When a transfer price is used to value inventory (materials), it carries a profit or markup in addition to the base manufacturing cost. Many times this transfer pricing requirement is also known as profit in inventory. The parallel valuation solution offered by the SAP material ledger helps to meet the business requirement around transfer prices.

Using this standard solution, multinational companies can comply with various local US Generally Accepted Accounting Practices (GAAP) rules set up by the Financial Accounting Standards Board (FASB) and governed by the U.S. Securities and Exchange Commission (SEC) in the US, income tax rules set up by the IRS in the US, or transfer pricing rules set up by the Organization for Economic Co-operation and Development (OECD) in the EU. They can address the statutory need for preparing consolidated financial statements.

I describe the end-to-end process of using transfer prices for inventory transfers. This is a high-level currency remeasurement process used to valuate foreign currency balance sheet item balances in a financial statement of a company when this currency differs from company code currency. I also explain translation strategy and eventual elimination entries leading up to preparation of a consolidated financial statement.

This solution uses three valuation views in SAP ERP Central Component (ECC) to capture the transfer pricing postings. This solution can integrate with any final consolidation system (such as SAP Business Planning and Consolidation [SAP BPC] or Hyperion) seamlessly. Usually organizations do not develop this type of system in ECC and hence details are usually not available in the ECC system. An example of a system where this is usually developed is SAP BPC. If you do not have any solution in ECC, usually transfer pricing audits can become very cumbersome and can expose these organizations to potential fines.

The first view is called legal valuation, which is stored in the local currency 1 field of any accounting document and carries a value that meets the requirement for the local GAAP tax ledger requirement. The second valuation is called group valuation, which carries balances in the controlling area currency and a value from the perspective of the entire group of companies. The third valuation is called profit center valuation, which helps for management reporting or can also help in the preparation of consolidated financial statements. I suggest that you use the profit center valuation view to prepare the consolidated financial statements in this article. Therefore, the discussion of profit center valuation is limited to how it helps the currency translation requirement from the FASB 52 (US GAAP) perspective only.

Initial Design Decisions

There are certain decisions that become the foundation for the parallel valuation solution. The currency valuation and currency keys are the first and foremost important topic over which the business has to agree. Based on several implementation experiences for US-headquartered multinational organizations, I have seen that three currency/valuation keys can suffice for the transfer price solution requirements. Table 1 lists these three currency valuations that are used in my design.

The sidebar titled “Some Major Decisions” describes some key items that are required for this solution. You need to activate the SAP material ledger module, but this module needs to be activated configuring the setting for price determination as 2 (transaction-based price determination). This is a very lean implementation of the material ledger module. The step-by-step detail setting for this has been covered by my other article, “Streamline Cross-Company Postings Using SAP Parallel Valuation and Transfer Pricing in an LIV Process.”

Use transaction code MM03 with a material number and plant to call up the screen shown in Figure 1. This screen shows the accounting 1 view of a material master that carries three standard costs based on three views or valuation approaches. The company code currency view is otherwise known as legal view, group currency. Group valuation is alternatively known as group currency, group valuation. Group currency, profit center valuation, is also known as profit center valuation.

Figure 1

Material master accounting 1 view with parallel valuation

Clarification for Profit Center Valuation

Consider a scenario in which a material X is transferred between two plants (plant 1 to plant 2). Plant 1 is part of company code 1, and plant 2 is part of company code 2. If the original cost for plant 1 is $800, then that becomes the group cost, and the plant 2 group cost is the same ($800). But let’s say plant 1 sells to plant 2 with a markup of $200 and then the transfer price becomes $1,000. Therefore, this $1,000 becomes the legal cost for plant 2 as shown in Figure 1. The profit center value can be entirely different: $900 ($800 + $100 markup). This is the standard way of establishing the three views and standard costs.

For my solution, I suggest that you use the profit center view cost as $1,000. Therefore, if your company code currency and group currency match as in the scenario that I just described, then according to my proposal, the legal valuation and profit valuation become the same. Only in the case of intercompany scenarios does profit center valuation use such a setup. In the case of intra-company transfers, such as between two profit centers within one company code, any managerial transfer price can be used. The intra-company setup is not shown in this article as it’s not part of the intercompany solution scope. From my experience, my solution is fully compatible with any profit-specific transfer prices.

