Subcontracting Accounting Process
This chapter covers the following topics:
- Chargeable Subcontracting Accounting Process
- Buy/Sell Subcontracting Accounting Process
- Full Outsourcing Accounting Process
- Additional Processes to Manage Subcontracting
Chargeable Subcontracting Accounting Process
The Chargeable Subcontracting Accounting Process considers the following:
-
OEM ships components to the MP to manufacture the outsourced assembly, but retains the ownership of the components.
Therefore, the MP is not liable for the payment for the components received from the OEM.
-
MP manufactures the assemblies (added value) from the OEM supplied components, and ships them to the OEM.
-
OEM receives the assemblies, and pays only the added value amount to the MP organization.
Note: The MP organization is a simulated organization and is used for inventory planning and tracking and has no impact on costing. For this purpose, all accounting transactions in the MP organization are not posted to the general ledger (The Transfer to GL is set to No for the MP organization.)
For additional information, see: Setting Up Subcontracting Accounting.
Sales orders are used for shipping the components to the MP organization, and subcontracting orders are used to procure the assemblies from the MP. Invoices for Accounts Payables and Accounts Receivables are netted, and the OEM pays the MP only for the value added in the manufacturing at the MP's factory.
Key accounting concepts include:
-
OEM makes a provisional sale and ships the components but retains the ownership. Therefore, accounting transactions associated with shipping subcontracting components should be tracked separately. These transactions are processed by posting to the Subcontracting COGS, Subcontracting Revenue, and Subcontracting Receivables accounts specifically defined for subcontracting, and are associated with the OM transaction type. This transaction type is defined in shipping networks and when the Interlock Manager creates replenishment sales orders for the components, they are created with the OM transaction type defined in the shipping networks. The respective accounts are posted during the execution of sales orders for subcontracting components.
-
At period end, the OEM must account for the component inventory in its book of accounts. A report is provided to identify and calculate the component on-hand inventory and the value based on the simulated records.
Important: You must manually enter the appropriate book of accounts and reverse the same entry at the beginning of the next period.
-
The subcontracting order is used to procure the assembly from the MP. After receiving the assembly from MP, the OEM nets the Accounts Payables invoices with the Accounts Receivables invoices for the components shipped to manufacture the assembly. OEM makes the payment to the MP for the added value amount. The purchase price of the assembly is calculated based on the BOM requirement quantity and sales price of the components.
See the sales price and purchase price setup of the components and assembly in Chapter 2.
-
The purchase price of the assembly is defined to include the sales price of the components and added value amounts to support the payment process. Therefore, any purchase price variances associated to assembly receipts in the OEM should be tracked using a Subcontracting Variance account defined for subcontracting purposes. This account is associated with shipping networks, and when purchase order receipts are made, the purchase price variance is posted to the Subcontracting Variance account.
-
Since the entire process uses the fixed sales price of the components, the standard cost of components and assembly, and the purchase price of the assembly, any variations in the price and cost could affect the accounting process. A set of utilities (that is, reports) is provided to identify these changes and their effect.
Important: You must manually adjust the accounting records for consistency.
Costs and Prices
For subcontracting accounting, the costs and prices of the components and assemblies should be defined such that the net gain arising out the virtual sales transactions will be offset by the gain or loss associated with the purchasing of the assembly.
For details on setting up costs and prices, see Setting Up Subcontracting.
This figure illustrates the method for setting costs and prices. All amounts are in USD:
| Item | Material Cost | OSP (Added Value by MP) | Unit Cost |
|---|---|---|---|
| B | 2 | - | 2 |
| C | 3 | - | 3 |
| A | 2*2 + 3*1 = 7 USD | 5 | 12 |
| Item | Item Cost | Sales Price | Purchase Price | Gain/Loss per 1 Ea of Assembly A |
|---|---|---|---|---|
| B | 2 | 4 | N/A | 2*(4 - 2) = 4 |
| C | 3 | 6 | N/A | 1*(6 - 3) = 3 |
| A | 12 | N/A | 19 | 19 - 12 = 7 |
Gain or loss by shipping Components B and C to the MP on a replenishment sales order for manufacturing 1 each of Assembly A = 4 + 3 = 7 USD
Gain or loss offset by purchasing 1 each of Assembly A from the MP = 7 USD
The Original Equipment Manufacturer (OEM) should set up item prices so that the gain or loss by shipping the components to the MP is offset the gain or loss associated with the purchase of the assembly from the MP:
-
Define material costs for the components. Define material and OSP charges for assembly and update standard costs in the OEM organization. OSP charges are the added-value amounts added by the MP organization. The costing in the MP organization is of no significance.
