Financial planners responsible for preparing internal and external balance sheets on an annual, half-yearly or...
quarterly basis need accurate valuation of a company's stock and assets to assess its contribution to the profit and loss statement.
The balance sheet statement also needs to comply with global financial reporting standards, such as Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS).
Balance sheet valuation is a function available in the SAP Materials Management (MM) component of SAP ERP Central Component (ECC), and it completely integrates with the SAP Financial Accounting (FI) component of ECC to valuate company stock as accurately as possible, while complying with GAAP and IFRS. From the MM component, balance sheet valuation functionality uses procurement and stock information, while the FI component provides financial information.
There are three types of balance sheet valuation procedures that a company can choose from to meet its business and financial needs.
Lowest value determination
The lowest value determination for valuating materials follows the lowest value principle. In accounting terms, this principle is known as the principle of conservatism, and it entails valuating the material at the lowest price, even when there's a market increase of its price. For example, a company purchases a raw material at $50 per pound, and the market value then increases to $60. Instead of valuating the current stock at $60, which is the current market price, the lowest value determination principle for the balance sheet valuation procedure requires the company to still value its stock at $50 per pound.
In the same context, anticipated losses are also reflected in the balance sheet valuation. For example, if the current market price of a raw material is $30, while the company purchased it at $40, the material is valuated at $30 to adhere to the principle of conservatism.
There are four procedures for the system to calculate lowest value determination.
- Lowest value determination based on market prices. Here, the system uses procurement data, such as from purchase orders, quantity or value contracts; supply scheduling agreements issued out to suppliers; or invoices received from suppliers to determine the lowest market price.
- Lowest value determination based on range of coverage. The range of coverage shows the average stock maintained over a given time period, such as a number of months, and the average consumption of a material (range of coverage = average stock ÷ average consumption). If the stock of a material is slow moving, then it must be devaluated.
In this case, the lowest price is determined by deducting the devaluation from the base price on which the stock is currently maintained. For example, if the current stock of a raw material is valuated at $10,000, but needs to be devalued at 20% (or $2,000) due to its high range of coverage (or because it's slow moving), then the revised stock value would be $8,000.
- Lowest value determination based on movement rate. If a raw material's movement rate is slow or even dead -- that is, total receipts and issues are slower than the total stock held by the company for a given period -- it needs to be devalued. The formula to calculate movement rate = ([total quantity of receipts and issues ÷ material stock] × 100).
For slow-moving materials, the company can set a threshold percentage that the system can use to see if a raw material's movement falls within that threshold. If it does, then the material is devalued at the predefined percentage.
- Lowest value determination based on loss-free valuation. If the company still holds a stock of obsolete technologies -- for example, floppy drives for computers -- then the loss-free valuation procedure can be used. There are also a few system enhancements available to enable the company to define their own procedure for valuating such materials using obsolete technologies.
Using last in, first out (LIFO) valuation of the balance sheet procedure, companies can ensure their older stock isn't overvaluated due to a surge in the current market price of a material during a given period.
The LIFO valuation creates a layer to account for any value changes in stock. The system creates a layer in case there is an increase in stock quantity value between current and previous periods, and it reduces the layer in case there's a reduction in stock quantity and value. The formula to calculate layer value is: layer value = layer quantity × total value of goods received ÷ total quantity of goods received.
Companies have the option to LIFO-valuate individual materials or groups of materials on a quantity or value basis and on a monthly or yearly basis. Also, since LIFO valuation is run at the end of the fiscal or reporting year, it is best to first simulate the stock valuation before going for an actual run, which will update valuations of all the materials for balance sheet valuation.
The first in, first out (FIFO) valuation is best-suited for companies that wish to valuate material stock as realistically as possible. In FIFO valuation, the value of the stock is calculated based on the last stock of the material received. FIFO valuation, or the moving average (or weighted average) price of materials, is also acceptable as per GAAP or IFRS as a balance sheet valuation procedure.
It's always better to err on the side of caution for financial reporting by adopting the principle of conservatism in balance sheet valuation.
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