Methods of formation of cost in the procurement unit ERP-systems

Purpose of the article

The purpose of this article is to start talking about the possibilities and methods of modern systems to provide various options for accounting, movement and write-off of goods. And how different cost formation options can affect the final results.

1. What is the cost price

Just a few words about the very concept of cost in trade. The cost price consists directly of the purchase price and various additional expenses, for example, for delivery, sorting, storage, packaging. And many also have the correlation of indirect costs, such as the salary of staff, office rent, warehouse. There are also laws, letters, and acts that determine how to correctly understand and interpret this essence. Thus, for example, the order of the Ministry of Finance of the Russian Federation of 12/28/2001 N 119 formulates the definition of the cost price:

“The actual cost of goods purchased for a fee is the sum of the organization’s actual expenses for the purchase, with the exception of value added tax and other recoverable taxes (except for cases provided for by the legislation of the Russian Federation)”.
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There are also accounting and tax rules, respectively, but this is not covered in this article.

2. How can cost use be used in profit calculations

For simplicity, we will assume that the cost of goods is equal to the price at which we bought it. Accounting for additional expenses, "exchange differences", etc. leave for the next article.

Let there be an organization that has a resale business. In its activities there are processes of procurement, distribution, storage and sale of goods. The organization conducts its activities in the accounting system and there are goals that a business should achieve:

Business objectives

Business purpose	Business issues	Questions to the accounting system
1. Maintain your market position	What is the situation now?	Profit for the period (+ -)
2. Optimization of activities and the capture of new markets	What processes go well (bad)?	Profit in terms of contracts, transactions ...
3. Personnel motivation system	What (who) works well (poorly)?	Profit in the context of departments, employees ...

What approaches exist in the organization of accounting systems to be able to meet these challenges? To begin, consider a simple example: the stock is already purchased goods from the "Supplier".

In stock
Item 5pcs purchase price 1r.
Sales totaled
Product 2pcs at a price of 2p
Then we can answer the first question like this:
Profit
Product (2 - 1) * 2 = 2p.

A little complicate the situation by adding different batches, i.e. Consider a situation where there are several arrivals of goods from a supplier in a warehouse. Accordingly, it will now be necessary in some way to determine which product leaves the warehouse. Of the common methods, this is FIFO (the first one came - the first one left), the LIFO (the last one came - the first one left) and the weighted average.

3. Options for writing off cost

Variants of write-off (write-off rules), of course, we’ll focus more on frequently used and considered standard ones.

FIFO (firstinputfirstoutput) - When using this method, the product that arrived earlier is first written off, and if it is not enough, then the product that arrives next is written off.
For example, three coffee makers were bought at the warehouse.
The first - 10 p, the second - 20 p, the third - 30 p.

Sold 2 coffee makers. The cost of writing off the coffee maker for FIFO 1 * 10 + 1 * 20 = 30 p.
The balance of stock 60 - 30 = 30r.
LIFO (lastinputfirstoutput) - When using this method, the product that was received last is the first to be written, and if it is not enough, then the product that was received before it is written off.

Sold 2 coffee makers. The cost of writing off a coffee maker for LIFO 1 * 30 + 1 * 20 = 50 p.
Balance on coffee makers 60 - 50 = 10p
Weighted average. In this approach, the average cost of the remaining goods in stock is calculated and multiplied by the quantity of goods sold.

Sold 2 coffee makers. Weighted average cost of decommissioning coffee makers:
((10 + 20 + 30) / 3) * 2 = 40 p.
The balance of stock 60 - 40 = 20r.

For us, the main thing is to understand that when selling all the goods from the warehouse, the profit of the enterprise is the same for any method. If there are balances in warehouses, then the result in the form of profit varies significantly. Let us have FIFO for convenience, then it is easy to answer the first question:

Warehouse by lot

Product consignment 1 qty 2 pcs at a purchase price of 1p. - entered first.
Product consignment 2 qty 2 pcs for purchase price 2p. - Received the second.
Product consignment 3 qty 2 pcs at a purchase price of 3p. - Received the third.

