Golden Rules of Accounting

Effect of Debit and Credit (VV IMP)

Debit is that aspect of transaction that causes:
An increase in an Asset, a decrease in Liability (Real A/c)
An increase in Expense or Loss, a decrease in Income or Gain (Nominal a/c)
An increase in Drawings, a decrease in Capital (Personal A/c)
Credit is that aspect of transaction that causes:
A decrease in Asset, an increase in Liability (Real A/c)
A decrease in Expense or Loss, an increase in Income or Gain (Nominal a/c)
A decrease in Drawing, an increase in Capital (Personal A/c)
Why do we use COGS Account?
To calculate profit, we have to subtract COGS and not inventory from Sales.  This is why cost of the
INVENTORY sold is transferred to COGS A/c.  The balance remaining in Inventory A/c is closing stock
with the business.

Accrual
An accrual is a journal entry that is used to recognize revenues and expenses that have been
earned or consumed, respectively, and for which the related cash amounts have not yet been
received or paid out. Accruals are needed to ensure that all revenues and expenses are
recognized within the correct reporting period, irrespective of the timing of the related cash
flows. Without accruals, the amount of revenue, expense, and profit or loss in a period will not
necessarily reflect the actual level of economic activity within a business.
Under the double-entry bookkeeping system, an accrued expense is offset by a liability, which
appears in a line item in the balance sheet. If accrued revenue is recorded, it is offset by an
asset, such as unbilled service fees, which also appears as a line item in the balance sheet.
Fundamentally accounting is based on two methods: Cash Basis or Accrual Basis.
Accrual Basis Accounting
Under the accrual basis accounting, revenues and expenses are recognized as follows:

For Accounts Receivable:

  Revenue recognition: Revenue is recognized when both of the following conditions are met:
    a. Revenue is earned.
    b. Revenue is realized or realizable.
  Revenue is earned when products are delivered or services are provided.
 Realized means cash is received.
 Realizable means it is reasonable to expect that cash will be received in the future.

For Accounts Payable:

 Expense recognition: Expense is recognized in the period in which related revenue is recognized
(Matching Principle).

Cash Basis Accounting

Under the cash basis accounting, revenues and expenses are recognized as follows:
AR:

 Revenue recognition: Revenue is recognized when cash is received.

AP:

 Expense recognition: Expense is recognized when cash is paid.

Timing differences in recognizing revenues and expenses:

1. Accrued Revenue: Revenue is recognized before cash is received.

2. Accrued Expense: Expense is recognized before cash is paid.
3. Deferred Revenue: Revenue is recognized after cash is received.
4. Deferred Expense: Expense is recognized after cash is paid.

VV Imp:
The types of accounts in Oracle Specially while creating the general ledger are of five types.
The account type may correspond to any one of the five account types:
1.) Liability 2.) Asset 3.) Ownership 4.) Revenue 5.) Expense
While defining the respective account type for values being assigned to the Natural Account
Segment, the account has to be a type of one of the above.

JV
A written authorization prepared for every financial transaction, or for every transaction that
meets defined requirements.

Jv’s in Oracle
Journal vouchers are used to adjust accounting entries for vouchers that have been posted and
paid and for vouchers for which payments have also been posted.
Adjustment Journal Voucher should be used for making adjusting entries in to GL whereas
Other Journal should be used for making other manual entries in to General Ledger.

Deferred COGS Accounting in R12

The deferred COGS of goods account is the new feature introduced in Release 12. The basic
fundamental behind the enhancement is that the COGS is now directly matched to the
Revenue. The same was not possible till now.

Prior to this enhancement, the value of goods shipped from inventory were expensed to COGS
upon ship confirm, despite the fact that revenue may not yet have been earned on that
shipment. With this enhancement, the value of goods shipped from inventory will be put in a
Deferred COGS account. As percentages of Revenue are recognized, a matching percentage of
the value of goods shipped from inventory will be moved from the Deferred COGS account to
the COGS account, thus synchronizing the recognition of revenue and COGS in accordance with
the recommendations of generally accepted accounting principles.

The Matching Principle is a fundamental accounting directive that mandates that revenue and
its associated cost of goods sold must be recognized in the same accounting period. This
enhancement will automate the matching of Cost of Goods Sold (COGS) for a sales order line to
the revenue that is billed for that sales order line.