I now explain how to configure the following settings that are used for this solution:

• Define a currency and valuation profile at the controlling area
• Define a valuation clearing account for intercompany markup accounts
• Define currency types at the company code level for the leading ledger
• Set up currency types in the material ledger
• Define costing variants for product costing
• Define pricing procedures for sales

Define a Currency and Valuation Profile at the Controlling Area

To complete this step follow menu path, Controlling > General Controlling > Multiple Valuation Approaches/Transfer Prices > Basic Settings > Maintain Currency and Valuation Profile. In the screen that appears, define a currency and valuation (C&V) profile (Figure 2). In my example I have defined three currencies or valuations by double-clicking the Details subfolder and entering the data shown under the Text and Valuation View columns.

Figure 2

A currency and valuation profile

To complete this step, follow menu path Controlling > General Controlling > Multiple Valuation Approaches/Transfer Prices > Level of Detail > Define Valuation Clearing Account. The screen that appears shows the settings to use subsequently to post the intercompany markup values into separate G/L accounts during the intercompany accounting postings (Figure 3).

Figure 3

Intercompany balancing account setup

I use two different G/L accounts (500200 and 440010) in my business scenario example. However, you are free to choose a single account. During the month-end closing process, these balances need to be cleared off with each other. Therefore, I recommend that you use the same G/L account.

To define currency types at the company code level, follow menu path Financial Accounting (New) > Financial Accounting Global Settings (New) > Ledger > Define Currency of Leading Ledger.

In the screen that appears (Figure 4), I activated three currency and valuation type combinations. For the first local currency, I applied the company code currency with the legal valuation (valuation field shows 0). For the second and third local currencies, I applied group currency with valuations of 1 and 2, respectively. A valuation of 1 stands for group valuation. A valuation of 2 stands for profit center valuation.

Figure 4

Company code level currency settings

Set Up Currency Types in the Material Ledger

Follow menu path Controlling > Product Cost Controlling > Actual Costing/Material Ledger > Assign Currency Types to Material Ledger Type. The screen that appears shows the settings of material ledger that help you to synchronize the G/L and controlling area postings (Figure 5). This setting enables the material ledger to transfer values for each material master (which has three standard costs) during accounting postings and also to receive back the values for material ledger balances and inventory reporting.

Figure 5

Material ledger currency setup

For stock transfers, you need to activate the control type for FI (the check box under the CT from FI column in Figure 5). For consumption to a cost center or a production order, you activate the control type for FI and the control type for controlling (the check box under the CO Crcy Typ column).

Define Costing Variants for Product Costing

To complete this step, follow menu path Controlling > Product Cost Controlling > Material Cost Estimate with Quantity Structure > Define Costing Variants (Costing Types within each variant) to configure the three costing variants. Figure 6 is a key piece of my design. In this screen I show one costing variant (legal valuation) and one costing type (01) within the variant (I have used the drilldown functionality to call up the screen shown in Figure 6). You need to set up three costing variants with legal, group, and profit center valuations. In a separate article, “Streamline Cross-Company Postings Using SAP Parallel Valuation and Transfer Pricing in an LIV Process” I explain the configuration details for the three types of costing variants.

Figure 6

Costing type setup within a costing variant

For this step, follow menu path Sales > Basic Functions > Pricing > Pricing Control > Define and Assign Pricing Procedure. Drill down on the maintain pricing procedure configuration element to call up the screen shown in Figure 7. The screen that appears shows the intercompany pricing procedure from the sales and distribution (SD) side (Figure 7). Three condition types (KW00, PCVP, and PC00) are very important for my solution. KW00 carries both the group valuation revenue and cost values during the intercompany billing (this posts values only in the group valuation view that I discuss later). The PC00 condition carries the revenue for profit center valuation, and PCVP carries the profit center cost for any material.