-
Define the sales price of the components and purchase price of the assembly so that the gain or loss from the virtual sale of components to MP is offset by the purchase price of the assembly. Gain or loss is the difference between the components sales price and standard cost, and the offset is the difference between the purchase price of the assembly and its standard cost. In addition, the difference between the purchase price of assembly and the sales price of the component is the added-value amount. After the OEM receives the assembly, it makes a payment to the MP organization for the added-value amount.
-
In the previous example, the respective standard cost of components B and C is 2 USD and 3 USD, and the respective sales prices are 4 USD and 6 USD. The sale of 2 units of B and 1 unit of C to the MP results in a virtual gain of 7 USD, 4 USD of which is from B and 3 USD of which is from C.
To offset the virtual gain, the purchase price of assembly is set at 19 USD, and its standard cost is 12 USD. The difference in the purchase price and standard cost is 17 USD, which offsets the virtual gain due to the sale of components.
-
The net amount of the Accounts Receivables invoice is 14 USD, 8 USD of which is for 2 units of B and 6 USD of which is for 1 unit of C. This net amount is calculated against an Accounts Payables invoice in the amount of 19 USD and the balance of 5 USD, which represents the added value that is paid to the MP organization.
Replenishment Sales Orders Shipments
Accounting transactions associated with the provisional sale of components are tracked in separate accounts.
At Ship Confirm Replenishment Sales Orders
This example shows the accounting entries at Ship Confirm: Components B and C. All amounts are in USD:
| Account | Debit | Credit |
|---|---|---|
| For Component B (2 each) | ||
| Deferred COGS (item cost 2 USD) | 4 | - |
| Inventory Valuation (item cost 2 USD) | - | 4 |
| For Component C (1 each) | ||
| Deferred COGS (item cost 2 USD) | 3 | - |
| Inventory Valuation (item cost 2 USD) | - | 3 |
These are regular transactions. Although the inventory appears as a credit to the OEM book of accounts, the OEM organization still owns the inventory. At the period end, run a report and calculate the on-hand inventory and value at the MP site, and then adjust the OEM books for proper accounting.
Invoicing Replenishment Sales Orders
This example shows the accounting entries for AR Invoice: Components B and C. All amounts are in USD:
| Account | Debit | Credit |
|---|---|---|
| For Component B (2 each) | ||
| Subcontracting COGS (deferred amount 4 USD) | 4 | - |
| Deferred COGS (deferred amount 4 USD) | - | 4 |
| Subcontracting AR (sales price 4 USD) | 8 | - |
| Subcontracting Revenue (sales price 4 USD) | - | 8 |
| For Component C (1 EA) | ||
| Subcontracting COGS (deferred amount 3 USD) | 3 | - |
| Deferred COGS (deferred amount 3 USD) | - | 3 |
| Subcontracting AR (sales price 6 USD) | 6 | - |
| Subcontracting Revenue (sales price 6 USD) | - | 6 |
COGS, revenue, and receivable transactions associated with invoicing replenishment sales orders for subcontracting components are posted to subcontracting accounts for tracking.
Subcontracting Orders Receipts
Subcontracting orders are the standard purchase orders or releases created to procure the outsourced assemblies from the MP. Purchase orders include these events:
-
Receiving the assembly into the receiving location
-
Delivering the assembly to Inventory
All amounts are shown is USD.
Receiving for Assembly A
| Account | Debit | Credit |
|---|---|---|
| For Assembly A (1 each) | ||
| Inventory Receiving (PO Price 19 USD) | 19 | - |
| AP Accrual (PO Price 19 USD) | - | 19 |
These entries are similar to standard items.
Delivery for Assembly A
| Account | Debit | Credit |
|---|---|---|
| For Assembly A (1 each) | ||
| Inventory Valuation (Item Cost 12 USD) | 12 | - |
| Subcontracting Variance (PO Price - Item Cost) | 7 | - |
| Inventory Receiving (PO Price 19 USD) | - | 19 |
Inventory is debited at 12 USD, which includes the component costs and added value. The purchase price variance is posted to the Subcontracting Variance account for tracking.
AP Invoicing for Assembly A
| Account | Debit | Credit |
|---|---|---|
| For Assembly A (1 each) | ||
| AP Accrual | 19 | - |
| Accounts Payable (Outsourced Assembly) | - | 19 |
Accounting entries after the Accounts Payable invoice is created.
Once the Accounts Payables and Accounts Receivables invoices are ready to be processed, you must use the Accounts Payable and Accounts Receivables Netting functionality available in Oracle Payables, and make payments to the MP only for the added value in the outsourcing process.
