5 Steps to Understanding Product Costing- Part 2 Activity Rate Calculation
Product Costing, part of the Controlling module, is used to value the internal cost of materials and production for profitability and management accounting. Product Costing is a niche skill. Due to costing’s high integration with other modules, many people avoid it due to the complexity. This 5 part blog will seek to simplify Product Costing.
Now that you understand Cost Center Planning, the next step in understanding the basics of product costing is Activity Rate Calculation. The goal of Activity Rate Calculation is to calculate the plan activity rates for each activity in each Cost Center in a Plant.
- Cost Center Plans are entered:
- Plan Costs in KP06
- Plan Activity units in KP26
Now that our Cost Center dollars and activity quantities are planned, we need to calculate Activity Type Rates. Activity Type Rates are used to value internal activities to produce products.
If you manually entered activity rates based on last year’s actual values instead of planning total dollars and units. You can skip most of this blog, and simply review activity rates in Transaction KSBT. Note that you can use a mixed approach and plan rates for some activities/cost centers and calculate rates for others.
If you planned all costs in production cost centers where they will be allocated, you can skip the next step of plan allocations.If you planned costs where they are incurred in overhead cost centers, you will need to use plan assessments and/or distributions to allocate costs. The specific details on Assessments and Distributions could be an entire blog in itself.The main difference between assessments and distributions is that distributions maintain the identity (primary cost element) of the cost. Assessments use Secondary Cost Elements which act as cost carriers to move costs, and therefore lose the identity (primary cost element) of the cost. You can choose to use Assessments or Distributions only, or use a mixed process. Plan Assessments and Distributions are created in Transactions KSU7 and KSV7 and executed in Transactions KSUB and KSVB.
After costs are allocated, it is important to review the Cost Center Actual/Plan/Variance report, Transaction S_ALR_87013611. Ensure that allocations credited sending cost centers and debited receiver cost centers.
Next, execute plan cost center splitting which splits costs when you have more than one activity type in a cost center and you want to split the costs between two activities based on activity qty or some other basis. This is a great place to use Cost Center groups to easily select desired cost centers since you cannot enter a range. Cost splitting uses Transaction KSS4.
Finally, Activity Type Rates are calculated using Transaction KSPI. If rates are undesirable, you can revise your cost center plans and recalculate rates. Rates are not final until you use them to calculate and release product costs. This is an iterative process, and it is expected that you will make several attempts at desirable rates.
After calculating Activity Type Rates, you can review rates in Transaction KSBT.
Let’s say we are using Product Costing to value our inventory in a cookie baking shop. This will help us value our cookies (finished good), frosting (semi-finished good), and baking items like eggs, milk, and sugar (raw materials). In order to calculate costs, we need to come up with rates for each activity, such as mixing baking items, oven baking, and cookie cooling. We planned overhead costs like our building rent, electricity, and baker wages at an overhead cost center. We need to allocate those costs to our production cost center in order to include those costs in our product cost. Prior to calculating costs, let’s assume there are some overhead costs in a cost center that should be split into multiple activities. Once we split these costs, then we calculate rates for activities. Now we have a dollar per unit for activities like indirect labor, direct labor, setup, and overhead to use in product costing.
- You can use Cost Center Groups and Cost Element Groups to simplify selecting Cost Centers and Cost Elements in KSBT and KSPI and in other Cost Center/Cost Element Reports.
- You may find that your rates are not appearing for certain months, or that they are averaged over 12 months. Make sure you review the ‘Period Overview’ screen in Cost Center planning Transactions KP06 and KP26. This screen shows costs and units by each month.
- You can reverse Assessments and Distributions if results are undesirable.
- In theory, your plan Assessments and Distributions should match your actual Assessments and Distributions.
The next blog in the series explains how production data like BOM’s (Bills of Material), Routings/Master Recipes and Work Centers integrate with Product Costing.
If you missed my previous blog, use the link below: