PO Price Variance Procedure

This procedure is used to correct situations in which an item is received into inventory at an incorrect price.  This procedure details the steps required in order to process the vendor invoice, and it also lists the steps to be followed in order to correct the average cost of the inventory item.  The steps listed in this document should be performed as soon as possible once an error has been discovered.  Timely correction of variances minimizes the damage to sales margins and other data that can be affected by incorrect inventory costs.

Accounts Payable Department

      Input the vendor invoice at the correct amount (the amount shown on the invoice).  If the vendor invoice amount is incorrect, and the purchase order was received using the correct price, please process the invoice as described in the section “Vendor Invoice is Incorrect”.

      Tag the inventory activity records that are associated with the invoice and that were created when the item or items were received at the wrong price (this step ensures that the related inventory activity records are cleared out of the unvouchered inventory account).  DO NOT adjust the amount that the computer automatically posts to the unvouchered inventory account when you hit the save key in the matching overlay.  This amount is based on the actual cost the items were received with and it should not be adjusted.

      Distribute any freight, sales tax, vat or other non-inventory amounts from the AP invoice to the appropriate general ledger accounts.

      Charge the price variance, (the difference between the amount of the inventory transactions for the receipt and the amount being billed by the vendor for the items) to the PO Price variance account in the General Ledger.   The variance amount should be the undistributed remaining balance for the invoice if you have already matched all related inventory receiving detail and have distributed the other non-inventory amounts from the invoice.

      The PO Price Variance account should be created if it does not already exist in your General Ledger. The Price Variance account should be created as a Type 60 or Cost of Sales account (this ensures that the difference between the cost of the item as received and its real cost are charged to the income statement if no other actions are performed).  The logic is that if the items with the incorrect cost are sold, the cost of sales in the general ledger is adjusted by the amount charged to the PO Price Variance account.  If the items with the incorrect cost are still in inventory, the cost of the items can be corrected before they are sold using the Average Cost Adjustment option in the Inventory Control system, and the average cost adjustment amounts offset the amounts posted during accounts payable entry.

      Adjust the cost of the incorrect items using the procedures described in the next section or forward the item numbers that were received with incorrect costs to the Inventory Control department to allow them to correct the cost of any items still in stock.

Inventory Control Dept.

      Take the information supplied by the accounts payable department to determine which items which have incorrect costs.

      Determine the correct cost for the items that were received using the wrong price.  Use the information provided by the accounts payable department, or the information from the vendor invoice to determine the correct cost for each item.  In most cases, the correct cost may be the same as the cost shown on the vendor invoice divided by the exchange rate for the currency used on the invoice and PO.   In some cases, you may have had a large quantity on hand for an item before receiving it at an incorrect price.  If this is the case, and the old and correct new costs are different, the new average cost can be determined by looking at the transaction just prior to the receiving error.  The cost and quantity prior to the error plus the cost and quantity received (using the correct price), divided by the new quantity on hand, equals the new cost.  In this case, the quantity on hand prior to the error includes the total on hand quantity for the item in all inventory locations in the current division (this amount is also stored in the Ref_Qty field of the receiving transactions).

      Adjust the average cost of the items received at the wrong price.  The adjustment should be based on the correct price from the vendor invoice.  The average cost of an item can be adjusted using the “Change Average Cost” Pull down Menu option available from the Inventory Master program.  This option is available only if the operator has been given rights to perform the function.  When the Change Average cost option is selected, the system displays the current average cost for the item and it prompts the user to enter the new cost to be used for the item.  The new cost entered by the operator is used to update the item cost in all inventory locations in the current division.  Average cost adjustments are recorded in the Inventory Activity file and are also included in the Inventory Activity Report (FV091R05).  The change to the inventory value resulting from each average cost transaction is also automatically posted to the general ledger.

      The average cost adjustment program uses a Gencode table to define the valid cost adjustment codes that can be used on the system, and where each of these adjustments should be recorded in the general ledger.  The table should include an entry with a code of  POPRICE.  This entry should be pointed to the same general ledger PO Price Variance Account that is used during AP Invoice processing.  This is done by assigning an autopost number to the account that is within the valid range supported by the Average Cost procedure).  This setup allows the variances entered during AP invoice entry to be offset by the amount of cost adjustments processed against the items as the costs of the items are corrected.

      As each average cost adjustment transaction is saved, the system adjusts the cost of the item in all warehouse locations in the current division and it makes a journal entry to record the change.  The journal entry is made to the inventory control account for the item (based on the item product line) and to the price variance account. 

