1. Internal Accounting Text Chapter 10 (C & L) and Chapter 5 (M &W) R/3 Profit & Cost Reporting

2. Internal Accounting Also called “Managerial Accounting” Oriented towards business planning and controlling and reducing costs –cost accounting- direct and indirect –conventional cost center accounting vs. process-oriented view

3. R/3 Internal Accounting Scenarios Cost Object Controlling Profitability Analysis Profit Center Accounting Overhead Cost Management

4. Cost Object Controlling Costs for manufacturing an object or service are collected for a cost object –planned and actual costs are calculated Applicable to repetitive manufacturing, process manufacturing and design-to-order –begins with preliminary costing –goods in production use simultaneous costing to compare planned vs. actual costs –when finished, period-ending closing begins

5. Cost Object Controlling ^^ Production order is to be created Creating/ processing prod. order Release of production order Production order is created Production order is partially released Prod. Order preliminary costing Prod. Order is to be carried out Prelim. Costing of prod. Orders triggered

6. Cost Object Controlling (part 2) ^^ Execution of production order Goods receipt process. From production Production order is completed Diff. Posted to price diff account Material is posted in consumption Goods receipt to be posted Actual data for period completed Production order simultaneous costing

7. Period End Closing and Final Costing Process costing calculation Process costing calculation is completed Overhead calculation Production order debited with indirect costs Determine WIP in workplace/ lot processing

8. Period End Closing and Final Costing (Pt 2) ^ Variance to be calculated Remaining cost to price difference acct Production order to be settled against material Settlement of production order Variance calculation Production var. settled to profit analysis Profitability Analysis

9. Profitability Analysis Identifies product/market margins Analyzes structure of profit-related criteria from specific orders –these profitability segments include: Customer Product Activity Organization

10. Profitability Analysis and Planning PA output is used to support different types of planning –automatic planning based on a calculation using previous year or other forecasting projection –bottom-up planning using aggregation of individual planning levels –top-down planning from comprehensive plan –time-based distribution working in seasonality, production-dependent time factors

11. Product Profitability Analysis Accounting data is used to determine the profitability of a company and its products –Inaccurate and/or incomplete data can lead to a flawed analysis –The three main causes of data problems are: Inconsistent record keeping Inaccurate inventory costing Problems consolidating data from subsidiaries

12. Inconsistent Record Keeping At Fitter Snacker: –Sales data is not maintained so that sales reports are easily generated Analyzing sales data by region or division usually must be done by hand –Production data is maintained with paper records Data must be typed into a spreadsheet from paper records before it can be analyzed –Manual entry leads to errors –Without an integrated information system, much of the effort in generating reports is devoted to working around the limitations of the systems

13. Inaccurate Inventory-Costing Systems Correctly calculating inventory costs is an important and challenging task in any manufacturing company A manufactured item’s cost has three elements: –Cost of raw materials used in the item –Labor used specifically to produce the product (direct labor) –Overhead: all other costs Factory utilities General factory labor (custodial services, security) Manager’s salaries Storage Insurance

14. Direct and Indirect Costs Materials and labor are called direct costs –Direct costs are relatively easy to tie to the production of specific products Overhead is an indirect cost –Indirect costs are difficulty to associate with a specific product e.g. the relationship between the cost of heating and lighting and a specific batch of NRG-A bars –To determine the cost of a manufactured product, indirect costs must be allocated to products

15. Direct and Indirect Costs Allocating indirect costs –One method is to use total machine hours Total overhead cost divided by the total machine production time (hours) available for a period to get an overhead rate per machine hour –Example: Overhead costs per month: $152,500 Production line capacity: 50 cases/hour 160 hours/month

16. Direct and Indirect Costs Allocating indirect costs –Another method is to use direct labor hours The assumption with this method is that overhead costs are incurred so workers can do their jobs –For Fitter Snacker, the snack bar bake line is the fundamental production process as well as capacity constraint, so allocating indirect costs using machine hours (snack bar bake line hours) would make sense

17. Standard Costs Costs are typically recorded using standard costs, which are based on historical cost data At the end of an accounting period, adjustments to accounts must be made as actual costs will differ from estimates made using standard costs –Balance sheet: cost of inventory held will need to be adjusted –Income statement: cost of goods sold will have to be adjusted Difference between actual costs and standard costs are called cost variances Cost variances arise with both direct and indirect costs

