Two significant benefits of drop shipping are the elimination of up-front inventory and a positive cash-flow cycle. A positive cash-flow cycle occurs because the trader or distributor is paid when the sale is made. However the distributor usually pays the wholesaler or manufacturer using longer credit terms. Therefore, there is a period of time in which the distributor received the cash from the customer, but has not yet paid the wholesaler or manufacturer.  

Drop shipping also eliminates some duplication of effort, as only one warehouse picks, packs, and ships the product. This approach can reduce total inventory management and shipping costs. These cost reductions can subsequently reduce the price to the consumer.

I explain the process flow, configuration settings, and output in terms of accounting entry for a drop-ship scenario. This knowledge enables you to set up a distribution business using a drop-ship scenario in which the credit days on a sale to a customer are fewer than the credit days received from the vendors on purchases. In this drop-ship scenario you can bill customers for the goods sold before receiving the vendor invoice. Configuring this expertise requires the use of sales and distribution (SD), materials management (MM), and FI.

The Drop-Shipment Process

Drop shipping is a supply chain management technique in which the trader or distributor does not keep the stock. Instead, the trader or distributor asks the manufacturer or wholesaler to ship the product directly to the customer.

The standard sales order automatically creates a purchase requisition for the materials to be delivered by the third-party vendor to the customer. For a standard drop-ship process in an SAP system, there would be no goods receipt in the books of the trader or distributor because no stock is received. The vendor sends an invoice based on the purchase order (PO) and delivery of materials made to the customer.

Because there is no delivery in a drop shipment, the invoice from the vendor updates the billing quantity, and the customer invoice is created only after the vendor invoice is posted. Figure 1 outlines the standard drop-shipment process.

Figure 1

Standard drop-shipment delivery

There is no accounting until the vendor sends an invoice to the distributor. Therefore, the distributor incurs cost of goods sold (COGS) only after receiving the vendor invoice. Table 1 shows the general ledger (G/L) entry posted at the time when the vendor invoice is posted.

Table 1

Accounting document for a vendor invoice

Table 2 shows the G/L entry posted when the customer invoice is posted.

Table 2

Accounting document for a customer invoice

As seen from the diagram shown in Figure 1, the customer is billed only after receiving an invoice from the vendor. Therefore, the customer billing depends on the vendor billing for the cost and the quantity requirements.

Business Requirement and Proposed Solution 

Consider a scenario in which a company in the distribution business procures goods (via drop shipment) from its vendor. The company then sells them to its customers. The sales through the drop-ship business constitute the major part of the company’s business and the days to pay to the manufacturer or supplier are higher than the days to be paid from the customer. This model helps to maintain a positive cash flow and also to save on interest and other incidental expenses.

However, using the SAP process in which the customer billing depends on the vendor invoice booking does not serve the client business requirement to bill the customer irrespective of whether the vendor invoice is booked. I now explain a solution that can be used to serve the business requirement.

The standard sales order automatically creates a purchase requisition for the materials to be delivered by the third-party vendor. Based on the PO, the vendor delivers goods directly to the customer. The vendor then either manually sends a confirmation to the distributor or sends an advance shipping notification (ASN) as shown in Figure 2.

Figure 2

The drop-shipment process with manual confirmation

A statistical goods receipt is posted in the books of the distributor based on the vendor’s confirmation. As per the business requirement, customer billing can be posted with reference to the statistical goods receipt and not based on the vendor invoice.

This eliminates the dependency of customer billing on the vendor invoice, and the quantity and the cost are captured based on the statistical goods receipt document. Table 3 shows the G/L posting when a statistical goods receipt is posted.

Table 3

Accounting document for a statistical goods receipt

When the third-party vendor sends a confirmation to the distributor, it creates an accounting entry similar to a goods receipt. However, that goods receipt is statistical in nature, and the customer is invoiced based on the statistical goods receipt quantity, thereby enabling a company to bill a customer at the moment when confirmation is received and goods receipt is posted. Therefore, the receivable is due to the customer based on the customer payment term. Table 4 shows the G/L entry posting with sales and cost of the goods. 

Table 4

Accounting entry for customer billing

The vendor can send an invoice any time after the statistical goods receipt is created. The goods receipt/invoice receipt (GR/IR) account is offset at this time. Therefore, the vendor is paid as per the payment term. Table 5 shows the G/L entry with a vendor invoice.

