Project Profitability for Engineering Products and Systems (Engineer-to-Order)
In my previous blog Using Market Segments in Margin Analysis I explained the difference between the real market segments shown in the “Product Profitability with Production Variances” app (account assignment type EO) and the attributed market segments shown in the “Project Profitability” app, where the WBS element is the real account assignment (account assignment type PR) and the market segments are derived from the sales order item linked with the WBS element and updated in the universal journal. In this blog I’m again going to use the “Project Profitability” app, but this time I’ll show the key figures associated with an engineer-to-order project (revenue, costs and now project stock) and explain how the journal entries behind these key figures are enriched to provide information about the market segments served, rather than waiting for settlement to move the revenues and costs from the project to Margin Analysis.
Unlike make-to-stock where there is a disconnect between manufacturing and sales from a Controlling point of view, with the introduction of the Engineer-to-Order process (scope item 6GD) both activities take place with reference to a project. The manufactured goods are placed in project stock (special stock type Q) on completion and multidimensional profitability reporting is made possible by the link between the WBS element driving demand and the sales order item that provides the link to the customer and the sales organization.
- The manufacturing activities (confirmation, goods issues, overhead, goods receipt) are recorded on the production order, but we extend the journal entries to include the link to the project so that we can select either the true account assignment (OR for the production order) or the associated WBS element in reporting. The WBS element in turn is linked to the sales order and sales order item and thus we can include customer and product related characteristics in the journal entry as attributed market segments. Until the production order is delivered to stock, we see event-based overhead and work in process being posted with every confirmation and goods issue and on completion the system reverses the work in process, updates the value of the inventory, calculates production variances, and assigns them to the project and the relevant market segments.
- The preliminary value of the project inventory is recorded as the production order is delivered to stock and is based on the planned costs for the production order (in other words, on the assumptions when production started). It is in the nature of an engineer-to-order process for variances to occur in terms of the work performed on the order and the substitution of components. Bearing this in mind, you are recommended to activate Actual Costing (scope item 33Q) in addition to scope item 6GD to true up the value of the project inventory and cost of goods sold to reflect any variances by running a costing run at period close. Actual Costing will also collect and assign any purchase price variances and changes to the activity price at period close.
- The sales activities (delivery and billing) are triggered by the sales order, but again we have the link to a project, so that revenue and cost of goods sold are captured with reference to the project and the derived market segments. Event-based revenue recognition is used to manage the accruals for the time between the outbound delivery and the billing to the customer, which may be dependent on customer acceptance in this environment. If you use actual costing, the project related cost of goods sold will be trued up at period close.
Markus Florian Oertelt has explained the ETO process and associated steps in detail in his blog Discrete Industries in SAP S/4HANA, Public Edition 2302 and Shuge Guo has explained the process from a Financials perspective in her blog What’s New in Finance for Engineer Products and Systems (Engineer-to-Order) and I would recommend reading these two blogs first. I will use the same sample data, but my focus will be on Project Profitability as it relates to Margin Analysis and specifically on the involved G/L accounts, the account assignments for the WBS elements and production orders and the link to the affected market segments, as shown in Figure 1.
WBS Elements and Project Profitability
Traditional project reports separate the requirements of the project accountant from those of the sales accountant, looking either at the project and its WBS elements or at the various market segments because of the dependency on settlement to move the costs to Margin Analysis. In the “Project Profitability” app shown in Figure 2 you can report by Project and Product Sold (the Product Sold being one of the market segments) in the default view and the fields available for drill-down include the market segments Customer, Customer Group, Division, Sales Organization, and so on. The key figures in the app are based on measures for Billed Revenue, Actual Cost, and so on (moved to the rows for ease of viewing). Each measure is based on a semantic tag that aggregates the values for the assigned accounts. The easiest way to get a feel for the contents of this report is to select the G/L Account as an additional drilldown and check the accounts updated during the ETO process. Notice that there are no settlement accounts, but that the costs appear under their original G/L accounts.
This link only works correctly if you map all relevant accounts to the appropriate Financial Statement Version and to the semantic tags used in the report. Compared to the report shown in my previous blog, the change in the engineering environment is the introduction of a new semantic tag for Project/Sales Stock (PRSLS_STCK) and the assignment of the relevant inventory accounts to this tag to enable us to see the value of the project stock in Margin Analysis. Figure 3 shows the new node Project/Sales Order Stock in the Financial Statement Version YPS2 with the inventory accounts used to record the value of the project stock. These G/L accounts are used in combination with the material segment for the project stock. Bear in mind, that project stock may cover both the value of the finished goods and any material components purchased or manufactured for the project.
