5 Steps to Understanding Product Costing- Part 5 Actual Costs
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.
The fifth and final step in understanding the basics of product costing is actual costs. Actual costs are determined through purchase prices, actual expenses, and confirmed production quantities. Actual costs are compared to standard costs through variance analysis to make management decisions and determine profitability.
- Material Masters (including MRP, Accounting, & Costing views)
- Quantity Structure (Bill of Materials, Routing or Master Recipe, Production Versions are optional)
- Configuration (WIP, Variance, and Settlement)
- CO Master Data (Primary and Secondary Cost Elements, Activity Types, Actual Assessment/Distribution Cycles, Actual Statistical Key Figures if required)
Throughout a given period, actual expenses are recorded in SAP as purchases are made, payroll is processed, bills are paid, and production occurs. At month-end, Work in Process, Variance, and Settlement are calculated. The variance between actual costs and standard costs can result in changes to product costing for the next period or year. Costs are settled and the posting period is closed at the end of the month end process to avoid material movement or accounting postings in the previous period.
In product cost by order, actual production yield, scrap, and activity quantities are entered in a production confirmation. The production costs are collected on the production orders for review and settlement. In product cost by period, product cost collectors are used to calculate WIP, variances, and settlement instead of the planned orders.
Prior to calculating variances and settling orders, orders must run through WIP calculation to determine what part (if any) of an order is not complete. You can calculate work in process at target costs for Product cost collectors, Production orders, and Process orders. Only orders that have a valid results analysis key and are not in status DLFL (Deletion flag) or DLT (Deleted) are included in WIP calculation.
In Product Cost by Period (repetitive manufacturing), the quantities confirmed (other than scrap) for manufacturing orders or production versions are valued at target cost based on the valuation variant for WIP and scrap. In Product Cost by Order (discrete manufacturing), WIP is the difference between the debit and credit of an order that has not been fully delivered.
SAP offers variance analysis on the input (consumption, overhead allocation, actual expenses) side and output (production quantity or valuation) side.
Input Price Variance:
Caused by differences between plan and actual material and activity prices. Only calculated if material origin is selected on material master.
Mixed Price Variance:
Caused when the system determines a different mixed cost than the released cost estimate. Must be selected in the variance variant to see.
Caused by the use of different materials and activities than were planned in BOMs and Routings/Master Recipes.
Output Price Variance:
Material Quantity Variance:
Caused by different material and quantities than were planned in BOMs.
Lot Size Variance:
Differences between the planned and actual costs that don’t vary with lot size.
Remaining Input Variance:
This occurs when costs are entered without a quantity or when OH rates are changed.
Differences between target and allocated actual costs that cannot be assigned to any other category. Also used when no variance categories defined in variance variant.
Caused by differences between operation scrap in routing and actual scrap confirmed.
Finally, we must settle our orders or product cost collectors. Product Cost Collectors and orders are debited with actual costs during production. The actual costs posted to an order can be more or less than the value with which an order was credited when the goods receipt was posted. When you settle, the difference between the debit and credit of the order is transferred to Financial Accounting (FI).
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).
At month-end, we determine what batches of cookies are still in progress (WIP), review our actual expenses and compare to our planned expenses (variances), and close our books for the month (settlement). The cookies still in the oven are considered WIP (order status not complete). We notice several types of cost variances due to higher milk costs (unfavorable input price variance), less frosting waste (favorable scrap variance), and a cost difference because we planned to purchase a higher percent of eggs from a lower cost farmer (unfavorable mixed price variance). After analyzing these variances, we make a few changes to our inventory costs of eggs and look for ways to save on milk costs. We close our books for the month and record our profit and loss to the Income Statement.
Thank you for reading this blog series on Product Costing. I plan to feature special configuration topics in product costing in my next blog series. You can read more of my blogs at TanyaDuncanBlog.com.
If you missed the previous four blogs, catch up by following these links:
Great job, thanks for your knowledge sharing!
Thanks for reading Luca!
I have been reading your blogs and i can not explain you how beneficial to me. Need one help form me, getting answer of below client requirement and if you have any config document for the same that would be great help to me. Below is the requirement.
How to distribute the cost of one cost center to different profit center. This is my client requirement.
Hope you help me. Thanks for your help in advance.
