Encumbrance Accounting in the Procure to Pay Flow: Best Practices PDF

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An Oracle White Paper May 2014 Encumbrance Accounting in the Procure to Pay Flow: Best Practices Encumbrance Accounting in the Procure to Pay Flow: Best Practices Executive Overview ..................................................................................................... 3 Introduction ....

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An Oracle White Paper May 2014

Encumbrance Accounting in the Procure to Pay Flow: Best Practices

Encumbrance Accounting in the Procure to Pay Flow: Best Practices

Executive Overview ..................................................................................................... 3 Introduction ................................................................................................................. 4 Encumbrance Accounting – Procure-to-Pay Overall Process Flow ............................ 6 Encumbrance Accounting – Procure to Pay with Journal Entries ............................... 7 Creating Budgets .................................................................................................... 7 Purchase Requisitions Approval and Reserve ........................................................ 9 Purchase Order Reservation & Approval .............................................................. 10 Changes to PO: Increase quantity or price through Revision ............................... 11 Changes to PO: Decrease Quantity or Price through Revision............................. 12 Cancellation of Quantities/Lines/Shipments in a Purchase Order ........................ 13 Receipt of Goods/Services .................................................................................... 13 Invoice Matched to PO .......................................................................................... 14 Invoice Payment .................................................................................................... 16 Technical Overview ................................................................................................... 17 Conclusion ................................................................................................................ 18 Appendix: Setup Overview ........................................................................................ 19 Setup in Oracle General Ledger ........................................................................... 19 Setup in Oracle Purchasing, Oracle Payables and Oracle Cost Management ..... 25 Setup in Oracle Inventory ...................................................................................... 26 Appendix: Common Customer Issues and their resolution ....................................... 29 Appendix: Important Tables used by Encumbrance Accounting ............................... 38 Appendix: Reference Documents / Notes related to Encumbrances ........................ 39

Encumbrance Accounting in the Procure to Pay Flow: Best Practices

Table of figures:

Figure 1: Setting up Budget for Encumbrance Accounting.................................................... 8 Figure 2: Funds Availability after Budget Creation .................................................................. 8 Figure 3: Budget Position after Commitment ........................................................................... 9 Figure 4: Budget Position after Obligation.............................................................................. 11 Figure 5: Budget Position after PO Amount increase ........................................................... 12 Figure 6: Budget Position after Invoice Matching ................................................................. 16 Figure 7: Encumbrance Accounting Technical Overview .................................................... 17 Figure 8: Enable Budgetary Control ......................................................................................... 19 Figure 9: Sub-ledger Accounting Method................................................................................ 20 Figure 10: Define Budget ........................................................................................................... 21 Figure 11: Define Budget Organization ................................................................................... 21 Figure 12: Account Ranges ........................................................................................................ 22 Figure 13: Budgetary Control Options .................................................................................... 22 Figure 14: Budgetary Control Group ....................................................................................... 23 Figure 15: Profile for Budgetary Control Group .................................................................... 23 Figure 16: Open Encumbrance Year........................................................................................ 24 Figure 17: Define Encumbrance Types ................................................................................... 24 Figure 18: Define Financial Encumbrance Options .............................................................. 25 Figure 19: Enable Encumbrance in Oracle Purchasing and Oracle Payables .................... 26 Figure 20: Costing Information ................................................................................................ 27 Figure 21: Organization Parameters - Other Accounts ......................................................... 27

Encumbrance Accounting in the Procure to Pay Flow: Best Practices

Executive Overview Most organizations understand the need to use budgetary controls in their business processes. Budgetary controls ensure that unnecessary and maverick spending is minimized or curtailed. Budgetary controls ensure proper approvals for legitimate expenses and users do not overshoot the budgets specified for their activities. It is a very useful tool to avoid unnecessary business transactions and expenses. Encumbrance Accounting in Oracle e-Business Suite integrates the entire budgetary control lifecycle and enables better control over expenditures incurred in organizations. With Encumbrance Accounting, organizations can monitor the amount of money they spend, ensure that departments don't exceed their budgets or are immediately notified if they do. It can also help predict cash flow balances more effectively. This paper will help users understand the concept of Encumbrance Accounting and how it can be set up and used within Oracle e-Business Suite. The main focus of this white paper is to explain the Encumbrance Accounting process from a Procure to Pay perspective.

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Encumbrance Accounting in the Procure to Pay Flow: Best Practices

Introduction Encumbrance Accounting is a widely used business practice for managing expenses and ensures that departments stay within budgetary expenditure targets. Encumbrance Accounting per se is a much wider concept than a simple budgetary control. Encumbrance Accounting helps organizations stay within budgets, so that it is easy for users and organizations to identify and report various business transactions and how they impact cash flows. This white paper provides an overview of the Encumbrance Accounting process used in Oracle E-Business Suite.

What is Encumbrance? Encumbrance is a commitment to pay in the future, although the goods or services have been ordered, however, they have not been received yet. For a company, Encumbrance reserves the money for paying for goods or services in the future; the amount is called Encumbrance. And the amount(s) will subsequently become expenditure when goods and services are received.

