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How to calculate Purchase Price Variance (PPV) and track PPV accounting entries in SAP

Lets learn what is Purchase Price Variance, how is it calculated and how can we track purchase price variance accounting entries (by using transaction codes in SAP. By the way, if you haven’t already, start following our blog and YouTube channel LearnAccountingFinance, so that you can stay up to date with practical information and training (knowledge you can use immediately at your work). This information is also available in video format. You can click on the link https://www.youtube.com/watch?v=e6p9XkuzXNQ to watch the video.

This is a detailed article on purchase price variance, where you will understand first, with the help of a simple example, what is purchase price variance, how it is calculated and recorded, and then we will follow a trail of accounting entries in the SAP system for a real example with purchase price variance and exchange rate variance entries. We will discuss all the transaction codes you can use in SAP to follow the accounting entries for goods receipt, invoice receipt and the related purchase price variance entries in SAP system.

What is Purchase Price Variance?

Purchase price variance (PPV) is the difference between the standard price of a purchased material and its actual price.

Purchase price variance = (Actual price – Standard price) x Quantity purchased

Lets understand what is standard price first. Many organizations, specially manufacturing organizations, use standard costing system to measure and value their inventory. What it means is that, the cost of inventory is calculated based on a standard cost model, with information such as prices, Bills of Material (BOM) and recipes defined in the model to calculate the total standard cost. The Cost Model is used to calculate the standard cost of finished goods. However, an important element of calculating the finished goods cost is the raw material and packaging costs. To calculate standard costs, prices for raw material and packaging materials are also predefined, often based on the most recent information available on the prices of those materials. For example, if a Cost Accountant or Controller is preparing or updating the Standard Cost Model in the month of September, he/she will be required to list all the raw and packaging materials in the Cost Model with standard prices. In order to determine the standard price, he or she will take a look at the most recent invoices to estimate what the price of the material is likely to be. This price will be considered as the Standard cost of those raw materials and packaging materials.

In SAP, the standard prices are loaded and the system then has the standard cost of each raw and packaging material. However, in real life, things change and so do prices. So when, a new Purchase Order is issued, the price of a raw material may change from what was originally set as standard. This generates a variance and a need to record the variance in the system. Lets take a look at the accounting entries recorded in this scenario.

Accounting entries for Purchase Price Variance (in SAP ERP).

To understand the accounting entries involved with purchase price variance, we will take a simple example (see below).

Purchase price variance for raw material A

In our example, we purchase Raw Material A. Before we purchase the material, the standard cost of the material is already maintained in the system. The standard cost of the material is $10 per KG. The purchasing agent negotiated the price with the supplier and the current price the supplier has offered is now $12. So, the Purchasing agent maintained the price of $12 in the Purchase Order (in SAP). Later on, we received the invoice, and it seems that the supplier lowered the actual price on the invoice to $11. What accounting entries will we see in SAP for this scenario?

Accounting entries when material is received (GR/IR) – The first accounting entry will be made in SAP system when Raw material A is physically received by the company. Lets say 5 KGs of raw material A are received by the Receiving officer at the warehouse/store. At this point, the receiving officer records a Goods receipt (GR) in the system. This generates accounting entries as the company now owns inventory. The price that SAP will use to receive the material is the Purchase Order (PO) price of $12 (because at this point, invoice is not received and PO price is the latest price available in the system). However, since the company uses standard costing system, inventory is always recorded at the predefined standard cost (which is $10 in this case). So the accounting entries will be:

Accounting entries for purchase of raw material in SAP (Goods receipt)

As you can see, raw material inventory is debited (increase) by $50 ($10 x 5 KG) because inventory is maintained at the standard cost. However, the amount payable to the supplier at this point is $60 ($12 x 5KG). Since, an official invoice is not received from the supplier, SAP records the amount payable in a GR/IR account (Goods receipt/invoice receipt). This is a temporary holding place for the amount payable and is fully offset when the actual invoice is received.