The deferral of COGS applies to sales orders of both non-configurable and configurable items
(Pick-To-Order and Assemble-To-Order). It applies to sales orders from the customer facing
operating units in the case of drop shipments when the new accounting flow introduced in
11.5.10 is used. And finally, it also applies to RMAs that references a sales order whose COGS
was deferred. Such RMAs will be accounted using the original sales order cost in such a way
that it will maintain the latest known COGS recognition percentage. If RMAs are tied to a sales
order, RMAs will be accounted for such that the distribution of credits between deferred COGS
and actual COGS will maintain the existing proportion that Costing is aware of.  If RMAs are not
tied to a sales order, there is no deferred COGS.

For more on this refer to http://oracleebslearning.blogspot.in/2012/10/deferred-cogs-

accounting-in-r12.html
PPV
 Purchase Price Variance (PPV) can be defined as the price difference between the amount that
is paid to a supplier to buy a product and the actual cost of the product.

The purchase price variance is the difference between the actual price paid to buy an item and
its standard price, multiplied by the actual number of units purchased. The formula is:

(Actual price - Standard price) x Actual quantity = Purchase price variance

Please see for PII

https://docs.oracle.com/cd/E18727_01/doc.121/e13635/T372621T379162.htm#T412160
Profit in inventory

Inventory profit is the increase in value of an item that has been held in inventory for a
period of time. For example, if inventory was purchased at a cost of $100 and its market value
a year later is $125, then an inventory profit of $25 has been generated.

There are two possible reasons for inventory profit, which are:

 Appreciation. The market value of an inventory item may increase over time. This is most
common when commodities are held in stock. A company could generate a profit through
speculation, holding onto inventory in the hope that its market value will rise.
 Inflation. The value of the currency in which inventory is recorded declines, so that the amount
of currency required if someone were to purchase the inventory increases. Inflation is a
common cause of inventory profit in a first in, first out (FIFO) inventory costing system, where
the cost of the oldest items in stock are charged to the cost of goods sold when units are
consumed. Since the oldest items in stock should have the lowest cost in an inflationary
environment, this leads to an inventory profit.

If an inventory is well-managed, it should turn over with great regularity, which means that
there is little time for an inventory profit to accrue. Conversely, an inventory with low turnover
has a greater opportunity to generate a profit, since more time passes before it is consumed.

Realistically, there is at least as good a chance for the value of inventory to decline as to
increase, so the probability for an inventory profit to occur in any size is relatively low.

When reviewing the performance of a business, it is best to strip out the effects of inventory
profit in order to determine the amount of profitability generated by operations. Thus, an
inventory profit should be considered an occasional and incidental part of doing business,
except in situations where management is deliberately holding inventory in order to achieve
price appreciation.
Standard IR/ISO Process in Oracle R12:

 Internal requisition is a requisition in the Purchasing system that will directly result in the generation
of a sales order in the Order Management.

Internal Requisition/Internal Sales Order provide the mechanism for requesting and transferring
material from one inventory organization to other inventory
organization or expense location.

When Purchasing, Order Management, Shipping Execution, and Inventory are installed, they combine
to give you a flexible solution for your inter-organization
and intra-organization requests.

Intercompany and Intracompany in GL:

In R12 we have modified concepts to track the accounts for Intercompany and Intracompany Accounts.
Intercompany transactions are the Transactions between the balancing segments across legal entities.
Intracompany transactions are the Transactions between the balancing segments within the same legal entities or
ledger.
Illustration on Intercompany and Intracompany as below:

To understand the concept of Intercompany and Intracompany further more let us consider our illustration as below
for Intercompany:
Let us consider our Ledger as GSSTATA PL

Considering the above illustration if there are any transaction between balancing segment (COMPANY) 01 and 02
then it is intercompany transaction. If the transactions are between the balancing segment 03 and 04 then it is
intracompany transaction.

Transfer Price & Transfer Pricing

What is a 'Transfer Price'?
A transfer price is the price at which divisions of a company transact with each other.
Transactions may include the trade of supplies or labor between departments. Transfer prices
are used when individual entities of a larger multi-entity firm are treated and measured as
separately run entities. It is also known as "transfer cost".

