Issue

The purpose of this document is to provide a comprehensive assessment of the two Product cost valuation approaches currently utilized in Syensqo: the revaluation on actuals with the use of the Material Ledger and the Semi-standard approach. This evaluation aims to determine the most suitable approach to implement in the S4 system, based on a collaborative assessment by business and IT stakeholders.

Key areas covered in this document include:

• Pros and cons of each the two Syensqo approaches and the pros and cons of the annual standard valuation method as an alternative
• Overview & Background
• Similarities and differences
• Options
• Evaluation
• Recommendation
• Constraints and risks

The key objective is to evaluate the various approaches by considering the pros and cons identified by both the business and project finance teams. This collaborative effort involved interactions between technical and business colleagues, as the decision focuses on different methodologies rather than systems. Both the technical and finance teams contributed their assessments of the pros and cons.

Recommendation

Summarise the recommendation being made for the reader, leaving the pro/con evaluation and exact decision-making process to the subsequent sections.

Background & Context

As mentioned above, each system has its own distinct stock and COGS valuation method, along with corresponding configurations. However, a critical aspect to consider is the existence of separate financial controller teams for each method, which has led to the development of distinct ways-of-working (cultures). These ways-of-working have, in turn, influenced the underlying cost structures and the integration with manufacturing processes.

As we will elaborate on in the next paragraph, the two approaches share certain overarching similarities as well as notable differences. One approach primarily focuses on standard costs and variances, while the other places greater emphasis on historical costs. Additionally, one method tends to clearly separate fixed and variable costs in its reporting, whereas the other approach absorbs all costs into COGS and ending stock.

AS-IS summary

From a finance and controlling perspective Syensqo currently operates in at least two systems (SAP WP1 and SAP PF1) with two, as explained above, different valuation approaches and ways of working. These differences arose from mergers and acquisitions (M&As), where the acquired organizations used a different valuation methodology. Additionally, there were fiscal requirements that necessitated deviations from a standard operating procedure. In this document, the two approaches are referred to as follows:

• Re-valuation on actuals with Material ledger for PF1
• Semi-standard for WP1

From a manufacturing perspective, PF1 uses repetitive manufacturing scenarios with product cost collectors, whereas WP1 uses process manufacturing scenarios with process orders. Manufacturing plants are using Manufacturing Execution Systems (MES) as well as planning systems, specifically Dynasys, and in the future, Kinaxis. MES and in some instances spreadsheets and manual input feeds SAP processes and production orders with confirmations and consumptions. More in particular, in PF1, the confirmation and consumption process relies on standard quantities for material components and standard hours for activities. Conversely, within WP1, 99% of the cases manufacturing plants confirm actual quantities and hours. Additionally, plan activity prices are manually entered across both systems. Despite WP1 incorporating an activity calculation process, the loading of capacities remains a manual task. Further details on consumption are provided in the additional information sections below.   

 Currently Syensaqo has two different approaches for assigning company codes to controlling areas in the two systems. These are:

• PF1: single controlling area 
• WP1: Four controlling areas by Region (Europe, APAC, North America, South America) + one for Financial companies, total five controlling areas

Opportunity

The opportunity is clear: to standardize processes and conduct business with a single valuation approach.

Assumptions

• In S4 we anticipate having a uniform enterprise structure. Especially on lower controlling objects like cost centers, profit centers, segments etc
• In S4 we will have a single costing approach for all Legal entities. Local deviations are expected due to local fiscal requirements.
• The product cost system will be S4
• The implications of Universal Parallel Accounting, whether positive or negative, on the valuation question are not considered in this KDD. There will be another KDD to address Universal Parallel Accounting's new features and their overall implications for product costing.
• Material standard prices must be calculated or maintained consistently in either of the three options assessed in this document.  

Constraints

• In S4 material ledger is mandatory. But This does not imply that actual cost is mandatory.
• If the transfer price functionality is implemented then actual costing has to be activated. Transfer price functionality is addressed to a separate KDD with the same title.
• For actual costing (Single-level/multilevel price determination (indicator 3) the material price control has to be S. 