Batch sales

Item quantity 2 pcs for 2p. - the party leaves 1 profit (2 - 1) * 2 = 2p
Item quantity 2 pcs for 2p. - the party leaves 2 profit (2 - 2) * 2 = 0
Item quantity 2 pcs for 2p. - the party leaves 3 profits (2 - 3) * 2 = -2 p

Or so (Goods in the amount of 5 pieces):

Item quantity 2 pcs for 2p. - the party leaves 1 profit (2 - 1) * 2 = 2p
Item quantity 2 pcs for 2p. - the party leaves 2 profit (2 - 2) * 2 = 0
Item quantity 1 pc for 2p. - the party leaves 3 profits (2 - 3) * 1 = -1 p

Please note that if the selling price is constant, there may be losses, i.e. when maintaining one or another method of write-off from the warehouse, it is necessary to provide for a pricing system (pricing). Here we come:

4. Options for pricing, taking into account the forming cost

Options implemented in the sales unit of the ERP system, we list the most frequently used ones:

1. The sale price is formed according to the rule “the price of the last arrival” (CPP) multiplied by a certain percentage of the mark-up. Then any price increase at the supplier will immediately affect the price of sales. Note: if the price at the supplier falls, then the system will work in the negative. But on the other hand, if the company does not keep goods in a warehouse and works only on pre-orders, then the option is quite acceptable.

2. The sale price is formed according to the market price list (such a price list is usually kept by the managers responsible for pricing) and has nothing to do with the delivery of the goods. In this variant, there is a lot of work on tracking market prices and quite tough administrative rules for managers.

3. The system tracks the consignment of goods (known current cost, sold goods) and carries out actions aimed at informing or banning sales with low or negative profitability).

5. The impact of cost accounting policies on the assessment of the activities of individual units in ERP systems.

5.1. Almighty FIFO

The second question from the business goals (see p.2) is already much more complicated, as it is necessary to track the transaction along the entire chain from purchase to sale, and this, you agree, perhaps only in fairly simple cases. For example, we buy goods only for a specific customer, then the process of arrival of the goods, their storage, movement and sale are easily tracked, for example, by the same FIFO principle. In fact, this is possible when the goods are not stored in the warehouse, but are being traded directly from the wheels.

5.2. Reservation system

The second option is to introduce a backup system, which can track goods throughout the chain from left to right:

Buyer’s Order — Supplier’s Order — Act of Acceptance of Goods — Act of Issuance to Customer
Accordingly, the backup system would look like this:
Reserve on the road - reserve on the client - vacation

Consider this example:

Warehouse status

Product consignment 1 qty 10 pcs at a purchase price of 2p. - entered first.
The supplier gives a 50% discount on the price of the Goods when purchasing from 10 pieces, i.e. This item will cost 1 p.
Product consignment 2 qty 10 pcs at a purchase price of 1p. - Received the second.
We offer the customer to buy 10 pieces from us. The product is priced at 2p and we launch the transaction:

Note that if we release the goods from the warehouse according to the FIFO rule (cost price 2 p), and look at the transaction as a whole, we will see:

Goods quantity of 10 pieces at the price of 2 rubles. - the party leaves 1 profit (2 - 2) * 2 = 0.
And if with a reservation system (table 1), then the situation will look like this:
Goods quantity of 10 pieces at the price of 2 rubles. - the party leaves 2 profit (2 - 1) * 2 = 2.
You will agree that it is much better for managers who have completed the transaction (for the enterprise as a whole, the situation does not change). I do not want to engage in self-promotion, but in our product the opportunity is realized, plus to the standard functionality, to set macros (vbs, javascript ...) for specific backup conditions that can be connected to the system by a full-time analyst.

