2 comments on “How to calculate Purchase Price Variance (PPV) and track PPV accounting entries in SAP”

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.

Are you an accounting and finance professional looking to improve your financial analysis skills? Make sure you connect with us by subscribing to the email list. We will be sharing practical tips and advice that will help you transform you career this year. Click here to subscribe to our email list.

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1 comment on “Explaining the impact of Sales Price, Volume, Mix and Quantity Variances on Profit Margin (Current year vs Last Year)”

Explaining the impact of Sales Price, Volume, Mix and Quantity Variances on Profit Margin (Current year vs Last Year)

How to explain the impact of Sales Variances on Profitability or Profit Margin of a business? In this article, I am going to explain with the help of an example, how to calculate sales variances, and how to understand the impact of these variances on the profitability of your business. Note that we are calculating the impact of Sales Variances on Profit. This is different from explaining sales variances in $.

By the time, you are finished with the article, you will be able to understand clearly how to calculate these variances. I will try to be concise, so I assume you are already aware of terms like Sales, margin, profits and variance etc. If you are not fully aware, click on Commonly used financial terms every new Financial Analyst and Accountant should know! to open the post and have a good idea of what they mean. Also, 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).

What you will learn?

We will start with data in the following example. The example uses data for 2017 and 2018 (current year vs last year) to calculate the variances. However, if you are trying to calculate variance with budget, simply replace last year (2017) with Budget and the calculation will work just fine.

We are selling three products which are fruits 1) Apples, 2) Bananas and 3) Oranges. We have data for Sales, Cost of Sales and Profit Margins. We also have the quantity, or number of units sold. See Tables below

sales Variance Table 1

sales Variance Table 2

As this article is about calculating the impact of Sales variances on Profit margins, we have deliberately kept the cost per unit as same over the two periods to avoid confusion. However, when calculated correctly, it does not matter if cost per unit has changed. The only thing to consider in that case would be that the profit margin change would have an element of variances from costs as well which needs to be calculated separately. In our example however, the profit margin increased by $268 and all of it is resulting from Sales related variances. After performing all variance calculations, you will see the split of variances as follows:

sales Variance Table 12

Types of Sales Variances

Lets look at types of sales variances quickly. Broadly, there are only two types of Sales variances.

  1. Price Variance (Change in Selling Price)
  2. Volume Variance (Change in Volume)

The Volume variance is further sub-divided into Quantity and Mix Variances. Do you like acronyms. Here is a good one to remember. Its PVTM

Sales Variance

Sales Variance Equation

where ‘P’ is for Price Variance, and ‘V’ is for Volume Variance. ‘T’ for Quantity and ‘M’ is for Mix.

If we calculate our variances correctly, the sum of Price and Volume variances should be equal to the total change in Profit Margin (excluding the impact of Cost variances). Similarly the sum of Quantity and Mix variances should equal Volume variance. Its time to calculate each of these variances individually.

Selling Price Variance

Lets deal with Price variance first. Any change in price directly impacts Profit margin From the data available, you can easily calculate the Selling price per unit of each fruit (Sales $ for each fruit sold divided by the number of units sold). So, for example for Apples, the selling price for 2018 is $11 ($660 Sales / 60 units sold). Similarly, the selling price of apples in 2017 was $10. Below is the table of selling prices per unit.

sales Variance Table 3

Looking at the table above, we can clearly see that the Selling price for apples and oranges have increased in 2018 compared to previous year, while that of bananas has decreased. This means, if we look at Selling prices alone, we should see a favorable impact, or favorable variance from apples and oranges and unfavorable impact from bananas. Now, Selling Price variance will be calculated as follows:

(2018 Selling price – 2017 Selling price) x Units sold in 2018.

For apples, this can be calculated as:

($11 – $10) x 60 units = $60 Fav.

Why did we use 2018 number of units sold, and not 2017 units? The answer is that we are trying to determine the impact of change in Selling price. In other words, we are trying to see if the 60 apples sold in 2018 were sold at 2017 price, how would this compare with 2018 price. Therefore, the variance could also be calculated as follows:

Apples sold at 2018 Price – Apples sold at 2017 Price

which is …

($11 x 60) – ($10 x 60) = $60

Apply the same logic to bananas and oranges

Bananas Sales Price variance = ($1.5 – $2) x 95 = -$48  Unfav. (numbers are rounded)

Oranges Sales Price variance = ($10 – $8) x 50 = $100 Fav

Here is the summary of Selling price variances,

sales Variance Table 4

So, we can say out of total change in profit margin of $268, Price variance represents $113 (rounded), and we can also see that oranges are the largest contributors to the fav. price variance.

sales Variance Table 5

Volume Variance:

This leads to the calculation of our second variance, Sales Volume variance. Sales variances comprise of Price and Volume only. Since we have calculated Price variance already, we can already calculate the total volume variance which would be…

Sales Volume variance = Total Sales Variance – Sales Price Variance

$268 – $113 = $155

However, we need to still calculate it, as well as the two sub Volume variances, which are Quantity and Mix.