• The business units transitioning to the new valuation method may have objections to the decision.

Risks

Statistical moving average price is not supported in Universal parallel accounting. Which means that the Semi-standard method might become obsolete according to the SAP future roadmap

Check scope note for UPA under CO-PC-ML (Material Subledger) area. Further information will be requested by SAP on this restriction.
https://me.sap.com/notes/0003191636

Impacts

Changing the valuation approach for the affected legal entities will impact their balance sheets. Stock values will be debited or credited according to the new valuation method. Half of the organization will have to change that does business currently in essence. 

Specialty Polymers operates with actual costing, whereas all other units use the semi-standard method. Despite this, Specialty Polymers accounts for 40% of the business and 60% of the revenue.

Business Rules

The new approach will apply to all business units (GBUs). Consequently, those transitioning to the new valuation method will need to change their operational practices.. 

Options considered

Option A: 

Revaluation on actuals with Material Ledger

The Material Ledger consists of two main functionalities: actual costing and parallel valuation. A common misconception about the Material Ledger is that it refers solely to actual costing because actual costing tends to get the most attention. Therefore, when hearing the term “Material Ledger,” many immediately think of actual costing, not parallel valuation. Conversely, when the actual costing functionality is mentioned, it’s usually referred to generically as a “Material Ledger functionality.”  Furthermore, the Material Ledger falls within the CO menu, but it has as much impact on the FI module as it does in the CO module because of its impact on the inventory transactions that are posted to the general ledger. The Revaluation on actuals program with ML creates postings to the general ledger and relevant cost objects.

The purpose of actual costing is to use the transactions that occur for a material during the month to calculate its actual cost. This actual cost is typically the addition of the standard cost of the material plus the variances that occurred for the month. It sounds simple when mentioned that way, but it can get complicated depending on the processes that occur for the material, such as goods receipts, invoice receipts, process and production order confirmations, consumption, and so on. In addition, if the material is maintained in multiple currencies or is used in several other materials, more layers of complexity are added to the calculation. Synensqo has products with more than ten levels of production.

This actual price for each material, is calculated at the end of the period and it is called the periodic unit price (PUP) and is used to revaluate the ending inventory (stock) and COGS (or other consumptions) for the period to be closed. This actual price can also be used as the standard price for the next period (Not the opening period). Alternatively, inventory revaluation can be avoided, and postings can be made to accrual accounts instead . Actual costing programs determine the portion of the variance debited to the next-highest level using material consumption. Variances are rolled up over multiple production levels to the finished product. The revaluation on Actuals with Material Ledger makes it possible to use an actual cost system in addition to the standard cost system. 

Option B: Semi standard

The semi-standard approach emphasizes the importance of accurately calculating and allocating costs. It distinguishes between fixed and variable costs and ensures proper accounting and variance tracking to maintain cost accuracy. 

Raw materials, trading goods, semi-finished and finished products, and packaging are controlled under Price Control S (standard price), while spare parts use Price Control V (moving average price). In SAP, the Moving Average Price (MAP) is calculated regardless of the material's price control designation. If a material is under Price Control S (standard cost), the MAP serves only as statistical information. The MAP is calculated at every goods receipt by considering the quantities and values in stock along with the quantities and purchase price of the goods receipt (GR). If the invoice does not match the quantities and values of the GR, the variances are also considered in the MAP, provided there are stocks available at the time of invoice verification. 

Exceptionally, in Brazil and Korea, raw materials are valued at the moving average price (Price Control V) due to tax authorities' requirements. Strategic raw materials can have their prices entered manually if the MAP is not adequate for calculating the semi-standard cost of the period.

A new standard price is recalculated monthly for raw materials, packaging, semi-finished products, finished products, and trading goods. This recalculated price is then released, revaluating the inventory accordingly.