In managerial accounting, when different divisions of a multi-entity company are in charge of

their own profits, they are also responsible for their own "Return on Invested Capital".
Therefore, when divisions are required to transact with each other, a transfer price is used to
determine costs. Transfer prices tend not to differ much from the price in the market because
one of the entities in such a transaction will lose out: they will either be buying for more than
the prevailing market price or selling below the market price, and this will affect their
performance.

What is Transfer Pricing?

A transfer price is what one unit of a business charges another unit of the same business for a
good or service.  The transfer price is usually close to the prevailing market rate when different
divisions of the same business are evaluated separately for profit and loss. 

For instance, Big Corp Inc. has two divisions.  Division A produces car sound systems sold to the
public.  Division B produces automobiles, which include a car sound system produced by
Division A.  If A charges B a price lower than the market rate for the sound systems, then A’s
sales, as measured in dollars, will be low.  On the other hand, a lower-than-market price helps
B, because the lower price improves its cost of goods sold.   

Tax authorities have strict rules regarding transfer pricing to prevent companies from shifting
profits to tax haven countries.  Assume A and B are in different countries.   If Division A is in a
low tax rate country and Division B is in a high tax rate country, Big Corp can reduce its overall
tax burden by making A profitable and B unprofitable.   This is accomplished by having A charge
B very high prices for the car sound systems.  A’s profits will be very high, but taxed at a low
rate.  B’s will be taxed at a high rate, but the overcharges by A reduce profits, and thus lower its
tax burden in its country.

What is the difference between transfer price and standard cost?

While an item's standard cost can be used to determine its transfer price, the two values are
inherently different. An item's transfer price is the sales price charged for a good or service in a
transaction between two entities under common ownership. Its standard cost, on the other
hand, is simply the anticipated cost of all of the item's component parts.

When one entity purchases goods from another entity under the same ownership, a sales price
is charged, just as it would be to an outside customer. This price is called the transfer price; the
sale is made to another entity as part of the production process rather than to the end user.

Assume companies A and B are part of corporation X, which sells laptop computers. Company A
manufactures microchips and assembles the laptops, while company B is the corporation's
public brand and is responsible for sales. To avoid operating at a loss, company A must charge
company B a transfer price for each laptop it purchases to sell to the public. The
optimal transfer price is based on a number of factors, including the cost of the item and which
entity receives the benefit of profits.

If management believes it benefits the corporation as a whole for company A to realize 100% of
the profits, the transfer price is set using the market price of the product.

For example, if a laptop costs $100 to produce but can sell for $700 on the open market, then
company A charges company B $700 per laptop. Company B then sells the finished product to
the consumer at or above this same price. Company A absorbs all the costs and profits
associated with the production of the item, while company B essentially breaks even.
Depending on the actual sales price, company B may realize a small profit or loss. While
corporation X's total profits do not change, it does not encourage company B to push sales of
laptops; there is little to no financial benefit to that entity.

If company B receives the profit generated by the sale of goods, then the transfer price is set
using the cost of manufacturing the product, rather than its market value.

Because the actual cost of manufacturing an individual item can vary due to operational
inefficiencies, temporary shortages or human error, the simplest way to set a cost-based
transfer price is by establishing the item's standard cost. The standard cost is the average, or
anticipated, cost of producing an item under optimal circumstances. The standard cost can be
adjusted over time to account for  variances between the anticipated and actual costs of
production.

Using the standard cost method in the above example, company B would pay company A $100
per laptop to cover the cost of manufacturing. Company B then sells the laptops at their market
value. In this way, company A does not lose money on production, and company B receives
100% of the sales profits. However, as with market-based transfer pricing, the allocation of
profits to one entity can discourage other entities from full participation.

How does transfer pricing affect managerial accounting?

In managerial accounting, the transfer price represents a price at which one subsidiary, or
upstream division, of the company sells goods and services to the other subsidiary, or
downstream division. Goods and services can include labor, components and parts used in
production and general consulting services.

Transfer prices affect three managerial accounting areas. First, transfer prices determine costs
and revenues among transacting divisions, affecting performance evaluation of divisions.
Second, transfer prices affect division managers' incentives to sell goods either internally or
externally. If the transfer price is too low, the upstream division may refuse to sell its goods to
the downstream division, potentially impairing the company's profit-maximizing goal. Finally,
transfer prices are especially important when products are sold across international borders.
The transfer prices affect the company's tax liabilities if different jurisdictions have different  tax
rates.