What is Encumbrance Accounting? Encumbrance Accounting is also known as Commitment Accounting. It deals with accounting for expenses from the time that the intent to incur that expenditure becomes clear, that is, the commitment to incur the expenditure becomes certain. Usually, the majority of spend in an organization happens in the procurement process; when purchase requests are created and approved, there is a greater degree of certainty about incurring that expense over a certain period. Encumbrance Accounting ensures that this expense is accounted for, against the sanctioned budget, when the request is approved. This implies that funds are set aside in accounting for meeting this expense which is not liable to be paid unless the requests are received and billed. Encumbrance Accounting also ensures that a reduced budget is available for other competing purchase requests. When the budget is completely utilized, it is no longer possible to create fresh purchase requests.

What is Encumbrance Accounting in Oracle e-Business Suite? Encumbrance Accounting ensures that money or budgets are set aside for meeting anticipated future expenses. There may be multiple scenarios in the procurement process that use Encumbrance Accounting: creation of purchase orders with backing purchase requisitions, creation of purchase orders without a backing requisition, directly accounting for an invoice and paying it, without a backing purchase order, etc. Encumbrance Accounting in Oracle e-Business Suite ensures that the money is correctly set aside and appropriately accounted for during the entire procurement lifecycle.

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Encumbrance Accounting in the Procure to Pay Flow: Best Practices

Oracle Encumbrance Accounting Terms The following terms are widely used while discussing Encumbrance Accounting, in this whitepaper. COMMITMENT Commitment implies the commitment to spend money in the future. In Oracle e-Business Suite, it denotes reserving and accounting for money committed to be spent on a Purchase Requisition document. Commitment happens on the approval of a Purchase Request document. OBLIGATION Obligation is the obligation on the part of an issuer of a purchase order or a contract to pay an amount to a vendor, as per the terms and conditions and supply schedules of the purchase order or contract. In Oracle e-Business Suite, it denotes reserving and accounting for money that will be required to pay for goods and services contracted through a purchase order / agreement type of document. Obligation takes place on the approval of a Purchase Order / Agreement. ENCUMBRANCE ENTRY An encumbrance entry is a journal entry that is created when you reserve a requisition or a PO or create an unmatched invoice – the type of encumbrance created is either a Commitment or Obligation. Encumbrance journal entries are always created using the functional currency (that is, the currency of the default operating unit). BUDGET ACCOUNTS These are accounts against which amounts are specified in a Budget that is created. These budgetary Accounts can be specified at the summary level or detail level. FUNDS AVAILABLE: Funds Available = Budget – (Actual Expenses + Encumbrances) Funds available are the amount of Funds, available to be encumbered. It is the difference between the amount you are authorized to spend and all actual and anticipated expenditures. In other words, funds available are the amount budgeted less actual expenses and encumbrances of all types. Users can use the Funds Check feature in purchase requisitions and purchase orders to review the available funds.

Benefits of Encumbrance Accounting Using Encumbrance Accounting, the following benefits are available: •

• •

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Enforces Control: Encumbrance Accounting works together with budgetary control, monitors spending by departments, avoids overspending and enforces controls. Increases Visibility: Encumbrance Accounting enables users to pre-allocate the budget amount, track expenditure, and increase spends transparency. Accelerates Planning Process: Encumbrance Accounting is used to predict cash outflow and is also used as a planning tool to accelerate the planning process.

Encumbrance Accounting in the Procure to Pay Flow: Best Practices

Encumbrance Accounting – Procure-to-Pay Overall Process Flow Encumbrance Accounting is closely integrated with the entire Procure-to-Pay (P2P) flow. It starts with a purchase requisition and ends when actual expenditure is booked against an invoice. Encumbrance Accounting in the Procure-to-Pay process is depicted in the diagram as follows:

Encumbrances flow throughout the procurement process; that is, from the intention to buy goods or services, to procuring and receiving the goods or services, to the final step of incurring the actual expenditure and making the payment. The following stages are basic Encumbrance Accounting activity in the procure-to-pay process:

• Creating and Approving a Purchase Requisition (Commitment Stage) • Creating and Approving a Purchase Order (Obligation Stage) • Creating and Approving Receipts / Invoices (Actual Stage) This is business major processes for company buying goods or services. Along with that, Encumbrances liquidate from one stage to the next. An example for this business flow is as follows: Business Transaction

Budget Remaining

Commitment

Obligation

Actual

Budget Allocated for Expenditure $10000

10000

-

-

-

Purchase Requisition (PR) created for $ 2000

10000

-

-

-

PR Approved

8000

2000

-

-

PR Auto-created to Purchase Order (PO)

8000

2000

-

-

Purchase Order Value changed from $2000 to $ 2500

8000

2000

-

-

Purchase Order Approved

7500

(2000) -

2500

-

Invoiced received and matched against PO for $ 1000

7500

-

(1000) 1500

1000

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Encumbrance Accounting in the Procure to Pay Flow: Best Practices

