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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.

Prerequisites:

  • 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)

Overview:

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 Variances

Output Variances

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.


Resource-Usage Variance:

Caused by the use of different materials and activities than were planned in BOMs and Routings/Master Recipes.

Output Price Variance:

  • If standard price changed between delivery to stock and when variances are calculated
  • If price control V materials are not delivered to stock at standard price
  • If price used to valuate inventory is not a mixed price

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.

Remaining Variance:

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.

Scrap Variance:

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).

Relatable Example:
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:

http://scn.sap.com/community/erp/financials/controlling/blog/2013/01/02/5-steps-to-understanding-product-costing-part-1-cost-center-planning

http://scn.sap.com/community/erp/financials/controlling/blog/2013/01/02/5-steps-to-understanding-product-costing-part-2-activity-rate-calculation

http://scn.sap.com/community/erp/financials/controlling/blog/2013/01/02/5-steps-to-understanding-product-costing-part-3-quantity-structure

http://scn.sap.com/community/erp/financials/controlling/blog/2013/01/02/5-steps-to-understanding-product-costing-part-4-costing-run

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      42 Comments
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      Author's profile photo Former Member
      Former Member

      Great job, thanks for your knowledge sharing!

      Author's profile photo Former Member
      Former Member
      Blog Post Author

      Thanks for reading Luca!

      Author's profile photo Former Member
      Former Member

      Hi Tanay,

      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

      Author's profile photo Former Member
      Former Member
      Blog Post Author

      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?

      Author's profile photo Udo Werner
      Udo Werner

      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.

      Author's profile photo Former Member
      Former Member
      Blog Post Author

      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.

      Author's profile photo Former Member
      Former Member

      Thank you Very much for your great Inputs Tanya

      Author's profile photo Former Member
      Former Member
      Blog Post Author

      Thanks for reading Fernando! Let me know if you have suggestions for future blogs.

      Author's profile photo Former Member
      Former Member

      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?

      For example:

      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.

      Thanks

      Author's profile photo Former Member
      Former Member

      Why should you separate it to sales cost and inventory? If you really need it, you should use Material Ledger.

      Author's profile photo Former Member
      Former Member

      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..

      Author's profile photo Former Member
      Former Member
      Blog Post Author

      I appreciate it!

      Author's profile photo RAHEEM BAKSH
      RAHEEM BAKSH

      Very good............

      Author's profile photo Sivakumar Thangarajan
      Sivakumar Thangarajan

      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.

      Regards

      Siva


      Author's profile photo Former Member
      Former Member
      Blog Post Author

      Thanks Siva! I like the cookie example because it's so easily understood.

      Author's profile photo Alexandre Costacurta
      Alexandre Costacurta

      Hi, Tanya. Thanks for sharing such informative steps. You really make PC understandable to everyone. Best regards.

      Author's profile photo Former Member
      Former Member
      Blog Post Author
      Thank you for reading Alexandre!
      Author's profile photo Former Member
      Former Member

      Dear Tanya,

      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

      Ganesh.

      Author's profile photo Louise O'Driscoll
      Louise O'Driscoll

      Very clear description and easy to understand

      Thanks Tanya

      Author's profile photo Muthukumareshan vijayan
      Muthukumareshan vijayan

      Hi Tanya,

      Good Work and Easy to understand all point

      Thanks

      Muthu

      Author's profile photo Jignashu Bodawala
      Jignashu Bodawala

      I loved your series. Excellent Work.

      Author's profile photo Former Member
      Former Member

      Thank you for sharing.......... Is it possible  to share COPA as well please..........

      Author's profile photo venkata ramana
      venkata ramana

      Thank your for sharing. and i want to copa

      Author's profile photo Alok Kumar Tiwari
      Alok Kumar Tiwari

      Dear Tanya Duncan,

      Ultimate Job...!!!

      Thank you for sharing and putting a lot of effort.

      Regards,

      Alok Tiwari

      Author's profile photo Former Member
      Former Member

      I am new to product costing and this blog helped me understand the basics. I love the cookie example too. Thanks Tanya! 🙂

      Author's profile photo Former Member
      Former Member

      Hi Tanya,

      Thanks for your detailed blog on PC with suitable instance. Great effort and good job.

      Regards,

      Prakash.S

      Author's profile photo Former Member
      Former Member

      Hi Tanya,

      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! 😘

      Regards.

      Hari Suseelan

      Author's profile photo Former Member
      Former Member

      Well done for five star contribution.

      Author's profile photo Amit Kumar Kataria
      Amit Kumar Kataria

      Great Effort!!!!!

      Amit

      Author's profile photo Venkatesh B
      Venkatesh B

      Hi Tanya, Thanks a lot for sharing.

      Regards

      Venkatesh  Bandi

      Author's profile photo Ajay Jawalkar
      Ajay Jawalkar

      Hi Tanya,

      Thanks for sharing.

      Enjoyed Reading!

      Regards,

      Ajay

      Author's profile photo Manohar Gowri Shankar
      Manohar Gowri Shankar

      Hi Tanya,

      Article is great help to people who are new to PC.

      Thank you for this details.

      Regards

      Manohar G Shankar

      Author's profile photo Erwin Leitner
      Erwin Leitner

      Hello,

      Thank you very much for excellent and super document.

      ➕ ➕ ➕

      all the best Erwin

      Author's profile photo Former Member
      Former Member

      Good work.

      Author's profile photo Chris Coviello
      Chris Coviello

      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?

      Author's profile photo Former Member
      Former Member

      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

      Author's profile photo Former Member
      Former Member

      Great article.....specially the variance part.

      Author's profile photo Junaid Shera
      Junaid Shera

      Great work 🙂

      Author's profile photo Former Member
      Former Member

      Thanks for your sharing. It helps a lot, especially the activity rate planning part.

      Author's profile photo Jaidev Solanki
      Jaidev Solanki

      all the parts are written in very nice manner enabling even for beginners to understand the concepts.

      Thanks Tanya Duncan

      Author's profile photo Sattaiah Gundu
      Sattaiah Gundu

      Good explanation

      Author's profile photo Shagun Maheshwari
      Shagun Maheshwari

      This is an awesome series on product costing for beginners 🙂

      Really appreciate your efforts.