Profitability analysis in Simple Finance

In a way to simplify SAP Finance architecture, SAP changed its vision on Profitability analysis usage in Simple
Finance environment. Now SAP recommends to use Account based CO-PA compared to Costing based CO-
PA in classical finance environment. This raises questions like:

1. What advantages does Account based CO-PA bring compared to Costing based CO-PA?
2. For which case it is better to select which type of Profitability analysis?
3. What to do with restrictions of Account based CO-PA compared to Costing based CO-PA?

Purpose of this document is an attempt to answer these questions.

Business requirements for Profitability analysis

Everything begins with business requirements. The same applies to selection of proper SAP functionality to
Profitability analysis. In General, SAP Profitability analysis is functionality to receive Profit and Loss
statement with possibility to drill down by dimensions. Question is - what type of Profit and Loss statement
could we built there?

From business perspective, the income statement is presented either by the period costing method or by
the cost of sales method.

In the period accounting method the sales of a period are compared to the total expenditures
(consumption) of the same period. Since the sales are market-oriented and the total expenditures stand for
the value produced, there is a difference if the production value of the units sold does not match that of the
units produced. This difference shows up in the inventory changes of finished goods, half-finished goods
and work in progress.

Period Accounting method

+ Revenues
- Sales deductions
Inventory change in finished goods and
+/- work in progress
+ Work in progress
+ Other operating income
- Material costs
- Personnel costs
- Depreciation
- Other expenses
= Operating result

The first four positions of the period accounting method combined are called total output. This is of interest
in the balance sheet analysis.

In the cost of sales method the sales of a period are directly confronted with the production costs of those
sales.

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 + Revenues
- Sales deductions
- Production cost of goods sold (cost of sales)
= Gross profit from sales
- Sales and marketing expense
- General and administrative expense
+ Other operating income
- Other operating expense
= Operating result

Period costing presentation of the income statement is more common in the German-speaking area, the
cost of sales method is popular among listed companies and rather in the Anglophone world.

Both methods produce the same result. To prove that, let’s show how figures are presented in each report
for the following example:

1. Material consumed to production (100$)

2. Received from production of FG (50$)
3. Calculation of WIP (50$)
4. Sold of FG to customer (COGS-30$) with revenue 50$

Period Accounting method

Value Steps
+ Revenues 50 (4)
- Sales deductions
Inventory change in finished goods and (2),
+/- work in progress -50-30 (4)
+ Work in progress 50 (3)
+ Other operating income
- Material costs -100 (1)
- Personnel costs
- Depreciation
- Other expenses
= Operating result 20

Cost of sales method

Value Steps
+ Revenues 50 (4)
- Sales deductions
- Production cost of goods sold (cost of sales) -30 (4)
= Gross profit from sales 20
- Sales and marketing expense
- General and administrative expense
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 + Other operating income
- Other operating expense
= Operating result 20

Important point here is that these methods do not contradict to each other. In SAP we could implement
both methods and receive both reports for the same entity from Financial accounting. As SAP originated
from Germany, where Period accounting is prescribed, this method is actually the base for configuration.
Accounts are defined on the level of production factors (e.g. Material, Personnel, Depreciation etc). To allow
simultaneous analytics and final reporting by function in Cost of sale accounting, object Functional area
supposed to be used.

Following is the possible mapping in SAP between accounts, functional areas and reporting lines:

Functional
Account area Cost of sales method Period accounting method
100000 Revenues Revenues
200000 Sales deductions Sales deductions
300000 Cost of sales Change in stock - FG
310000 Change in stock - SFG
700000 Work in process
410000 100 Material costs
510000 100 Personnel Costs
610000 100 Other Costs
410000 200 Sales and Distribution Material costs
510000 200 Sales and Distribution Personnel Costs
610000 200 Sales and Distribution Other Costs
410000 300 Administration Material costs
510000 300 Administration Personnel Costs
610000 300 Administration Other Costs
410000 400 Research and development Material costs
510000 400 Research and development Personnel Costs
610000 400 Research and development Other Costs

Grey marked items do not have representation in Cost of sales method and are only showed in Period
accounting method.

Described above is the way, how we could get Profit and Loss reports out of Finance modules of SAP based
on Accounts and Functional areas.

SAP historically distinguished between external reporting and internal (managerial) reporting. External
reporting should have been done from SAP Financial accounting, while internal reporting from SAP
Controlling. With introduction of Simple Finance, SAP clearly wants to change historical split of the system
into Financial accounting and Controlling and combine them into one. But will we receive same financial and
managerial data in this case? From external perspective, there is no problem (as presented above). Let’s
see, what we need to implement in Profitability analysis from managerial perspective.

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SAP Profitability Analysis types
There are 2 types of Profitability analysis (CO-PA) possible in SAP:

 Costing based profitability analysis is the form of profitability analysis that groups costs and revenues
according to value fields and Costing based valuation approaches, both of which you can define
yourself.
 Account based is a form of profitability analysis organized in accounts and using an Account based
valuation approach

We could select profitability analysis types during the definition of Operating concern in SAP. We could even
select both of them to be run in parallel, but fully parallel implementation is hard to be achieved as all
assignments allocations and reports are defined individually per Profitability analysis type. This would place
heavy burden on system maintenance and bring big reconciliation problems without really business value.
As a result, SAP recommendation was to use Costing based profitability analysis as a main profitability
analysis tool with Account based probably activated in background for reconciliation purposes with
Financial accounting.