Accounts Payables and Accounts Receivables Netting
| Account | Debit | Credit |
|---|---|---|
| AP (Outsourced Assembly): 19 USD, Subcontracting AR: 14 USD | ||
| AP (Outsourced Assembly) | 14 | - |
| Subcontracting AR | - | 14 |
After netting Accounts Receivables, the amount of 14 USD is adjusted as a partial payment, and the balance of 5 USD can be paid to the MP.
For more details on AP and AR netting, see the Oracle Payables User's Guide.
Buy/Sell Subcontracting Accounting Process
In Buy/Sell Subcontracting, the sale of subcontracting components and the purchase of outsourced assemblies are treated as independent business transactions. They are similar to standard sales and purchase of items. Therefore, the specific accounting of subcontracting transactions required for Chargeable Subcontracting is not relevant in the context of Buy/Sell Subcontracting. Also, Subcontracting Receivables and Payables are generally not netted in Buy/Sell Subcontracting. The OEM pays the MP for purchasing the outsourced assemblies and the MP pays for buying the subcontracting components from the OEM. However, system allows for netting of Payables and Receivables even for a Buy/Sell relationship.
Full Outsourcing Accounting Process
In Full Outsourcing, all the specific accounting steps required for Chargeable Subcontracting are followed except that for Full Outsourcing you set up and define Subcontracting Intransit (COGS) account in the Order Management transaction type, and Subcontracting Intransit (PPV) in the Shipping Networks. Additionally, Subcontracting Receivables and Payables are not netted in Full Outsourcing. The OEM retains ownership of the components used to manufacture the outsourced assembly so the MP does not explicitly pay for the Components. Keeping this in mind, the purchase price of the assembly includes only the value addition and does not include the component value supplied by the OEM.
Costs and Prices
For Full Outsourcing accounting, the value addition should be defined as OSP charges in the costing setup and the assembly purchase order price should be the same as the value addition.
For details on setting up costs and prices, see Setting Up Subcontracting.
This figure illustrates the method for setting costs and prices. All amounts are in USD:
| Item | Material Cost | OSP (Added Value by MP) | Unit Cost |
|---|---|---|---|
| B | 2 | - | 2 |
| C | 3 | - | 3 |
| A | 2*2 + 3*1 = 7 USD | 5 | 12 |
| Item | Item Cost | Sales Price | Purchase Price |
|---|---|---|---|
| B | 2 | N/A | N/A |
| C | 3 | N/A | N/A |
| A | 12 | N/A | 5 |
To set up item prices, the Original Equipment Manufacturer (OEM) should:
-
Define material costs for the components.
-
Define material and OSP charges for assembly and update standard costs in the OEM organization.
OSP charges are the added-value amounts added by the MP organization. The costing in the MP organization is of no significance.
Replenishment Sales Order Shipments
Accounting transactions associated with the shipping of components to MP are tracked in Intransit Account
At Ship Confirm Replenishment Sales Orders
| Account | Debit | Credit |
|---|---|---|
| For Component B (2 each) | ||
| COGS (item cost 2 USD) | 4 | - |
| Inventory Valuation (item cost 2 USD) | - | 4 |
| For Component C (1 EA) | ||
| COGS (item cost 2 USD) | 3 | - |
| Inventory Valuation (item cost 2 USD) | - | 3 |
These are regular transactions. Although the inventory appears as a debit to the COGS accounts, COGS is an intransit account, reflecting the value of the material at MP site, but still owned by OEM. At the period end, use Endeca Information Discovery to view the onhand at MP site. In this example, the Intransit Value of components is 7USD.
Invoicing Replenishment Sales Orders
Since the OM transaction type is Ship only, there won’t be any AR transactions generated.
Subcontracting Order Receipts
Subcontracting orders are the standard purchase orders or releases created to procure the outsourced assemblies from the MP. Purchase orders include these events:
-
Receiving the assembly into the receiving location
-
Delivering the assembly to Inventory
All amounts are shown is USD.
Receiving for Assembly A
| Account | Debit | Credit |
|---|---|---|
| For Assembly A (1 each) | ||
| Inventory Receiving (PO Price 5 USD) | 5 | - |
| AP Accrual (PO Price 5 USD) | - | 5 |
These entries are similar to standard items.
Delivery for Assembly A
| Account | Debit | Credit |
|---|---|---|
| For Assembly A (1 each) | ||
| Inventory Valuation (Item Cost 12 USD) | 12 | - |
| Subcontracting Variance (PO Price - Item Cost) | - | 7 |
| Inventory Receiving (PO Price 5 USD) | - | 5 |
Inventory is debited at 12 USD, which includes the component costs and added value. The Purchase Price Variance is posted to Subcontracting Variance, which is the Subcontracting Intransit account, reflecting the consumption of onhand inventory at MP site. At this moment the net debit Value in the Intransit account is zero, showing the Value of inventory at MP site as zero as they are consumed in the manufacturing of the assembly and OEM receives the assembly.