All reporting is based on the universal journal where we are viewing the G/L account either directly or via a measure, the account assignment (the green boxes in Figure 1) and the market segments that are derived from the project. We see the same merging of data sources at work in the “Display Line Items – Margin Analysis” app shown in Figure 4. In the first case we have selected journal entries for the Account Assignment Type PR and the Project ETOFIN along with the more familiar Product Sold and in the second for the Account Assignment Type OR, the Product Sold and the Project ETOFIN that triggered the demand for the production order.
You can create the WBS elements shown in Figure 2 independently from the sales order if you need to begin work on the project before contractual arrangements with the customer are complete. This means that costs can be assigned to the project before the system is able to derive the market segments. If this is the case, you should run the “Run Realignments – Profitability Analysis” app to update the market segments once the link to the sales order item is made. In the simplest case, there will be a one-to-one relationship between the billing element and the sales order item and any cost postings to the underlying WBS elements will be automatically assigned to the correct market segments via the sales order and sales order item. If, however, you select the flag Multiple Sales Order Item Scenario for the WBS Element, you must manually update the Settlement Rule for the billing element with the market segments to be updated with each posting to ensure that revenues and costs are assigned correctly for Margin Analysis.
Production Orders and Project Profitability
In an engineer-to-order environment, we are not just dealing with projects and their associated market segments but also with the assigned production orders. The postings in Figure 5 look like those in a make-to-stock environment with the work in process, raw material consumption, material overhead, manufacturing activities, production overhead, and finally the delivery to stock being captured as described in my previous blog: The Differences between Traditional and Event-based WIP and Variance Calculation. The difference is that in an engineer-to-order environment demand is triggered by a project and the link to the requesting project can be used as a selection parameter when choosing the production order to view or shown in the results list of the “Event-Based Order” app. The link to the project is included in the journal entries alongside the production order.
In Figure 6 we’ve selected one of the line items for work in process, where we see the Controlling Object (OR, plus the order number for P&L accounts) and the assigned Project (ETOFIN) and WBS Element (ETOFIN1). In this case the project and WBS element are acting as attributes for reporting, while the true account assignment remains the production order. If you’ve worked with engineer-to-order in SAP ERP, you’ll be used to storing work in process under a results analysis cost element and then settling to Financial Accounting under a G/L account. In the new ETO process, the WIP accounts are primary cost elements (account type P) and include the link to the production order as the real account assignment.
If we use the settings for the results list to display further dimensions, we can see in Figure 7 that the system has used the link to the project to derive the Customer, Product Sold and other market segments for this production order. This establishes the link that ensures that the values on the production order are shown correctly in the “Project Profitability” app without the need to settle to move the costs to Margin Analysis.
Project Stock and Project Profitability
Whereas any cost assigned to a service project can potentially be billed to the customer, in an engineering environment there is also inventory in the form of project stock (special stock of type Q) and this inventory carries a value. You can display the value of the project stock by using the “Manage Material Valuations” app shown in Figure 8 (you will need to add the WBS element to the report filters and to the results list). Notice the WBS element alongside the Material and Plant in the General Information tab. The total inventory value is zero as the product has already been issued to the sales order.
To see the value of the project stock in detail, select Material Price Analysis to access the app shown in Figure 9. The Receipts > Production line shows the value from the preliminary valuation of the project stock. This was set using the planned costs for the production order. Refer back to Figure 5 to check the planned costs for the production order. In the same line we see the production variances for the production order. Refer back to Figure 4 to see the line item for the production variances in Margin Analysis. The Consumption > Project line shows that the preliminary value has been used to issue the project stock to the customer, but that the production variances are not yet reflected in the valuation. The production variances will only be assigned correctly to the project inventory and cost of goods sold when you perform a costing run (Actual Costing) at period close.
The need for a costing run is important in this context, as it will adjust the value of the project inventory to reflect the production variances, plus any purchase price variances for the raw materials consumed and any activity price variances for the manufacturing steps performed. Without the actual costing run, the “Project Cost Report” app is potentially misleading as the value of the project stock is based on the planned costs for the production order and any variances are held with respect to the WBS element, but not the inventory and cost of goods sold.
Universal Parallel Accounting
The final motivation to use the new engineer-to-order process is that it is fully integrated with Universal Parallel Accounting. This means that you can have different inventory values depending on the ledger as shown in Figure 10 and that any work in process, production variances, and so on calculated with reference to the production order can vary depending on the ledger. You’ll find more information in my previous blog on this topic: Inventory Accounting with Universal Parallel Accounting in SAP S/4HANA 2022
You should, however, be aware that the new intercompany sales and intercompany stock transfer processes do not yet support valuated project stock.
These developments significantly change the scope of Margin Analysis, which was historically P&L focused and ignored any inventories. We now see additional lines for project stock, project-related WIP and revenue adjustments in the “Project Profitability” app in accordance with the vision to make the universal journal the basis for 360-degree financial reporting.
If you are new to the topic, you may also find the information in my book helpful.