Basic Overview on

Product Costing
Table of Contents
OBJECTIVE .................................................................................................................. 3

PRODUCT COST PLANNING .............................................................................................................. 3

VALUATION METHOD OF MATERIALS (AS BEST PRACTICE) ..................................................................... 4
MOVING AVERAGE COST................................................................................................................. 4
STANDARD COST ............................................................................................................................ 4
COST OBJECT CONTROLLING .......................................................................................................... 15
EXECUTION OF MANUFACTURING PROCESS – COSTING ...................................................................... 16
MONTH END CLOSING STEPS PERFORMED ........................................................................................ 20
ACTUAL COSTING ......................................................................................................................... 21

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Objective
The objective of this white paper is to explain, how the product cost is calculated
in SAP System.

Product costing is one of the key areas in Manufacturing and process industries. It
is used for estimating and valuating the internal cost of a product. Product cost
planning is used for estimating/predicting the cost incurred in producing a Finished
Product. This estimate is also used for budgeting purpose. When the material is
actually produced, the actual cost is incurred and the variance between planned
cost and the actual cost is calculated. Based on the magnitude of variance,
decision is taken to re-estimate the cost of the materials.

The complete Product costing in SAP is divided into three main components:

1. Product Cost planning

2. Cost Object Controlling

3. Actual Costing

The details of each component is described in next section.

Product Cost Planning

Product Cost Planning makes a distinction between assemblies (materials that
have Bill of Materials - BOMs) and material components (materials that do not have
BOMs). The costs of the assemblies are calculated level by level. The process of
assigning the costs of the subordinate material components and assemblies to
each of the higher production levels is called cost rollup.

The purpose of cost rollup is to include the cost of goods manufactured of all the
materials in a multilevel production structure within the costs of the material located
at the top of the structure. The costs are rolled up automatically using the costing
levels.

The system first calculates the costs for the materials with the lowest costing level
and assigns them to cost components.

The materials in the next higher costing level (such as semi-finished materials) are
then costed. The costs for the materials costed first are rolled up and become part
of the costs of goods manufactured in the next higher level.

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This process is continued until the costing results of the highest material in the
structure (such as the finished product) contain the cost of goods manufactured
for every material in the structure.

Valuation Method of Materials (as best practice)

Raw Material Moving Average Cost

Packaging Materials Moving Average Price

Finished Goods Standard Cost

Semi Finished Goods Standard Cost

Moving Average Cost

This is an Actual Price, calculated and adjusted with every goods receipt and
Invoice receipts.

It is calculated as follows:

Total Value of Materials / Total Quantity in Stock

Standard Cost
The cost of a product consists of following components:

1. Direct Material Cost

2. Indirect Material Cost

3. Manufacturing Overhead

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Anatomy of Product’s Cost

Structure Component Component

Quantity Bill of Material Routing

Structure

Valuation Cost of Input Material Price of Activity

(defined in material
master – could be the
Standard Cost or
Moving Avg Cost)

Components of Costing Products

Bill of Materials (BOM): Bill of Material is the recipe of the materials that go into
producing or making the (Semi Finished or Finished) products.

A Single-level BOM comprises of components that make up a recurring production

process. This BOM can be used multiple times to produce the same product.

A multi-level BOM comprises components that make up a production process. The

assembly has its own single-level BOM.

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Routing: Routing is a list (and details) of operations that are carried out in
production process.

It is a good idea to create a separate cost center per work center to capture cost
and recoveries from production.

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Cost Center is assigned to Work Center through Activity Type. For example, you
carry out Activity Type ‘Pack’ in Work Center ‘Packing’ that is associated with a
Cost Center ‘Packing’. The Work Center belongs to Operation ‘Packing’.

With routing, you can plan the operation steps to be carried out in production; the
activities to be performed; the location where activities will be performed.

Below is an example of the data routing could hold.

Activity Type quantity per

Operation Work Center Activity
ton
Cleaning Cleaning Labour Hour 5 hr
Milling Milling Electricity 20 KW
Mixing Mixing Electricity 5 KW
Packing Packing Labour Hour 2 hr

Material Cost: Unit Cost of Material is stored against the Material Master. Material
Master in SAP stores Standard Cost and Moving Average Cost. The selection of
basis of valuation (‘Price Control’ in SAP terms) will determine which price is used
to valuate the material.

Activity Rate: Rate at which individual activity type is valued. Activity rate is
fixed for a combination of activity type + Cost Center + period/year + version.