Additional Processes to Manage Subcontracting
In Chargeable Subcontracting and Full Outsourcing, accounts are posted correctly if all standard costs, sales price, and purchase price of the components and assemblies are unchanged. These costs and prices could undergo changes due to various business reasons such as an increase in the cost of raw material, changes to added value charges etc., that force the OEM to make changes in the standard cost prices and also the sales and purchase prices. This in turn influences accounting.
The following set of utilities and procedures are provided to help identify the impact of those changes in advance and assist you in managing them for proper accounting:
-
Standard cost updates
-
Sales price changes
-
Consumption adjustments
-
Component returns
Standard Cost Updates
You must run the Cost Update Analysis report to find the impact of proposed cost changes. This report gives the cumulative impact of all the components and assemblies by the MP for the proposed cost change. You must make manual adjustments to the general ledger accounts, and then update the standard costs of the components and assemblies as follows:
For Chargeable Subcontracting:
-
Debit the Inventory Valuation account if the value is positive
-
Credit the Inventory Valuation account if the value is negative
For Full Outsourcing:
-
Debit the subcontracting intransit account if the value is positive
-
Credit the subcontracting intransit account if the value is negative
Sales Price Changes
The sales price of the components will generally be changed at the beginning of the period. Like standard costs, changes in sales price will also affect gain or loss.
Note: This is applicable only for Chargeable Subcontracting. In Full Outsourcing, replenishment sales orders are ship only sales orders and no invoices are created so sales price changes do not have any impact on accounting.
To null the impact of sales price changes, the OEM must:
-
Reconcile the inventory in the MP organization by using the confirmation report.
-
Make logical returns of the unallocated replenishment sales order quantity by creating sales order returns (RMA). (Logical returns mean that the returns are made in the OEM records, but the components are still physically located in the MP organization.)
-
Change the component sales prices in the price list to the new sales price.
-
Create new replenishment purchase orders for the returned quantity and run the Interloc Manager:
-
Interlock Manager creates replenishment sales orders with the new price
-
make logical shipments; components are still with the MP but shipments are registered with the new price.
-
After this process, you can continue with the execution process.
Consumption Adjustments
Variances in the consumption of components over the planned consumption based on the BOM are registered and processed using the consumption adjustment processing at the MP organization. This process will adjust the on-hand inventory of simulated records in the MP organization for planning and execution.
In Chargeable Subcontracting, the impact of the variances in OEM organization on payments process must be handled manually.
In the case of over consumptions, the MP consumes more quantity than the planned quantity, and the sales price of this excess consumption is not part of the purchase price of the assembly. Consequently, the Accounts Receivables amount will be more than the Accounts Payables amount and netting will suggest payments to the MP organization. To overcome this situation, the OEM must create a credit note for the excess consumption and then make payments for the value addition.
In the case of under consumptions, the MP consumes less than the planned quantity, resulting in the Accounts Payable amount being more than the Accounts Receivable amount, and netting will suggest paying more than the value addition. Creating a debit note for the less consumption amount, and then paying only the value addition, can resolve this condition.
Both the scenarios can be handled by using either by using proper netting setup or manually.
See: Accounts Payables and Accounts Receivables feature in the Oracle Payables User's Guide
In Full Outsourcing, the variances in the consumption at MP site results in the variation in the onhand inventory value at MP site (tracked in the subcontracting intransit account), which must be handled manually. You can do the following to adjust the accounts:
-
Use Endeca Information Discovery, and take snapshot of onhand inventory Value in MP site before adjustments.
-
Make adjustments.
-
Refresh Endeca Data and take the new snap shot of onhand inventory Value at MP site after adjustments
-
Compare the inventory value at MP site, before and after the adjustments and make the following adjustments:
-
Debit the Inventory Valuation account if the adjusted value is positive.
-
Credit the Inventory Valuation account if the adjusted value is negative.
-
Component Returns
The MP returns components to the OEM for various business reasons such as:
-
Defective components
-
Excess components due to better yield
-
Obsolete components
-
Logical returns due to price change differences in the standard cost at the time of shipping the components and at the time
RMA receipts are created impact the gain or loss. Use the following procedure to null any gain or loss due to returns:
-
Run the Cost Update Analysis report with the Period End option to calculate the gain or loss.
For Chargeable Subcontracting:
-
Debit the Inventory Valuation account if the value is positive.
-
Credit the Inventory Valuation account if the value is negative.
For Full Outsourcing:
-
Debit the subcontracting intransit account if the value is positive.
-
Credit the subcontracting intransit account if the value is negative.