The strategy sequence used in the semi-standard approach (WP1) is as follows:

- Commercial price

- MAP (Moving Average Price) plus any additive cost

- Purchase price (info-record)

- Standard price

This valuation strategy ensures that with the new standard price calculation, the Moving Average Price becomes the standard price for raw materials, trading goods, and packaging. Using the cost roll-up method, these new standard prices for the Bill of Materials (BOM) components will roll over multiple production levels all the way to the Semi Finished and finished products.

In summary, the semi-standard approach is also a "revaluation on actuals" process with notable similarities and differences, which are summarized below.

(Alternative) Option C:

An alternative option is to shift to an annual standard cost approach, typically preferred by most European companies. This method will not be described in detail as it is well known. A standard price is calculated at the fiscal year opening and remains unchanged throughout the year. COGS and stock will always be valued at this standard cost. Production variances and over/under absorptions will be reported to the P&L in a manner similar to the semi-standard approach.

Similarities and differences 

The two methods (A and B) might sound different but are quite similar in a way. ML Actual valuation allocates cost variances from lower levels of production to higher levels, whether these variances come from purchasing or production. Similarly, the semi-standard approach does something similar but instead of allocating variances, it recalculates the standard prices by using the moving average price.

One major difference between the two approaches is that the ML approach revaluates not only the inventory but the COGS and other consumptions, as well.

Broad Similarities and differences

Here below are listed some important similarities and differences between the two approaches that we need to look at closely. The similarities are not about the system used (which is SAP in both cases) but more about the accounting and financial controlling aspects. On the other hand, there are also some key differences between the two approaches. It is worthwhile to examine what can remain the same irrespective of the final choice. 

Evaluation

Outline why you selected a position. The best format could be a pro/con table (sample below), but is up to you as the author. You must consider complexity, feasibility, cost/effort to implement, but also ongoing operational impact and cost. You must consider the program principles and explain any deviations in detail. This is probably as important as the decision itself.

