Introduction to Material Ledger

Material Ledger is SAP’s solution to performing actual costing. It is supposed to contain the
benefits (without inheriting the disadvantages) of the two traditional methods of inventory
valuation - Standard Costing and Moving Average Costing. Before you can understand the
functionality of Material Ledger, it is always good to start with some of the characteristics of
these two traditional approaches.

Standard costing is an effective method of obtaining stable prices for your materials
which can be benchmarked against any price fluctuations. You can therefore perform
variance analysis to better understand whether you are producing efficiently or whether your
raw material prices are reasonable. However, a weakness of the standard costing process
is that the variances that relate to unsold inventory remain in the cost of sales (price
variance) account, and are not posted back to inventory. I was posed this question by a
client about ten years ago, when Material Ledger was still in its infancy “If I do not sell
everything that I have produced in a period, then what happens to the production variances
that are sitting in the P&L?”. The answer to this at the time was to take the fraction of the
production variances which relates to the inventory not sold in the period and post it back to
the inventory accounts. This was a top-level journal which did not specify the activity for
each individual material (as this would have been too cumbersome a task). The downside to
this if you looked at a profitability report for each material, the variance may skew the actual
cost of sale for the period if you did not sell everything that you produced.

Moving Average Costing is a good method of keeping your material costs up to date,
particularly in cases where the prices keep fluctuating. Each time you perform a goods or
invoice receipt, the moving average price is updated based on the total inventory value
(taking the latest purchased price into account) and dividing it by the total inventory quantity.
One of the weaknesses of moving average costing is that the new price is only posted back
to inventory if there is enough inventory quantity to cover the difference. This could be the
case if you consume a material between the time that you receive it and when you invoice
it, and the invoice price is different from the goods receipt price. If the invoice is for a
quantity that is greater than the amount of the material left in inventory, the difference
between the invoice and goods receipt will not fully be allocated back into inventory.
Instead, only the portion that relates to the existing inventory quantity will be allocated back
to inventory and the remainder will be posted to the price variance account. This means that
if you looked at the Moving Average price for that material, it will not represent the true
current price.

Material Ledger’s two main objectives are:

(1) Inventory Valuation in up to three currencies and valuation methods

(2) Performing Actual Costing for Materials
The real beauty of material ledger is number (2). This is because it takes the variances that
occur from inventory transactions and post them back to ending inventories in order to value
them at an actual cost. It does this while retaining the standard cost of the material as a
benchmark. You also have the option of revaluing the current standard cost with the
periodic unit price (which is the actual cost calculated by material ledger). The two types of
price determination that occur with material ledger:
(1) Single-level price determination: This takes the variances that occur for an individual
material and roll them back into its ending inventory.
(2) Multilevel price determination: This takes the variances that occur for a lower-level
product (e.g. raw material) and roll them (in the proportion of consumed quantity) into a
higher-level product (e.g. finished product).
You can choose to roll the variances that relate to sold inventory, into the cost of sales
account in order to value COS at actual costs. This involves using Material Ledger’s
“Revaluation of Consumption” functionality. With Material Ledger, you can therefore achieve
actual costs for ending inventory of single and multilevel products and cost of sales, and still
measure your procurement processes according to standard costs.