Figure 7

Sales and distribution pricing procedure setup

KW00 and PC00 are standard condition types available in the standard SAP system. To define the PCVP condition type, copy the existing KW00 condition type and change the Cond. Category field from b to c where the b stands for group valuation and c stands for profit center valuation. The details step to configure this condition type has not been shown in this article as this a very common configuration step for the SD module and the steps are readily available in the SAP Help portal.

The value for the condition type PC00 is in the controlling area currency and is the same as transfer prices. To explain this condition record value, consider this example. Plant A (company code A) is selling to plant B (company code B). The standard cost in plant A is $800, but there is a $200 markup between these plants. Therefore, the legal transfer price is $1,000, and the PC00 condition record needs to be maintained as $1,000. The condition record maintenance is a master data that is done using the transaction code VK11. The steps are not covered in this article as this is a standard sales and distribution process.

The following master data records play an important role in my solution to store the transfer pricing conditions and values and make them available across all logistics transactions:

• Purchase information records
• Profit center pricing tool
• Sales pricing conditions

Purchase Information Records

To set up a purchase information record, use transaction code ME11. In the screen that appears (not shown) enter a code for the intercompany vendor, material number, plant, and purchasing organization number. Press Enter. In the next screen (also not shown) click the Conditions button. As you can see in the screen that appears (Figure 8) the transfer price is determined based on a cost-plus method, and the markup percentage is 30 percent on the source plant manufacturing costs.

Figure 8

Purchase information record setup for an intercompany vendor

Profit Center Pricing Tool

To set up profit center pricing, use transaction code 8KEZ. In the screen that appears (Figure 9) you manage the profit pricing valuation, pricing procedure, and condition types. Figure 9 shows the profit center pricing procedure ZTP001 that has been set up with two conditions (original cost plus markup percentage). In the left section, you can create these condition types. In this screen you can manage all the condition creations and then pricing procedure setup (ZTP001 in my case).

Figure 9

The profit center transfer pricing cockpit

As shown in Figure 9, you can click the create or copy icon to either create a condition from scratch or use an existing condition. For my current solution, I use the standard condition type TPB1 as is and create a percent markup condition ZPT2. These two should suffice to set up a profit center valuation based on cost-plus markup.

This screen deals with the configuration part only. However, to set up actual condition records for the percent markup condition ZPT2, use transaction code VK19. This is a standard transaction code for condition record maintenance and therefore I do not include the instruction for this setup. You can find the instructions in the SAP Help portal for condition record maintenance. The condition type TPB1 is a standard condition, and no record maintenance is necessary.

Based on my simple case, if plant A (company code A) has profit A and it is moving the material to plant B (company code B) that has profit center B, you need to maintain the transfer price of $1,000 (based on the continuing simple case discussion) for the material, receiving profit center B. Usually, if you have a lot of materials that you deal with, you can use a common material that can be maintained in the material master of the group of materials. For this article I assume that the prices have been set up using each individual material level.

Sales Pricing Conditions

You need several standard SD condition records for a successful intercompany billing process. In addition to all standard SD condition types that are needed for SD intercompany billing processing, the condition record for condition type PC00 particularly needs to be maintained for my solution. The other two condition types, KW00 and PCVP (Figure 7), are automatic condition types having no access sequence, and therefore get their values without any condition records (these condition types basically carry standard costs) directly from the accounting 1 view of material master for receiving plant. The SAP screen for maintaining condition record PC00 using the transaction code VK11 is not shown in this article as it’s a common SD transaction and instruction for setting this up is readily available in the SAP Help portal.

Figure 10 shows an end-to-end business process flow for a cross-company stock transfer. Note that one material is being transferred from plant U111 to U112, which belongs to two different company codes (i.e., legal entities). In this diagram all examples are demonstrated using US dollars. However, the proposed solution also works in cases of multicurrency business transactions.

Figure 10

An example business process for an intercompany stock transfer

In the example business process, you need to follow these steps:

• Standard cost estimates in the sending and receiving plants
• Goods issue against CCSTO (cross-company stock transfer order) in the sending plant
• Goods receipt against CCSTO in the receiving plant
• Billing against CCSTO in the sending plant (intercompany accounts receivable)
• Invoice against CCSTO in the receiving plant (intercompany accounts payable)

To configure settings for standard cost estimates in sending and receiving plants, use transaction code MM03 with the material number and plant and press Enter. In the screen (not shown), select the accounting 1 view option from the pop-up box (not shown here) and press Enter again. The screen that appears shows the accounting 1 view of the material number (Figure 11), and it displays various costs from three valuation view perspectives.