Ashu- sorry for the delayed response. I don't check my notifications frequently enough on SCN. I'm wondering if you really want to distribute the costs in one cost center to another cost center that has the profit center you want to use. Or perhaps you want to change an existing cost center to have the proper profit center. Can you explain more?
One should add that real actual costs by product come with the usage of material ledger actual costing. The variance analysis WIP etc covered here is always by order, not by material, and it doesn't take multi-level price differences into account.
In the cookie baking exmple above that would mean, if you have a semi-finished material, let's call it batter, in your production process, you would see the milk price and usage variances only in the daily orders for batter production, but they would not appear in the cookies.
With Material Ledger you would get a monthly reporting on actual costs for cookies, including all variances from Milk, Eggs, scrapping etc., based on actual prices and actual consumption and production quantities.
Very true. I think a follow up blog to this series would be material ledger/actual costing. I decided to keep it simple with repetitive and discrete orders with standard costing. Material ledger is a complicated topic for beginners.
Thank you Very much for your great Inputs Tanya
Thanks for reading Fernando! Let me know if you have suggestions for future blogs.
Hi Tanya, thanks for your know-how.
Gegarding the variance, I have following question.
If the Material Ledger is inactive, how to classify the variance after settlement?
Finished Goods A, the plan quantity of the production order is 10, the standard cost is 9 while the actual cost is 7. in current month, the production order is completed. and the variance of the production order is 20. the FI document as follows:
Dr: COGM offset 20
Cr: COGM Variance 20
All the variance settled to PL account. That figure should be ok is all the Finished Goods is sold out in same period. But, If the quantity of the FG sold out is 6 in same period, we should split the variance manually. Amount 20*4/10=8 repost to inventory while amount 20*6/10=12 posted to Cost of Good Sold. some developed reports required to determine rate between Good sold and Inventory.
Is there any standard solution for that case?
Hope this is clear and look forward to your reply.
Why should you separate it to sales cost and inventory? If you really need it, you should use Material Ledger.
Very good and informative article related to Product Costing , You have explained the complex Product Costing module in simple 5 steps.Kudos. It will be understandable even to the end users..Thanks for your information Tanya..Continue the good work...my best wishes...I registered myself in your blog..
I appreciate it!
The cookie baking shop example has added the real value to your article and makes the readers to understand the real concept of Product Costing in a simple way. Thanks for sharing the Knowledge.
Hope to get one more article for COPA too in the near future.
Thanks Siva! I like the cookie example because it's so easily understood.
Hi, Tanya. Thanks for sharing such informative steps. You really make PC understandable to everyone. Best regards.
Many thanks for sharing the Product costing knowledge transfer. through this blog i understand the product costing very clearly .I hope this thread will be useful for many viewers.
Hope if you share threads on CO-PA it will be very grateful.
Thanks in Advance
Very clear description and easy to understand
Good Work and Easy to understand all point
I loved your series. Excellent Work.
Thank you for sharing.......... Is it possible to share COPA as well please..........
Thank your for sharing. and i want to copa
Dear Tanya Duncan,
Thank you for sharing and putting a lot of effort.
I am new to product costing and this blog helped me understand the basics. I love the cookie example too. Thanks Tanya! 🙂
Thanks for your detailed blog on PC with suitable instance. Great effort and good job.
Good explanation about Input Variance and Output Variance. Keep up the good work!
I like the way you have documented. Keep sharing and motivating others! 🙂
Good Luck! Happy New Year 2014! 😘
Well done for five star contribution.
Hi Tanya, Thanks a lot for sharing.
Thanks for sharing.
Article is great help to people who are new to PC.
Thank you for this details.
Manohar G Shankar
Thank you very much for excellent and super document.
➕ ➕ ➕
all the best Erwin
Great article... have you ever had an issue with the cost collector during separated back flush? For example, we have an issue with the product cost collector being blocked during back flush processes. Any idea what might be causing the error?
Thank you Tanya. Have you developed any document on Profit Center and Profitability Analysis? If you develop on different modules of controlling. That would be very helpful
Great article.....specially the variance part.
Great work 🙂
Thanks for your sharing. It helps a lot, especially the activity rate planning part.
all the parts are written in very nice manner enabling even for beginners to understand the concepts.
Thanks Tanya Duncan
This is an awesome series on product costing for beginners 🙂
Really appreciate your efforts.