Table 5

Accounting entry for a vendor invoice

Configuration Steps for a Drop-Ship Scenario to Link a Sales Order to a Goods Receipt

The company has a requirement to generate the customer billing the moment after the confirmation of the goods is received. To meet the requirement, several prerequisite steps and configuration changes need to be done. The settings that you configure in the following steps define an integration process that begins with the creation of a sales order and that also is used in accounting posting during the time of a good receipt.  

Create a new item category that is a copy of the standard item category. Follow menu path SPRO > Sales & Distribution > Sales > Sales Document item > Define item category. To copy the standard item category TAS select TAS and click the copy icon (this screen is not shown). Create a new item category ZTAS under the ItCA column and enter a description (Figure 3). Click the save icon.

Figure 3

Maintain an item category

Create a new account assignment category that is named Z. Follow menu path SPRO > Material management > Purchasing > Account Assignment > Maintain Account assignment category. To copy the standard account assignment category C select and click the copy icon (this screen is not shown). Create a new category Z with the description as shown in Figure 4. Click the save icon.

Figure 4

Account assignment category

Valuated goods receipt functionality must be leveraged so that the accounting entry is triggered when a delivery occurs. Account assignment category X and account modifier VAX are used for normal goods issue. To differentiate drop ships, you create a new account assignment category Z as shown in Figure 4, but you also need to assign a new account modifier (e.g., VAZ).

To complete this step follow menu path SPRO > Material management > Purchasing > Account Assignment > Maintain Account assignment category. In the screen that appears (Figure 5) make sure the modifier is VAZ and change any of the fields as necessary for your account.

Figure 5

Account assignment category details

Schedule line category CS to have Z instead of X as the account assignment. CS is a schedule line category that links the item category and the account assignment category. To complete this step follow menu path SPRO > Sales & Distribution > Sales > Sales Document > Schedule lines > Define Schedule lines Categories. In the screen that appears enter Z in the Acct. Assgt Cat. field (Figure 6) and click the save icon.

Figure 6

Schedule line category settings

Now you assign this schedule line category to the item category ZTAS. Follow menu path SPRO > Sales & Distribution > Sales > Sales Document > Schedule lines > Assign Schedule lines Categories. In the screen that appears enter ZTAS in the ItCA column (Figure 7). Click the save icon.

Figure 7

Assign the item and schedule line categories

Configuration Steps to Automatically Assign an Account Setting for Material Movements

To automatically assign an account setting for material movements, use transaction code OBYC.  In this transaction you determine the G/L account based on the material valuation class and the account modifier VAZ. The G/L account assigned is inventory shipped, not billed.

Follow IMG path > Materials Management > Valuation and Account Assignment >Account Determination >Account Determination Without Wizard > Configure Automatic Postings > Account Assignment. 

Execute transaction code GBB. There are many different business scenarios that post to inventory accounts that may require postings to separate G/L accounts, such as goods receipt from a production order, goods receipt from a PO, goods issued to a customer (sales order), or goods issued to a  drop shipment. Assign the G/L offsetting account for the inventory (Figure 8). This is a standard setting for account determination with material movements. Using transaction code GBB, you can assign the offsetting accounts. Enter a name in the Group field (e.g., RMK) and a description of the account. Select the check box under the Account determ. column and press Enter.

Figure 8

Automatic posting for an offsetting account

Generally, you use the account modifier VAX for goods for sales orders with an account assignment object. However, to differentiate between normal sales transactions and drop shipments, you create a custom account modifier VAZ as I explained in the section “Configuration to Link a Sales Order to a Goods Receipt.”

In addition, you need to make the following changes:

• Create a new account assignment category Z for drop shipment with the new account modifier VAZ
• Maintain the combination for item category S for account assignment category Z
• Change schedule line category CS to have Z as the account assignment category

The combination of transaction key, valuation class, and account modifier points to the required clearing account (Figure 9). Assign the G/L account that is used for a goods-in-transit account (e.g., 140190). 

Figure 9

Automatic account assignment for goods in transit

Use transaction key WRX to determine GR/IR clearing accounts. G/L accounts defined here act as a clearing account between the GR and IR (Figure 10).

Figure 10

Automatic account assignment for a statistical goods receipt

The accounts configured for transaction key GBB have to be updated on the sales side as well. Use transaction code VKOA to update both cost and revenue keys on the sales side.