Figure 11

Material master standard costs in sending and receiving plants used in the example

In Figure 11, I have shown two screens together to contrast the sending and receiving side cost estimates. The top screen in Figure 11 is for the sending plant (U111) company code, and the bottom one is for the receiving plant (U112) company code. The sending plant has all the currencies and valuation values in US dollars with the same amount. This business case assumes that this material originates from the plant.

The same material is subsequently transferred to plant U112. Therefore, the material valuation of the receiving plant U112 has $1,430 as the legal value ($1,100 plus a 30-percent markup equals $1,430). The transfer price between these two plants or company codes is also $1,430. The group valuation at the U112 plant shows the same cost as the source plant (U111) (i.e., $1,100). My design for the profit center valuation is to make it the same as legal valuation in US dollars (assuming this entire controlling area or parent organization is based in the United States). Therefore, the profit center valuation view at the receiving plant U112 is $1,430.  Remember that three different costing variants help to create three types of standard costs in both sending and receiving company codes (refer back to Figure 6).

To display the accounting document for a goods issue posting, use transaction code FB03 or follow menu path Accounting > Financial Accounting > General Ledger> Document> Display. In the screen that appears (Figure 12), enter an accounting document number, company code, and fiscal year. Press Enter. Figure 12 shows the same accounting document with three different views or valuations. You can navigate through these views by clicking the Display Currency button. The goods issue posting occurs at the sending plant, and all the views or valuations have the same amounts being posted. These amounts in turn are equal to the material cost of $1,100 (based on the values shown in Figure 11 for the sending plant). The accounting posting has credited the inventory account and debited the stock-in-transit account.

Figure 12

Goods issue document posted in the sending company code in three views

Goods Receipt Against CCSTO in the Receiving Plant

Use transaction code FB03 or follow menu path Accounting > Financial Accounting > General Ledger> Document> Display with accounting document number, company code, and fiscal year as the parameters. Press the Enter key to display the accounting document for a goods receipt posting as shown in Figure 13. The goods receipt occurs in the receiving plant and in a separate company code in the example business scenario.

Figure 13

Goods receipt document in the receiving company code

Based on the business requirement mentioned earlier, the legal valuation shows the goods receipt value as $1,430. This legal value is transferred from the standard cost field of the material master accounting 1 view for the receiving plant as shown in Figure 11. The group valuation does not carry the markup, so it shows the value as $1,100. The profit center value matches carry the same markup, and therefore, they have been posted with $1,430. The group and profit center values are stored in a stock transfer purchase order that in turn receives these values from the material master accounting 1 view.

For this step, use transaction code FB03 or follow menu path Accounting > Financial Accounting > General Ledger> Document> Display with accounting document number, company code, and fiscal year as the parameters. Press Enter to display the accounting document for intercompany billing posting as shown in Figure 14.

Figure 14

Intercompany accounts receivable invoice in the sending company

The legal valuation view is chosen first for demonstration. This is posted in the sending company code. The intercompany receivables and sales for legal valuation are based on the legal transfer price ($1,430). Also, this accounting document shows that the intercompany cost of goods sold (COGS) has been posted by debiting intercompany COGS (540000) and crediting the In-transit I/CO (Intercompany transit account 130070). This is based on the conditions in the sales and distribution (SD) pricing procedure.

I used a separate accrual condition to post the COGS at the time of billing. This is a very common process to reconcile Profitability Analysis (CO-PA) and the G/L. The configuration detail behind this posting is not discussed here as it pertains to the CO-PA module. Coming back to the valuation, I note that the COGS has been posted with the source or sending plant standard cost that is $1,100 based on the values shown in Figure 11.