Lets start with Volume variance.

Sales Volume Variance =

(2018 Units Sold – 2017 Units Sold) x 2017 Profit Margin per Unit

Yes, I know you have some questions here.

  1. Why did we use Profit Margin per unit, and not Selling Price?
  2. OK, even if we use Profit Margin, why 2017 and not 2018.

See .. I can read your mind 🙂

Answer to Question 1. Remember we are trying to explain the impact of Sales variances on profit margin, not total Sales $. If we had taken Selling price instead of Profit margin, we would be explaining Sales $ variance (change in Sales $ from 2017 to 2018), but we are calculating the impact on Profit margin. For each increase or decrease in unit sold vs last year, the profit margin will be impacted only by the amount of profit margin per unit and not the total Sales value. Understanding this is important. Note that in the calculation of two sub Volume variances (Mix and Quantity) as well, we will use profit margin per unit and not Selling price per unit.

If you have understood answer to Q1, then you can also understand that when we calculated price variance, we took into account the change in profit margin per unit in 2018. Now we are calculating the impact of change in volume (or number of units) and should exclude the impact of change in Profit margin in 2018. This is why we use 2017 Profit Margin. Think about it for a little while, internalize it and if you still do not understand, leave a comment and I will try to explain further.

Time to do the Math:

sales Variance Table 6

At this point, we have understood the impact of Sale price and volume on the $268 change in Profit Margin in 2018 vs 2017.

sales Variance Table 7

However, our analysis is not finished, and we need to understand the impact of Mix and Quantity.

Sales Mix Variance:

Sales Mix refers to the share of each product in total Sales, in terms of percentage. If you look at the number of units sold, you will see that in 2017, 50 apples were sold which is 28% of total sales of 180 units (50/180).

sales Variance Table 8

Sales Mix variance can be calculated as …

(2018 Mix % – 2017 Mix %) x Total units sold in 2018 x 2017 Profit Margin

So, our Sales Mix variance for each fruit will be as follows:

sales Variance Table 9

The share of apples in the overall product mix increased to 29% in 2018 (60/205). This change in mix of 1% multiplied by the total number of units sold in 2018 (205) will give us the number of apples sold that resulted in the increase in Mix %. In this case it is 3 apples (1% x 205 = 3). We know that the total number of apples increased by 10 (50 in 2017 and 60 in 2018). So out of the total Volume change of 10 apples, 3 apples represent Mix change and the remaining 7 represent Quantity change. We can see from the variances above that a drop in mix % of bananas by -9% has impacted the profit margin unfavorably by -$19 but this has been more than compensated by the increase in Mix % of Oranges by 8% (which has a higher Profit margin per Unit compared to bananas).

Calculating Mix variance separately in this way is important because each product may have a different profit margin. Assume the overall volume increased from 180 to 205 (just as in our example) but the mix remained the same as last year, then the change in total profit margin of the business would have been different, although we see the same quantity increase. This calculation of impact of increase in quantity while maintaining the same mix as last year is really our next variance, the Quantity Variance. Calculating Mix variance also helps when trying to explain Profit Margin % changes over the years, or vs budget because Quantity variance has neutral impact on % Profit Margin.

Sales Quantity Variance

As mentioned above, Sales Quantity variance measures the impact of increase in volume, or quantity while maintaining previous year’s mix.

Sales Quantity Variance

= (2018 Units sold @ 2017 Mix – 2017 Units Sold) x 2017 Profit Margin per unit

In our example fruit sales increased from 180 to 205. If the sale had increased maintaining the same product mix as 2017, our unit sales for 2018 would be as follows:

sales Variance Table 10

And the Sales Quantity Variance can be calculated as follows:

sales Variance Table 11

Conclusion:

We have calculated all the variances now. The overall increase of $268 in Profit margin can be clearly explained with Price increase resulting in fav. variance of $113 and Volume increase resulting in fav. variance of $155. The volume increase includes $76 due to change in Product Mix.

sales Variance Table 12

If you are also interested in learning how to calculate purchase price variance and the accounting entries involved in recording purchase price variance, click on the link How to calculate Purchase Price Variance (PPV) and track PPV accounting entries in SAP

Are you an accounting and finance professional looking to improve your financial analysis skills. Make sure you connect with me by subscribing to my email list. I will be sharing practical tips and advice that will help you transform you career this year. Click here to subscribe to my email list.

I have a YouTube channel with helpful accounting and finance, Excel and career related videos. You can find my channel by clicking on the link LearnAccountingFinance.