	Option A - Revaluation on actuals with Material Ledger	Option B - Semi standard	Option C - Annual standard	Stronger option
Financial Reporting and Analysis	Makes it possible to use an actual cost system in addition to the standard cost system.  ML revaluation on actuals, returns back to standard costing on the following month. Financial controllers can carry on monitoring purchase price variances and more critically production variances on production/process order level. Moreover, the periodic unit price (actual price) can become the standard price of the following month. To summarize, it is possible to have the semi standard practices with the actual valuation on Month end Revaluates both ending inventory and closing COGS This enables transfer pricing with global valuation and global P&L at the product selling (at least) level. Facilitates more accurate Margin analysis/Profitability analysis at the material level. Absorbs all actual production costs at the COGS level for selling materials (Finished and semi finished products) Meets legal and regulatory requirements for inventory valuation and cost accounting, ensuring compliance with financial standards. Especially for countries like Brazil, South European and others that require actual stock reporting. The aforementioned advantage can also be considered disadvantages, as all variances are allocated to Cost of Goods Sold (COGS). Nevertheless with the COGS split you can possibly de-allocate the cost component groups from COGS. e.g Fixed costs.	Semi-standard has created a more standard cost-oriented approach and ways of working (culture), enabling quicker reactions to high production variances. Same for the purchase price variances. This way of working, it does allow you to measure purchasing efficiency by comparing actual prices with planned purchase prices and making informed decisions about your purchasing strategy. In alignment with the aforementioned benefit, integration with manufacturing functions (MES) is effectively managed within the WP1 system. Through semi-standard practices, actual activity confirmations and material component consumptions are recorded. It is important to clarify that this isn't a technical limitation. In PF1 (actual costing), they have the capability to record actual consumptions, but this capability is not currently utilized. Please also see the Manufacturing KDDs Semi-standard controllers work with standard COGS (plus production variances), typically resulting in a COGS that does not include all variances (e.g., fixed variances) at the selling product level. This can lead to a higher or lower contribution margin at the selling product level compared to using actual costs. Over/under absorptions are allocated below the contribution margin for selling products. It should be noted that this applies only to the selling product level, not to the profit center or plant level. Semi-standard is based on the moving average price (MAP). Frequent updates to the MAP based on the latest purchase price can distort the true cost of inventory, especially if recent period-end purchases are significantly higher or lower than previous prices. However, it should be noted that in Syensqo, price fluctuations are minimal, and therefore the impact on inventory is insignificant. Closing COGS is not revalued, only stock is subject to revaluation. Moreover, This revaluation occurs at the beginning of the opening period, not at the end, which seems a bit odd. It does not support the Transfer pricing functionality	Similar to the semi-standard Standard costs that do not reflect actual purchase prices can distort inventory valuation, affecting the accuracy of financial statements. Any operational changes, like improvements in efficiency or changes in supplier contracts, are not captured until the next standard cost update, resulting in a misalignment between actual and standard costs. It does not provide any actual reporting. Except from statistical Moving average price which has been proved weak to meet specific regulatory requirements for actuals It is not strong in meeting IFRS requirements for fiscal year end inventory valuation	A
Complexity and Training	Working with ML revaluation on actuals can be complex, requiring careful planning and execution. The complexity is mostly related to the account determination related to ML closing. Typically, it requires training for the accountants to understand the closing entries. Sometimes it’s easy to be overwhelmed by the volume of postings created by the Material Ledger’s closing entry and what they mean. There is a level of complexity involved in the configuration and maintenance of this functionality	Semi-standard simplifies the process of inventory valuation. There is no accounting complexity during period end closing, as there are no complex stock related accounting entries generated (like in the case on ML actual valuation) during period-end closing, streamlining the process significantly.  The semi-standard approach is a methodology "developed" by Syensqo, not found in other organizations. Consequently, new employees will require training to familiarize themselves with this method Maintaining Bills of Materials (BOM) and Routings at a mature status demands considerable effort. It should be noted, however, that even with actual valuation, BOM and Routings must be kept up to date to effectively monitor variances.	Less complex	C
System Performance	Can impact system performance due to the extensive data processing required, particularly for large volumes of transactions. Especially during actual valuation.	The statistical moving average price update is recalculated and locked during the processing of goods movements, which can slow down the throughput of inventory transactions.	The less system intensive approach. Once per fiscal year standard cost calculation.	C
Future Compatibility	It is consistent with the future SAP roadmap, and upcoming solutions like Universal Parallel Accounting can further enhance the capabilities of this option It does support the Transfer prices functionality	Statistical moving average price is not supported in Universal parallel accounting. Which means that this method might become obsolete according to the SAP future roadmap Check scope note for UPA under CO-PC-ML (Material Subledger) area. Further information will be requested by SAP on this restriction. https://me.sap.com/notes/0003191636   It does not support the Transfer prices functionality	It is consistent with the future SAP road map It does not support the Transfer prices functionality	A

Qualitative Analysis

Given the importance of Financial Reporting and Analysis, Option A - Revaluation on actuals with Material Ledger stands out as the most robust approach. This option uniquely allows the use of an actual cost system in addition to the standard cost system, providing a dynamic and flexible approach to inventory valuation and cost analysis. It facilitates accurate financial reporting, supports compliance with legal and regulatory standards, and enables detailed margin and profitability analysis. The approach supports transfer pricing with global valuation and global P&L at the product selling level, which enhances transparency and accuracy in financial assessments across different segments of the organization. Despite its complexity and impact on system performance, its alignment with future SAP roadmap and support for transfer pricing functionality make it the most suitable choice for ensuring comprehensive and precise financial reporting and analysis.

See also

Insert links and references to other documents which are relevant when trying to understand this decision and its implications. Other decisions are often impacted, so it's good to list them here with links. Attachments are also possible but dangerous as they are static documents and not updated by their authors.

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