To display the accounting postings for intercompany billing for group valuation, click the Display Currency button in Figure 14 and select the group currency/group valuation radio button (not shown) to display the accounting document as shown in Figure 15. The accounts receivable balances in all three views are the same. Therefore, the first line does not show any difference from the value shown in Figure 14. However, the values for intercompany sales and other accounts are based on the group cost for this material. Therefore, $1,100 has been posted for intercompany sales, cost of goods accounts.

Figure 15

Intercompany accounts receivable invoice in the sending company

In this view an automatic intercompany markup is calculated and posted to the G/L account based on the configurations shown in Figure 3. This is a feature of the parallel valuation solution from a standard SAP system. The group valuation that represents the corporate /parent company view segregates the markup, and it can be helpful in consolidation.

To display the accounting postings for intercompany billing for profit center valuation, click the Display Currency button in Figure 15 and select the group currency/profit center valuation radio button (not shown) to display the accounting lines for intercompany billing posting as shown in Figure 16. The accounts receivable balances are again the same as the ones shown in Figure 15 as discussed in the earlier section.

Figure 16

Intercompany accounts receivable invoice in the sending company

The intercompany sales value is based on the sales condition record PC00, which, according to my example, has the same value as the legal valuation. This is a coincidence as the legal valuation is also in US dollars, which is the same as the controlling area (parent company) functional currency. However, the theory behind this value is that it includes the markup and flows in from the sales condition type PC00.

Invoice Against CCSTO in Receiving Plant (Intercompany Accounts Payable)

Use transaction code FB03 or follow menu path Accounting > Financial Accounting > General Ledger> Document> Display with accounting document number, company code, and fiscal year as the parameters. Press Enter to display the accounting document for intercompany accounts payable invoice as shown in Figure 17.

Figure 17

The legal and group valuation views for the intercompany accounts payable invoice in the receiving company

The legal and group valuation views are chosen together first for demonstration. Again, click the Display Currency button and select the appropriate radio button (not shown) to toggle between the two parts of the screen shown in Figure 17. The accounts payable amount that is the first line again contains the same values in all valuation views. Therefore, this screen and the profit center view screen have the same amount for the payables. The GR/IR (Goods Receipt or Invoice Receipt) account (in the Figure 17 the G/L account is 210020) contains the transfer prices (including markup) for the legal valuation and group costs (without the markup $1,100) for group valuation.

To display the invoice with profit center valuation from the Figure 17, click the Display Currency button, and select the group currency/profit center valuation radio button (radio button options not shown here) to display the accounting document line items for intercompany accounts payable invoice posting as shown in Figure 18. The accounts payable amount is the same as the legal and group valuation views. The GR/IR account (210020) for profit center valuation carries the same amount as in the legal valuation view. Therefore, the markup account amount is posted as zero.

Figure 18

The profit center valuation view for the intercompany accounts payable invoice in the receiving company

This step concludes the example business scenario. Each of the valuation views has been able to capture its own values based on the transfer pricing rules and with a focus on final intercompany elimination. Now I discuss how these values can be leveraged during month-end closing.

The Currency Translation Approach

As you can see from the examples that I described, parallel valuation has many advantages, but at the same time it requires some unique approaches from the month-end closing aspect.  In particular, I discuss two important concepts here: foreign currency translation and ideal valuation view for consolidation. If you do not activate parallel values, the legal valuation is the only choice. It is used for currency translation of foreign company code financial statements at the end of each month to meet the FASB 52 regulation. It deals with US GAAP rules regarding translation of foreign currency financial statements as well as for overall financial consolidation.

With my solution, the legal valuation can still be used for translating the foreign currency balance sheet, but the results are written to the group currency valuation view after taking into account the profit center valuation view values. This is a standard process in the SAP G/L for foreign currency translation (transaction code FAGL_FC_TRANS) that you can use. The details of the configuration for this transaction are not discussed in this article to keep the scope limited to the parallel valuation solution only. 

To summarize, you use the legal valuation with the desired exchange rate type, translate the values into group currency, and take the difference between this translated value (which is in the controlling area currency/group currency) and profit center valuation view values (which is also in group currency per my solution). You would then need to use this differential value to update the group currency valuation views values.