      The journal entry made when the average cost transaction is processed has the effect of reducing the balance in the Price Variance account.  The average cost adjustment is able to fix the cost of the items that are still on hand when the adjustment is processed.  Note: As of the 11/14/2001 revision of the software, the average cost adjustments are automatically posted by the system and step two is performed online when the adjustment is processed.  The general ledger accounts used when the average cost adjustment is processed are the inventory control account for the item (based on the product line it is assigned to) and the expense or other account pointed to by the Cost Adjustment code selected for the transaction.  The cost adjustment codes are set up and selected using the IACCODES Generic Code table.

      If the inventory average cost adjustment is less than the amount charged to the Price Variance account by the accounts payable department, the remaining variance should be left in the Price Variance account (which is part of cost of sales).  This corrects cost of sales (in the general ledger) for the items sold, consumed or otherwise processed during the time that the average cost was incorrect.

PO Price Variance - Detailed Example

The following example illustrates the procedure.  This example assumes there was a quantity on hand for the affected item before the bad receipt was processed.

1.) Qty 10 of an Item is received at $1000.00 instead of at the correct price of $100.00.  When the item is received, the system

a.) Increases the inventory qty on hand for the item by 10 and re- averages the cost of the item.  In this example we will assume that the item had a qty on hand of 5 units @ $100.00 before the receipt.  The new average cost would be $700.00 per unit calculated as follows.

Old Value  5 units  @   100.00 = $500.00

Receipt     10 units @ 1000.00 = $10,000.00

subtotal                                       $10,500.00

$ 10,500.00 /15 units = $700.00 new average cost for item.

b.) Creates a receiving transaction for 10 X $1000.00 or $10,000.00 and posts this transaction to

Inventory (as a debit) and to the Unvouchered Inventory account (as a credit).

Dr Inventory  $10,000.00

Cr       Unvouchered Inventory $10,000.00

2.) During AP Invoice Entry the operator notices that the vendor is billing for 10 units at $100.00 (the correct price for the item) instead of at the $1000.00 incorrect price that was used on the PO.  The AP operator then does the following.

a.) The operator enters the invoice amount at $1000.00 (the correct amount to be paid to the vendor).

b.) The operator tags the inventory receipt records for the item which have a value of $10,000.00.  This attaches the correct receiving records to the invoice and clears the entire $10,000.00 amount out of the unvouchered inventory account balance.

c.)  At this point, the AP invoice has an undistributed amount of $9000.00 which is charged to the PO Price Variance account.

The journal entry resulting from these steps is as follows.

Dr Unvouchered Inventory  $10,000.00

Cr       Accounts Payable     $1000.00

Cr       P.O. Price Variance   $9000.00

3.) The information about the variance is forwarded to the inventory control clerk who must determine what the correct cost for the item should be and then make the appropriate adjustment using the Average Cost Adjustment feature available from the Inventory Master program.  In this case, the item cost is $700.00 instead of the correct cost of $100.00.  The correct cost is determined by looking at the last transaction prior to the incorrect receipt, or by looking at the vendor invoice if no quantity was on hand when the incorrect receipt was processed.

If no items have been sold since the receipt took place, the operator can adjust the cost for all 15 units to $100.00 which will change the inventory value by $600.00 per unit X 15 units = $9000.00. If the PO Price variance adjustment code is used and this code is properly set up to post to the PO Price Variance account, the system would automatically post the adjustment as follows.

Dr. PO Price Variance  $9000.00

Cr       Inventory      $9000.00

This entry corrects the inventory account in the general ledger and it removes the balance in the price variance account that was posted by the accounts payable department.  If items have been sold since the receipt at the incorrect price, the inventory control clerk has already corrected the cost of sales in the general ledger by leaving the remaining variance in the PO Price Variance account (this account is treated as part of cost of goods sold).  For example: If only 10 items are still in stock when the inventory control clerk fixes the average cost of the item, the adjustment to inventory will be $6000.00 ($600.00 per unit * 10 units) and the remainder has been charged to cost of sales ($600.00 per unit * 5 units).

The journal entry that would be posted after the inventory average cost adjustment is processed would be.

Dr.  PO Price Variance  $6000.00

Cr       Inventory      $6000.00

In this case, the items remaining in stock show the correct 100 cost and the 3000 remaining in the variance account offsets the incorrect cost of sales recorded due to the bad costs in the items when sold.


PO Price Variance - PO received using wrong currency