18. Activity-Based Costing (ABC) In ABC, records are kept on overhead costs and the activities associated with overhead cost generation The goal is to more precisely associate costs with the causes (drivers) and avoid rough allocation procedures Profitability of particular products is more accurately determined ABC is often used when: –Competition is stiff –Overhead costs are high –Products are diverse Not all overhead costs can be linked to activities

19. Activity-Based Costing (ABC) ABC requires more bookkeeping than traditional cost- accounting approaches ABC is often used for strategic purposes in parallel with standard cost accounting A recent study noted that: –ERP companies had nearly twice as many cost- allocation bases to use in management decision-making –ERP companies’ managers rated their cost-accounting system much higher

20. Companies with Subsidiaries Companies with subsidiaries must prepare financial statements for each subsidiary, plus be able to provide a consolidated statement for the entire company Different currencies and transactions between subsidiary companies can make the consolidation task challenging Currency translation is challenging because exchange rates fluctuate daily Intercompany transactions must be handled properly –Sales from one subsidiary to another within a company do not result in a profit or loss, because no money has entered or left the consolidated company

21. Example: Microsoft Microsoft must consolidate financial information from 130 subsidiaries Prior to installing SAP R/3, each subsidiary did accounting in its own system, then transmitted the files to another system, where manipulation of the data was required –Subsidiaries used different systems, with different field sizes, types of characters, account structures, etc. –Consolidation took over a week With SAP R/3, Microsoft can look directly at financial activity at any subsidiary around the world

22. Management Reporting with ERP Systems Reporting accounting information is often challenging Without an ERP system, obtaining the information needed for a report is frequently a monumental task With ERP, the information is in a single system, however: –The system configuration must be set to gather the correct “raw data” –The appropriate reports are needed, which may require custom coding (e.g. ABAP)

23. Document Flow for Customer Service In SAP R/3, Document Flow is a tool that finds, organizes and displays a summary of all documents related to a sales order Sales orders can be very complicated, with: –multiple products –multiple shipments –multiple invoices –multiple payments Being able to find all related documents easily is important in providing efficient customer service

24. Figure 5.6 Document flow of a transaction in SAP R/3 Details of any document can be viewed from the document flow screen—a process known as “drilling down”

25. Management-Reporting and Analysis Tools Because ERP systems use a database, the database can be queried to provide a wide range of reports and analyses Because reports access the same database where transactions are recorded, reporting and analysis requests can slow down the processing of regular business transactions –SAP R/3 has built-in information systems (SIS, LIS, etc.) with their own data tables for analysis –Business Warehouse (BW) is a completely separate system that extracts data from the SAP R/3 system BW provides greater reporting flexibility and can combine data from other information systems

26. Enron Collapse Enron was a trailblazing energy company that was revolutionizing the oil and gas business and making millionaires of its investors On Oct. 16, 2001, Enron’s creative financial arrangements began to unravel On Dec. 2, 2001, Enron made the largest bankruptcy filing in history A primary cause of the collapse was Enron’s partnerships that shifted billions of debt off Enron’s books so that Enron could borrow money more cheaply Arthur Andersen, a highly regarded accounting firm, had annually issued annual reports attesting to the validity of Enron’s financial statements

27. Enron Collapse Arthur Andersen was indicted for, among other things, the destruction of Enron documents in the face of an SEC investigation As a result of the Enron collapse: –Enron’s 20,000 creditors will receive approximately 20% of the $63 billion they are owed –Shareholders will receive nothing Many employees invested large sums of money in Enron stock via 401K savings plans –Arthur Andersen, once a firm with 28,000 employees, has been all but dismantled –31 individuals either have been tried or will be tried on criminal charges –The Sarbanes-Oxley Act was passed

28. Sarbanes-Oxley The Sarbanes-Oxley Act is designed to encourage top management accountability –Top managers in recent scandals (Enron, WorldCom, Global Crossing) have claimed ignorance of accounting abuses –Title IX of Sarbanes-Oxley requires a company’s CEO and CFO to sign a statement that financial statements comply with SEC rules Penalties can be up to $5 million and 20 years in prison –Title II restricts the non-audit services that an auditor can provide

29. Sarbanes-Oxley and ERP Title IV of the act specifies more stringent requirements for financial reporting –Section 404 requires a public company’s annual report contain management’s internal control report –The control report outlines management’s responsibility for: Establishing and maintaining adequate internal control over financial reporting Assess the effectiveness of its internal control over financial reporting To meet the internal control report requirements, a company must document the controls that are in place and verify that they are not subject to error or manipulation