However, we see a difference of $10, between the standard cost of material and the amount payable to the supplier at this point calculated as:

(Actual price – Standard price) x Quantity purchased

or ($12-$10) x 5KG = $10

This difference in standard cost and Purchase Order price is recorded in the purchase price variance account as a debit (showing expense because the PO price is higher than standard price).

Accounting entries when Invoice is received – After goods receipt is recorded, an invoice is received by the Accounting Department from the supplier. The Accounts Payable Officer finds the Purchase Order related to the invoice in the SAP system and records the invoice against the Purchase Order. Usually, the invoice price is the same as the Purchase Order price. In that case the GR/IR account is offset against the Supplier payable account and no additional purchase price variance is recorded. The accounting entry would be

Debit: GR/IR Account $60, and Credit: Vendor account $60.

However in our case, the invoice price is also different from the Purchase Order. The Invoice price is now $11 per KG (may be as a reduction in price offered by the supplier). The accounting entries in this case will be as follows:

Accounting entries for purchase of raw material in SAP (Invoice received)

As you can see from the above accounting entries, the GR/IR account is fully reversed with a debit as the supplier invoice is now received and we do not need the GR/IR accrual once the invoice is recorded. The supplier account is credited with $55 based on invoice price ($11 x 5 KG). There is a difference again between the GR/IR reversal and the supplier payable balance of $5 calculated as ($12 – $11) x 5 KG = $5. This difference is recorded as a gain or credit to the purchase price variance account because the invoice price is lower than the accrual already recorded in GR/IR account.

On an overall basis, the net purchase price variance recorded is $5. Initially, when the material was received, a loss of $10 was recorded. Later when the invoice was received at a lower price than PO, a gain of $5 was recorded. As a result, a net purchase price variance loss of $5 was recorded, which makes sense because the difference between standard cost and actual cost of the 5 KG material purchased was $5, and therefore, in the end, the actual cost of purchasing the material is recorded in the books of the company.

Purchase Price Variance (PPV)

Real Example, Purchase price variance entries in SAP System

Now, we will see how to follow the purchase price variance transactions for a material in SAP. There are multiple ways of doing this, but we will take an example where, lets say, you know the material you want to track the variance of. So you start with the material and then follow the variance trail. The first step is to open the “Purchasing documents for material” window by using transaction code ME2M. Here you enter the material number and click on Execute button to see a list of all purchase documents related to this material (see below).

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The output may look something like this (see below – the actual output screen layout depends on the layout selected in the “Scope of List” field for you system). A typical layout can be see below:

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List of purchase documents

You can see information such as Purchase order number, supplier name, material number and description, purchase price and currency, quantity ordered, quantity still to be delivered and still to be invoiced. Now you can double click on the Purchase Order number of your choice to open up the Purchase Order window. In this case, we double click on the purchase order number 4500212814 as follows:

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This will open the purchase order window (t-code ME23N) as follows:

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Example Purchase Order History

Accounting entry in SAP at the time of Goods Receipt

As you can see in the above picture, the Purchase Order price was entered at 623.28 USD per 1,000 KG of material 1003975. On June 25th, 2019, 16,790 KG of material were received by the receiver into the SAP system. This generated accounting entries for receiving material into the system. You can trace the accounting entries by clicking on the material document number for goods receipt 5002189751.

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This will open the material document view window as follows:

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You can click on the FI Documents button to see the accounting entries that were posted in the system at the time this transaction took place. The following window will open once you click on “FI documents” button, and select “Accounting documents” in the next window. The next screen will look like this

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Accounting entries for goods receipt (GR) in SAP

What you see above is very similar to the raw material A example we looked at earlier. This reflects the goods receipt accounting entries. As we discussed, inventory is always recorded at the standard cost (already maintained in the system). In the above entry, you can see, inventory account (47000) is debited with the standard cost for 16,790 KG of raw material 1003975. You can see the standard cost of the material by opening up transaction code MM03, selecting the material number 1003975 and then heading to Costing 2 tab as follows:

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As you can see the standard cost of the material is CAD 1,004.24 per 1000 KG (the standard cost was maintained in Canadian dollars). This means inventory should be recorded at the value of CAD 16,861.19 ($1,004.24 / 1000 x 16,790 KG). We see that this is exactly the amount recorded in the account 47000 in the accounting entry above.