Therefore, after the currency translation transaction execution (and after the system finds the differential and adds it up to the group currency values as I described), the resulting group valuation view value is fully compliant with the US GAAP FASB52 requirement. At the same time it carries values that do not include the intercompany markup. Therefore, intercompany inventory-related consolidation becomes easier. Two requirements are solved: translating from the legal valuation view and not including the markup values.

I present two options for consolidation before concluding this article. One is the traditional method, and the second is an alternative option that is based on my solution approach. To give you a complete picture, I extend my business case assuming that the receiving company code also has made an external customer sale for part of the intercompany inventory.

To revisit my example here, two units of a particular material were sold from company code U015 (having a standard cost of $1,100) to company U016 with a 30 percent markup (making the transfer price $1,430 excluding any additional charges). At the month end, one unit has been sold to an external customer for $1,600. Usually, if you do not have the parallel valuation solution that I described, the legal valuation is used for intercompany elimination and final consolidation.

Table 2 shows the conventional intercompany elimination using legal valuation, and includes several columns. U015 is the source or sending company code. U016 is the receiving company code, assuming the functional currency of this company code is in US dollars. The translated values (column U016 translated) are also the same US dollars. The Elim journal column specifies the various elimination entries for various accounts that need to be performed every quarter or month end to prepare consolidated financial statements.

I use major elimination entries to explain the concepts. First, the intercompany sales and intercompany COGS account have been completely eliminated and the external cost of goods account has been brought down by the markup amount for one unit of material that has been sold to an external customer. The remaining inventory account (balance sheet) has been adjusted to take out the markup amount within it ($330). The last column (Consolidated total) is a sum of the U015, U016 translated, and Elim columns with correct signs. The gross profits in Table 2 for company codes U015 and U016 are shown to remind you that the corporate income tax may need to be paid off by each company code separately.

Based on US GAAP or any other local GAAP, inventory balances in legal valuation (Table 3) needs to be adjusted ($330 credit as explained above) for the intercompany materials that are still not sold to external customers. Also, the taxable profit and income tax payable for this profit based on the intercompany sales in legal valuation requires additional deferral if the intercompany materials are not sold externally right away.

The details of income tax deferral and the SAP technical corporate income tax process is not covered in this article. Therefore, reviewing the elimination entries based on the legal valuation shown in Tables 2 and 3 (which may seem easy at first glance) pose many challenges as it’s very complex to keep track of the units of materials purchased, sold to external customers, and still remaining under your inventory or units being used in a further manufacturing process. If U016 company had used the material transferred from U015 in the manufacturing process, it would have been more complex.

Switching gears, I now discuss the option of using the group valuation view for intercompany elimination instead of legal valuation. Within the previous sections I have also described the currency translation concepts for foreign currency financial statements using the group valuation and profit center valuation views that make this alternative consolidation option fully viable. Table 4 describes this alternative consolidation approach. Note that the same example has been reused here, and the columns headings have been kept intact.

The most important observation for this alternative approach (Table 4) is the reduced number of elimination entries. As the group valuation balances are always posted without the markup, they serve better for consolidation/elimination entries. The complexity that I described during the legal valuation consolidation approach (Tables 2 and 3) poses less of a challenge while using this valuation view. The primary reason is that the group valuation values are always stripped off the markup, and therefore, multiple production levels, inventory stages such as work in process, or final delivery and transfer across multiple company code have no impact using this view.

Surajit Mohanty

Surajit Mohanty is an independent consultant with more than 14 years of SAP Financials consulting experience. In the past he has worked with various consulting firms such as IBM, Deloitte, and BearingPoint. He has vast experience in SAP CO (Controlling/Management Accounting) and FI areas spanning across nine end-to-end implementations. He has delivered solutions to a broad range of clients with various roles in the areas of product costing, material ledger average costing, transfer pricing, profitability analysis, revenue recognition, accounts receivable and payable, sales and use taxation, SAP General Ledger, and integration of the SAP General Ledger with materials management, production execution, and sales and distribution areas. He lives in Schaumburg, IL, with his wife and son.

 

 

You may contact the author at surajit.mohanty@hotmail.com.

If you have comments about this article or publication, or would like to submit an article idea, please contact the editor.