When we consider Account based CO-PA with respect to possible Accounting methods we could satisfy,
then we see, that this does not really differ from the pictures we showed in previous chapter. As we have
both Account and Functional area in Account based CO-PA, we could build at the end reports based on both
accounting principles. Combining that with additional analytics coming from postings (e.g. Material,
Customer) we could receive both External and Internal profitability reports. Postings are done at the same
time to Account based CO-PA as to Financial accounting and there are no discrepancies between them.

Costing based CO-PA usually supports Cost of sales method only. This is functionality primarily to support
sales decisions and mainly based on sales process. Only when postings are done from Billing, full spectrum
of possible analytics is being filled by SAP. COGS are posted also from billing and usually with a split by costs
components.

Functional
Account area Value Field Cost of sales method – FI Costing based CO-PA
100000 VV1xx Revenues Revenues
200000 VV2xx Sales deductions Sales deductions
300000 Cost of sales
VV300 COGS
VV301 COGS - Material
VV302 COGS - Personnel
VV303 COGS - Other
410000 200 VV401 Sales and Distribution Material costs
510000 200 VV402 Sales and Distribution Personnel Costs
610000 200 VV403 Sales and Distribution Other Costs
410000 300 VV501 Administration Material costs
510000 300 VV502 Administration Personnel Costs
610000 300 VV503 Administration Other Costs
410000 400 VV601 Research and development Material costs
510000 400 VV602 Research and development Personnel Costs
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 610000 400 VV603 Research and development Other Costs

Change of Inventory postings are not usually posted to Costing based CO-PA, as this does not bring any
value to understand sales result of the company. In addition, it is hard to transfer WIP there. To simulate
reporting by function in CO-PA we usually need to multiply number of components by number of functions
and this brings big number of value fields and complexity in allocations. Theoretically, we could nevertheless
implement both reporting principles in Costing based CO-PA, but few (if any) companies do that. Costing
based CO-PA must in first place satisfy requirements of sales analysis and theoretical complex allocations
must be avoided there.

To summarize what was written above, accounting method is not a main driver of selections of
profitability analysis as both SAP profitability analysis types support both methods. With detailed
comparison, Account based CO-PA has clear advantages here compared to Costing based CO-PA to satisfy
both accounting methods. Therefore, we must analyze further, why historically most of the companies
selected Costing based CO-PA and why now with introduction of Simple Finance, we must probably
reconsider this approach.

Detailed functionality comparison

Besides general business perspective, there were previously functional GAP’s, which made usage of Costing
based CO-PA preferable compared to Account based. In Simple Finance there are additional functions
available in Account based CO-PA, which were previously only possible on Costing based CO-PA. Of course,
it is not copy-paste of what was done in Costing based, as there is anyway the need to keep CO-PA
reconciled with Financial Accounting. Let us see for each case, which options we have currently. Following
are the main functionality GAP’s, which differentiated Account based CO-PA and Costing based CO-PA in the
past:

1. COGS postings
2. Valuation
3. Top-down allocation
4. Production variance allocation
5. Additional value fields

COGS postings
There is a timing difference between COGS postings to Financial accounting and Costing based CO-PA:
posting in Financial accounting is done at the moment of Finished good issue from the stock, while posting
to CO-PA is done at the moment of billing. COGS in CO-PA is derived from VPRS condition in Billing
document or from standard cost estimation using CO-PA valuation. In second case, we could split COGS
based on standard cost estimation cost components and put them to different value fields. COGS in
Financial accounting is derived on the other side from material valuation view of sold good.

Main disadvantage of such timing difference is reconciliation problems:

 What if we issued good from the stock, but not issued invoice yet?
 What if VPRS condition is not correctly maintained in SD pricing?
 What if we perform return of sold goods in different period?

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All business and technical issues are piled up and at the end we receive results, which could be hardly
analyzed and justified. Companies write big manuals on how to track and handle different types of
differences and introduce complex business controls.

From Ehp4 for SAP ERP, there is a possibility in the system to post to Costing based CO-PA also at the
moment of Goods issue. Not lot of companies use this function, as there were anyway following restrictions:

 No possibility to split COGS down to cost components

 There are not all characteristics available during Goods issue compared to Billing and therefore
profitability segment for COGS is posted not on the same level as Revenue.

In Simple Finance SAP introduce new function for Account based CO-PA, which is intended to solve first
problem. Now it is possible to split COGS based on cost components of standard cost estimate and post this
split to different General Ledger accounts. Posting is done at the moment of Goods Issue and therefore
values are always reconciled between Financial accounting and CO-PA.

This is similar to CO-PA valuation based on standard cost estimate in Costing based CO-PA. Difference here
is that values are posted to Accounts (as there are no Value fields in Account based CO-PA):

There are still following restrictions compared to Costing based CO-PA:

 Only one Cost component structure assignment is possible – as otherwise we would double postings
 No possibility to perform revaluation of cost components based on actual price from Material
Ledger. Posting will be done to one COGS account in this case. SAP promises to deliver this function
later.