Transfer prices can be determined under the market-based, cost-based or negotiated method.
Under the market-based method, the transfer price is based on observable market price for
similar goods and services. Under the cost-based method, the transfer price is determined
based on the production cost plus a  markup if the upstream division wishes to earn a profit on
internal sales. Finally, upstream and downstream divisions' managers can negotiate a transfer
price that is mutually beneficial for each division.

Transfer prices determine the transacting division's costs and revenues. If the transfer price is
too low, the upstream division earns a smaller profit, while the downstream division receives
goods or services at a lower cost. This affects the performance evaluation of the upstream and
downstream divisions in opposite ways. For this reason, many upstream divisions price their
goods and services as if they were selling them to an external customer at a market price.

If the upstream division manager has a choice of selling goods and services to outside
customers and the transfer price is lower than the market price, the upstream division may
refuse to fulfill internal orders and deal exclusively with outside parties. Even though this can
bring extra profit, this may harm the overall organization's profit-maximizing objective in the
long term. Similarly, a high transfer price may provide the downstream division with incentive
to deal exclusively with external suppliers, and the downstream division may suffer
from unused capacity.

Transfer prices play a large role in determining the overall organization's  tax liabilities. If the
downstream division is located in the jurisdiction with a higher tax rate compared to the
upstream division, there is an incentive for the overall organization to make the transfer price
as high as possible. This results in a lower overall tax bill for the entire organization.

However, there is a limit to what extent multinational organizations can engage in overpricing
their goods and services for internal sales purposes. A host of complicated tax laws in different
countries limit companies' ability to manipulate transfer prices.

Transfer Pricing in Oracle ERP

Transfer Price is the price at which an item is transferred from one operating unit to another
operating unit. Transfer price is also usually called as “Arm’s length Price” and is generally
guided by the originating country’s accounting standards.
Logic for transfer price determination for shipping flows is explained in Figure . However, for
procuring flow, you can specify whether the transfer price is same as the PO price in
intercompany transaction flow. This means that an operating unit sells at the same price at
which it procured the item to another operating unit. If you specify that the transfer price is not
same as the PO price in the intercompany transaction flow, then system uses the same logic as
depicted in . For procuring flow, you specify the pricing option (transfer price or PO price)
separately for asset and expense items.
Source: http://www.oracleerpappsguide.com/2012/01/transfer-price.html

Also Read: http://www.oracleerpappsguide.com/2012/01/intercompany-invoicing-overview.html &

http://www.oracleerpappsguide.com/2012/03/intercompany-invoicing-cycle.html

Subledger Accounting

What is Sub Ledger Accounting?

SLA is a robust, centralized accounting engine and a repository that facilitates true global accounting. R12 Sub
Ledger Accounting is designed to offer global visibility into enterprise-wide accounting information with a single,
global accounting repository and with user driven reporting.

By introducing SLA in EBS, Oracle has separated Accounting from Transaction.

It is to be noted that SLA is complementary to the existing account generation tools like Auto accounting or Work flow
accounting generator. SLA streamlines these processes and facilitates management of accounting rules in a global
manner.

Key Features of SLA:

 Enables a single business transaction (Business Event as per new terminology) to create multiple 
journals using multiple accounting representations across multiple currencies
 SLA serves as an intermediate layer between the sub-ledger products (AP, AR. Projects, FA etc) and the 
Oracle GL
 SLA allows you to define multiple accounting rules (US GAAP, IFRS etc) for a single legal entity and apply 
them in different ledgers
 SLA offers the flexibility to create accounting in draft or final mode

Encumbrance Accounting

Encumbrance is a commitment to pay in the future for goods or services ordered by not yet received.
The terms encumbrance and commitment are used interchangeably.  The budget amount can be
reduced by the amount of encumbrance
In management accounting, encumbrance is a management tool used to reflect commitments in
the accounting system and attempt to prevent overspending. Encumbrances allow organizations to
recognize future commitments of resources prior to an actual expenditure.

Encumbrance accounting is a form of budgetary control within Oracle Applications that enables a
company to allocate funding for specific accounts.  The funds checking feature which is an integral part
of encumbrance accounting, checks for availability of funds on a particular accounting combination.