected to be valid for all stock management units included in inventory sampling.On the basis of the posted count results, the system carries out an extrapolation for all the stock management units included in the physical inventory.The inventory sampling is considered successful, if there is only a small deviation between the extrapolated value and the book value and a high probability that the extrapolation result contains only a minor error.If an inventory sampling is successful, it is assumed that the estimated deviations from the book inventory balances are so small that they can be neglected. As in the case of a "standard" physical inventory, only the stock of the elements actually counted is adjusted. The stock of the remaining stock management units remains unchanged.If an inventory sampling is not successful, a complete physical inventory must be carried out for the stock management units not counted.Inventory sampling can be carried out in the areas of Inventory Management and Warehouse Management. The steps required to carry out an inventory sampling are the same in both areas. The only difference is the selection of the objects included in the physical inventory: Inventory Management:The physical inventory is carried out through selection of the materials by plant, storage location, material type, and stock type. In Warehouse Management:The physical inventory is carried out through selection of the storage bins by warehouse number and storage type.

Inventory sampling processes1) Select stock management levelIn this step, thestock management levels (plant and storage location or storage number and storage type), for which the inventory sampling will be created are selected.The tableSBSE(Stock Mngmt Levels for Inventory Sampling) will be filled with this information.2) Stock population(Form S1_LAGERGESAMTHEIT)In this step, the materials or storage bins that are participating in the inventory sampling process will be determined.The tableSLGH(Elements of Stock Population) will be filled.3) Stratification(Form P2_SCHICHTEINTEILUNG)Depending on the value, the participating elements will be sorted into classes and strati.The tableSSCH(Strata of Inventory Sampling) will be populated.4) Random selection(Form P3_ZUFALLSAUSWAHL)With a randomizer, the elements that have to be counted will be determined.These elements will be marked in table SLGH.XSPELstands for sampling element,XVERRstands for element in the complete count area.5) Creation of PI documentsThe PI documents will be created and are processed in thesame manner asother PI documents.6) Update(Form P4_AKTUALISIERUNG)Counted and difference posted PI documents will be detected and stored in table SLGH.Probably subsequent random selection has to be made (P4_NACHERHEBUNG).7) Extrapolation(Form P5_HOCHRECHNUNG and P5_GESAMTFEHLER_BERECHNEN)With the parameters and the posted PI differences, the systems determines, if the status of the inventory sampling is successful.

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