As posting is performed at the moment of Goods Issue in Account based CO-PA, it is not posted with the
same analytical details as document from the billing, and these are derived from Sales order.

In addition, when we avoid difference between COGS values in Financial accounting and CO-PA, we receive
at the same time difference between Billed quantity (Revenue) and sold quantity (COGS). In costing based
CO-PA these were same figures by definition. In Account based these could be different as they come from
different sources.

Following is the table, which summarizes differences between CO-PA usages in Simple Finance with regards
to COGS treatment:

Costing based Account based

Time of posting Billing Goods issue

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 Split of COGS based on cost  Based on standard Based on standard estimation to
components structure estimation to different value different accounts (new in Simple
fields Finance)
 Revaluation on actual from
ML is possible
 Possible to use both cost
component structures
Reconciliation issues Between COGS in Financial Between COGS quantity and
accounting and COGS in CO-PA Billed quantity
Characteristics From billing document From sales order

Valuation
Valuation is a function, which is to some extent utilized by most of the companies using Costing based CO-
PA.

In simple case this function allows to split COGS according to cost components of standard or actual cost
estimates. We touched this function in COGS chapter and showed, that in Simple Finance this function is
realized for Account based CO-PA.

Anyway, more complex solution in Costing based CO-PA could be realized with valuation using the
Conditions and Costing sheets. This functionality allows to build dependencies between posted values to
CO-PA and generate additional postings based on user logic. This is sometimes used for value field
corrections, transfer prices treatment, intercompany cases. Problem here is that these additional CO-PA
postings are not depicted in Financial accounting and therefore place reconciliation issues. Therefore, even
in Simple Finance, valuation functionality is not possible for Account based CO-PA. That means, that if there
is a requirement to generate additional postings, they must be configured and created in SD and/or FI
respectively and only from there portrayed to CO-PA.

This in fact is possible, as SD pricing procedure uses in general similar functions to CO-PA costing sheets. Of
course, it will be more complex SD customizing and more GL accounts, but at the end we’ll receive more
reconciled results.

For postings in FI there is no such functionality as Costing sheets and there additional postings must be
generated using different methods. But the underlying concept remains – there must be no postings in CO-
PA that are not reconciled with Financial Accounting.

Based on described above, decision for Account based must be made, where there is a prevailing
requirement to have same picture in Financial accounting and CO-PA. Costing based is on the other side
allows to segregate these functionalities and build separate profitability model.

Top down
There was a long living misperception that top-down distribution is not allowed in Account based CO-PA.
Actually, top-down distribution is available in Account based CO-PA. Of course, processing instruction differs
compared to Costing based CO-PA, as there are no value fields in Account based CO-PA. When you select
Value fields tab in KE28 for Account based CO-PA you will find no value fields and no accounts (as one could
have expected). You must select value in object currency and then combine it with the cost elements that
store e.g. your revenues in order to make your distribution.

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That is a little bit more fiddly than directly accessing one of the 200 value fields, but you can definitely set
up a selection logic to pick up the reference data you need to make the distribution.

Therefore, top-down distribution it is not really a differentiator of Costing based CO-PA as this function
could be used in Account based CO-PA as well.

Production variances allocation to CO-PA

In Costing based CO-PA it is possible to transfer Production variances from Variance calculation to CO-PA
and segregate different variance types by different value fields. This was previously not possible in Account
based CO-PA.

In Simple Finance there is a new function available, which allows to post production variances to different
accounts based on the different variance categories. These accounts are then taken up to Account based
CO-PA. Customizing is similar to FI transfer structure, which is used for the same function in Costing based
CO-PA:

Additional quantity fields

It is a common business requirement to store not only the sales order quantity for financial analysis, but
also to convert quantity into the quantity that is common across the product lines. Historically, in Financial
reporting, only quantities like invoice quantity and delivered quantity are stored. This applies also to
Account based CO-PA, where quantities from Financial accounting are used.

In Costing based CO-PA it is possible to define additional value fields to store additional quantities and
define rules (although with small enhancement), how to derive such quantities.

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In Simple Finance it is possible to define up to 3 additional quantity fields in the Universal Journal. Result is
similar to what we could achieve with additional quantity value fields in Costing based CO-PA.

There is BADI available, which allows to influence Unit of measure conversion like in Costing based CO-PA.

Summary
SAP made clear statement, that future direction of Profitability Analysis is Account based CO-PA. This
follows simplification and integration way, which SAP has chosen for S/4HANA and overall SAP solution
portfolio. Functional GAP’s, which differentiated Costing based CO-PA in the past are now incorporated in
Account based CO-PA. There are additional developments for Account based CO-PA are foreseen to shorten
the functional GAP with Costing based CO-PA.

Main decision factor, which functionality to select must be the requirement either to have common and
integrated profitability model or to have more separate tool to calculate and analyze profitability. While
Account based CO-PA is tightly integrated with Financial accounting and always reconciled, this could be in
some business environments undesired.