Now, the other side of the entry is the GR/IR account 186200 Tr Pay Accrued. As we discussed, at the time of goods receipt, the account is credited with the Purchase Order price. the Purchase Order price was maintained in US Dollars. You can see in the accounting entry above, the account is credited with USD 10,464.87, which is exactly the price per Purchase Order times the quantity purchased (USD 623.28 / 1000 x 16,790 KG = USD 10,464.87). Since, this is a Canadian company with local currency of CAD, the system converts this amount into Canadian dollars 14,162.48, based on the exchange rate maintained in the system. With this entry we now have a difference between the amount debited (inventory account) and the amount credited (accrued payable account). This difference represents the difference between the standard cost of the material and the purchase order price of the same material. The difference also included an element of exchange rate difference, because the rate used to calculate standard cost may have been different from the exchange rate maintained at the time of the transaction. The difference is CAD 2,698.71, and is recorded in the purchase price variance account (in this case, account 400600). This is a gain because the standard cost of the material was much higher than the purchase price, which means that the material is much cheaper now compared the standard cost originally maintained. Here is the accounting entry screen again:

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Accounting entry in SAP at the time of recording Invoice

Now, we take a look at the accounting entry at the time of receiving and recording the invoice. We go back to the Purchase Order document screen in the Purchase Order history tab. We click on the invoice receipt document now.

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Clicking on the invoice receipt document will open up the display document window (t-code FB03) which looks like this …

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Here you can see some important financial information including the amount of invoice, vendor information and tax details. To see the accounting entries you can click on the “Follow-On Documents” button, and then select “Accounting Documents” to see the accounting entries. You will see a screen that looks like this …

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Now you may have noticed that the invoice was received for two purchase transactions, and therefore the total value of the invoice covers both transactions. However, we are following only the first transaction with receipt of 16,790 KG. So, in this window, we will try to isolate the entries only to that one transaction.

In the accounting entry above, you can see, since the invoice received was the same amount as the purchase order price with some minor rounding difference, no purchase price variance is recorded. The GR/IR account is fully offset (made zero) by debiting with the same amount as was originally posted at the time of good receipt, while the vendor account is credited with the invoice price converted at the new exchange rate now available in the system. The CAD to USD exchange rate available in the system when goods receipt was recorded was 0.73982. However, when the invoice was received, the rate had changed to 0.76362. This resulted in an exchange rate variance of CAD 458.03 (calculated as [(0.73982 – 0.76362) x USD 10,465] (adjusted for rounding difference 0.13 USD). This is a gain or credit, because the Canadian Dollar has strengthened between the goods receipt date and the invoice date (and therefore the company has to pay a lesser amount in Canadian dollars to the vendor, then was originally recorded at the time of goods receipt. The vendor account is credited with the amount of the invoice USD 10,465 converted into Canadian dollars at the exchange rate of 0.76362. If we only had one transaction in the invoice, the amount credited would have been CAD 13,704.45. However, the amount credited in this case is CAD 31,260.63 because we have another transaction included in the invoice. So, in this way, you have been able to follow the complete trail of accounting entries for recording a purchase of material in SAP.

We hope you found this information valuable and it clears some of the confusion around purchase price variance calculations and accounting. If you have any questions and comments, let us know in the comments section. This information is also available in video format on Youtube. You can click on the link https://www.youtube.com/watch?v=e6p9XkuzXNQ to watch the video now.

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