30. Sarbanes-Oxley and ERP An integrated information system provides the tools to implement internal controls –Controls cannot necessarily prevent a pervasive effort to circumvent standard processes by a company’s leadership (e.g. Enron) Companies with ERP systems in place will have an easier time complying with Sarbanes-Oxley than those without

31. Archiving In SAP R/3, there are limited situations where data can just be deleted If data could just be deleted, an unscrupulous employee could: –Create a fictitious vendor –Post an invoice from the vendor –Make payment to a Swiss bank account –Delete all records of the transactions so the fraud won’t be detected In SAP R/3, most data must be archived before it can be removed from the system, so auditors can reconstruct the company’s financial position at any point in time

32. Figure 5.7 Transaction options for material master data Data on a company’s materials cannot be deleted directly, but must be archived for deletion

33. Figure 5.8 Change record for material master SAP R/3 maintains detailed records on all changes made to material master data

34. User Authorizations A fundamental tool to avoid fraud is separation of duties and user authorizations –To complete critical business processes, more than one employee must participate so that a single employee cannot commit a fraud –User authorizations ensure that employees can only perform those transactions required for their job –SAP R/3’s Profile Generator provides a simple method for creating user authorizations based on the functions (transactions) a user should be allowed to perform –Pre-defined roles make developing authorizations easier

35. Figure 5.9 Role for material management master data Menu paths/transactions that a person assigned the role of maintaining management master data can perform

36. Tolerance Groups Another way to ensure that employees do not exceed their authority (and to minimize the risk from fraud and abuse) is to set limits on the size of a transaction that an employee can process Tolerance groups are predefined limits on an employee’s ability to post a transaction Tolerance limits can be set on items like: –Line items in a document –Total document amount –Payment difference –Discounts

37. Figure 5.10 Default tolerance group No group specified, so this is the default tolerance The default only allows posting of documents for $1,000 or less Payments can differ by $10 or 1%

38. Financial Transparency An advantage of an ERP system is the ability to “drill down” from a report to the source documents (transactions) that created it “Drill down” capability makes it easier for auditors to verify the integrity of reports and financial statements By double-clicking on an item in a report in SAP R/3, the user will be taken to the document(s) that created the created the item

39. Figure 5.11 G/L (general ledger) account balance for raw material consumption Double-clicking on the 8,810.00 debit will provide details on the transactions that make up the item

40. Figure 5.12 Documents that make up G/L Account Balance for Raw Material Consumption Selecting the 10.00 item and clicking on the details icon will provide more information on the item

41. Figure 5.13 Details on $10.00 line item in G/L account for raw material consumption

42. Another Look—The One-Day Close Some companies strive to “close the books” in one day –Other companies take days, weeks and even months to get all the financial figures correct and in balance Some companies perform virtual closings, simulating the closing process at various times during the month to see how well the company is doing Cisco’s closing went from 2 weeks to 1 day by switching from un-integrated systems to Oracle ERP With ERP, companies can streamline their financial supply chains, holding less cash in the same way supply chains hold less inventory

43. Summary Companies need accounting systems to record transactions and generate financial statements. The accounting system should let the user summarize data in meaningful ways. The data can then be used to assist managers in their day-to-day work and in long-range planning. With un-integrated information systems, accounting data might not be current, and this can cause problems when trying to make operational decisions, such as granting credit. Data can also be inaccurate because of weaknesses in un-integrated systems, and this problem can have an effect on decision-making and therefore on profitability.

44. Summary Closing the books at the end of an accounting period can be difficult with an un-integrated IS, but it is relatively easy with an integrated IS. Closing the books means zeroing out the temporary accounts. Using an integrated IS and a common database to record accounting data has important inventory cost-accounting benefits. More precise record keeping is possible, and this can lead to more accurate product cost calculations. These, in turn, can help managers decide which products are profitable and which are not.

45. Summary The use of an integrated system and a common database to record accounting data has important management- reporting benefits. The user has built-in drill-down and query tools available as a result. The introduction of the Sarbanes-Oxley Act, a 2002 U.S. federal regulation written and passed in the wake of the Enron collapse, promotes top management accountability by requiring extra financial approval and reporting. Because ERP systems can help companies meet the requirements of this legislation, the act has increased the need for integrated data reporting.