Initially, assume that a budget amount of $10000 is allocated for certain expenditure. Notice that when a Purchase Requisition is created, there is no impact on Encumbrance. The commitment is recorded when the Purchase Requisition is approved. If there are multiple approvers, it gets recorded at the time of the final approval for the document. Once the commitment is created, it is not liquidated until the Obligation is recorded. Obligations are recorded when a Purchase Order is approved. Again, if there are multiple approvers, the obligation is recorded at the time of the final approval for the PO. The obligation is always created for the PO amount, irrespective of the backing commitments. While recording the obligation, any backing commitments created through the backing PRs are liquidated. When receipts are created or invoice is matched against a PO, the obligation is liquidated and the actual expenditure is recorded.

Encumbrance Accounting – Procure to Pay with Journal Entries In the following section, we will focus on the following flows: •

•

•

•

•

•

•

•

Creation of Budgets Purchase Requisition Approval & Reserve Purchase Order Approval & Reserve PO Changes: Increase or Decrease of Qty PO Changes: Cancellation of Quantities/Lines/Shipments Receipt of Goods/Services Invoice Matched to PO Payment to PO Vendor.

Creating Budgets Encumbrance Accounting always works together with budgetary control. At the beginning of a fiscal year, enterprises estimate how much they are going to spend in the future, based on business plans for the forthcoming year. The planned expenditures under various heads is estimated and used to create budgets. Enterprises can use this budget amount to compare it to actual expenditure at any time in order to track and monitor actual spending. In Oracle e-Business Suite, users can create budgets using the following steps:

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1.

Login and select an appropriate General Ledger responsibility.

2.

Navigate to General Ledger > Budget > Enter > Journals

Encumbrance Accounting in the Procure to Pay Flow: Best Practices

Figure 1: Setting up Budget for Encumbrance Accounting

3.

Enter a budget amount for specific accounts for each period.

Figure 2: Funds Availability after Budget Creation

Navigating to the Funds Availability Inquiry window, the budgets would now reflect as created. In this example, the Budget was created for $20,000. The next section describes how these budgets will be used and encumbrances created or liquidated in various scenarios.

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Encumbrance Accounting in the Procure to Pay Flow: Best Practices

Purchase Requisitions Approval and Reserve The following example outlines Encumbrance Accounting for recording commitments. The user intends to buy some office stationery this month. The estimated amount is approximately $ 3,000. Steps: User creates a Purchase Requisition (PR) for $3,000. User ensures that the correct distribution account is selected for the PR line. •

•

The user performs the Funds Check action to ensure that sufficient funds are available for reserving the money required for this purchase, against the Budget. The user submits the document for approval and the approver approves the document. The following are the accounting details:

Event Type

Requisition Reserve

Encumbrance Type

Commitment

Balance Type

Encumbrance

Journal Entry Date

Encumbrance Date as provided in the PR distribution

DEBIT

Budget Account from PR Distribution

CREDIT

Reserve for Encumbrance (Commitment)

$3,000 $3,000

Note: If there are multiple PR distributions for the PR line, each distribution is debited separately with corresponding credit on the Encumbrance Date specified in the respective PR distributions. The remaining budgetary funds are as follows:

Figure 3: Budget Position after Commitment

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Encumbrance Accounting in the Procure to Pay Flow: Best Practices

Purchase Order Reservation & Approval After the Requisition is approved, the user can place the Purchase Requisition details in a Purchase Order (PO) document. Steps:

• •

The user uses Autocreate process to create the Purchase Order document from the Purchase Requisition. The user submits the PO document for approval and the Approver approves the document. The following are the accounting details:

Event Type

Requisition Un-Reserve

Encumbrance Type

Commitment

Balance Type

Encumbrance

Journal Entry Date

Encumbrance Date as provided in the PO distribution

DEBIT

Reserve for Encumbrance (Commitment)

CREDIT

Budget Account from PR Distribution

$3,000 $3,000

Event Type

Purchase Order Reserve

Encumbrance Type

Obligation

Balance Type

Encumbrance

Journal Entry Date

Encumbrance Date as provided in the PO distribution

DEBIT

Budget Account from PO Distribution

CREDIT

Reserve for Encumbrance – (Obligation)

$3,000 $3,000

Note: If the user creates the PO manually without the referenced PR, it can lead to the duplication of reservation of funds for the same transaction. Further, if the PO line distribution amount changes from $3,000 to $3,500, the commitment un-reserve will take place for $3,000 (backing PR distribution amount) and PO reserve will happen for $3500.

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Encumbrance Accounting in the Procure to Pay Flow: Best Practices

The budgetary funds remaining will now reflect as:

Figure 4: Budget Position after Obligation

Changes to PO: Increase quantity or price through Revision After the PO is approved, it is likely that the PO quantities / prices / amounts may be changed. A PO revision is created in such situations in order to update these changes in ...