5.3. Contract accounting in relation to the process of product distribution (cost movement).

There is another option for tracking transactions by introducing a document "contract" through which we can receive the entire document flow of a transaction. In this case, it is necessary in the ERP system to describe the process of determining the allowable, estimated cost, for example, let's call it “the minimum price of goods”. And it will have already laid the minimum profit of the enterprise. And it is precisely from this price that all reports on the "profitability" of transactions will be generated in the context of divisions, departments and individual employees.

Here, of course, I must say about the existing rules within the commercial enterprise itself. And they may contradict the logic of "hard" backup. For example, there is an additional goal - “minimization of stock”. In our case, the required product was in stock at the time when the “buyer's order” was created, it just did not fit the price. The reservation system, which is set up for “hard” behavior, will not allow the customer to release this product from the warehouse and thus violate the “goal of minimizing inventory”.

On the other hand, if you allow the transfer of reserves, then the transaction, taking into account the FIFO, will go to zero profitability.

Questions on point 3 of the “Business Goals” table resist the same problems, allowing reassignment of reserves, we can get a situation where managers transfer reserves from each other, purchasing goods with good profitability characteristics and swim to the “best” employees.

There are actually no simple solutions. Only when an organization can clearly formulate goals, form requirements and see a picture of what is happening in general can start using ERP accounting systems (Enterprise Resource Planning, enterprise resource planning), which allow describing complex chains of business processes. The main thing is that the goals that are set for developers, implementation and maintenance services should not contradict each other.

5.4. Variants of cost write-off when tracking transactions (examples).

In the case of transactions, it would be possible to use the opportunity to divide the distribution of goods in a warehouse with the manager’s document flow or apply sets of rules for reserving and writing off goods that allow describing goods movements taking into account such parameters as warehouses, product groups, organizational units and entire organizations.

For example:

Product warehouse	Write-off principle	Explanations
Retail Products	FIFO	For stores it is possible to maintain cost in sales prices
Food	FEFO (1)	It makes sense if you have a WMS system (see previous article)
Wholesale	FIFO Reserves (2)	Tracked transactions throughout the sales chain.
Wholesale	LIFO for retail department and FIFO for dealer units	For example, with an increase in prices for goods with dealers, we work under old contracts.
Any	LIFO for marriage	The found marriage is charged at the latest price of delivery.

(1) First Expire, First Out - first expire - first out (by expiration date)
(2) Reserved first - leaves first

And finally a small summary table:

Cost accounting options	Type of information system	Advantages of the solution	Solution minuses	Conditions under which the option is most optimal
Cost accounting is not kept	Missing	Ease of use	There is the likelihood of transactions with negative profitability, it is almost impossible to quickly deal with pricing.	All products sold are purchased only on order, i.e. transaction pricing. It is also possible in the situation of accounting for goods at the sale price with the receipt of interest from sales.
FIFO	Accounting system or warehouse cards	Very easy to use, it is easy to obtain warehouse balances, in the whole company reporting gives correct data	It is impossible to keep track of individual transactions that are on the verge of profitability, but at the same time provide a large turnover and ultimately profit.	The option is used, as a rule, in established markets with a certain list of goods, for example, everyday demand or with high price elasticity (cereals, salt ...)
Criterion Control	Accounting system is possible in conjunction with WMS	The most flexible control over the accounting of the movement of goods and cost	A flexible system of linking business objectives to the logistics of goods turnover requires a high level of professionalism of the staff and the IT service department. The need to purchase expensive equipment and software, including WMS	All types of businesses operating in competitive markets, where they work with low profitability, with a large turnover of goods and a complex system of competitive pricing.

In concluding the article, I want to emphasize that each company has its own views on the correctness of the information about product distribution and, accordingly, balances, profits and losses in its accounting and use in analytics or reports.

If there is interest, I would like to expand the descriptions by adding currency purchases and their correlation to the cost price. There is a very delicate moment in exchange rates, especially since the transaction itself often goes through several currencies. And there are many accounting options. In such conditions, it is interesting to set up a system for “really” multi-currency accounting (and not an additional “exchange rate difference”).