Rate of Activity Types can be calculated / entered on a periodic basis or on an

annual basis.

Calculation of activity rate:

Plan Activity Rate per Unit = Estimated (Plan) Costs related to that Activity /
Estimated Cosnumption of Activity in Units

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It is recommended that values planned (budgeted) at the begininging of the year
be used to calculate activity rates. This will ensure annual budget values compare
with actual.

Steps to generate an Activity rate / Price:

Plan Direct Overhead Costs:

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Allocate Plan Overhead Cost:

Calculate Overhead Activity Rate:

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Cost Roll up:

Cost Roll up refers to roll up of Cost bottom-up from component to finished

products. During cost roll up SAP costs the components and activities at the lowest
level of the production BOM and increments the cost by rolling it up to higher level
till the highest level of product is costed.

Process of Product Cost Roll up:

1. Cost estimate is a proposed cost estimate for the Semi Finished and Finished
Goods.

2. Business analyzes the cost estimate for accuracy. Changes (if any) are made
to quantity or valuation structure. Cost Estimate is re-run.

3. Once Approved, costs are Marked (i.e. marked as proposed or future cost
estimates)

4. The marked cost estimates are Released (i.e. made effective for all goods
movment subsequent to that release)

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Steps in SAP for a Product Cost Roll up:

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Price Update – Mark and Release:

EUR 11 EUR 12 EUR 0

New Cost Estimate EUR 13 is marked

EUR 11 EUR 12 EUR 13

New Cost Estimate EUR 13 is released

EUR 12 EUR 13 EUR 0

Accounting impact of Product Costing Process:

1. When a Standard Cost estimate is created, there are no accounting

implications.

2. When a Standard Cost estimate is marked, there are no accounting

implications. The new cost is updated in the field ‘Future Cost Estimate’.

3. When a Standard Cost Estimate is released,

3.1. The released cost is updated in the ‘Current Cost Estimate ‘ field (from
the ‘Future Cost Estimate’ field)

3.2. The Inventory will revalue with the new Standard Cost Estimate. The
revaluation difference is written off / written back to P&L.

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Accounting Impact of Release of Product Cost:

EUR 12

New Cost Estimate EUR 13 is released

EUR 13

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 To Summarize the Standard Cost of Material:

Indirect Splitting cost

Direct Production Activity Price
Production Cost Element to
By Activity or SKF Cost Center Calculate
Center
By SKF Activity

Run Cost
Estimate

By Activity Or SKF
Indirect
Production Cost Estimate product
Center costing

Standard Cost = Material Cost + Manufacturing Overhead Cost

Material Cost = Cost of RM + PM + SFG

Standard Quantity from BOM X Price from material Master

Manufacturing OH Cost = Cost of Electricity + Variable Cost + Fixed Cost

Standard Quantity in Routing X Plan Price

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Cost Object Controlling
The Cost Object Controlling component is designed to answer the question: What
costs have been incurred for which objects? For this purpose, the component
assigns costs to the output of the company. The output can be materials
manufactured in-house, individual orders, or intangible goods.

This component provides real-time cost management functions that measure the
cost of goods manufactured in all plants.

Cost Object Controlling enables you to determine the cost of goods manufactured
and the cost of goods sold.

You can:

Establish planned costs (budgeted costs)

Record actual costs for the cost objects

Compare actual costs with target costs and with planned costs, and analyze
variances

Determine price floors for products or individual orders.

Product Cost Integration:

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Execution of Manufacturing process – Costing
Process orders are created for the production of semi-finished and the finished
products.

Based on the product for production, the relevant Bill of material (BOM) and the
master recipe will be used for production and costing. Upon creation and release
of the process order, a preliminary costing will be calculated as follow.

Confirmation
Production Order Confirmation Period Cut Off
Consumption for RM &
Create & Release PM Goods Receipts for and Actual
Preliminary Costing Consumption for Activity SFG & FG Costing
Type

Raw material cost = Standard Qty in BOM X MAP price for raw material

Packaging material = Standard Qty in BOM X MAP price for packaging Materials

Chemicals = Standard Qty in BOM X MAP price for chemicals

While the Standard Qty for each material used in production is derived from the
BOM, the respective unit price for the material is derived from the material master
based on the price control indicated in the material master.

The following activities in production are included after each activity planned
price is calculated:

Electricity = Std Qty in Recipe X Planned activity price/KW

Steam = Std Qty in Recipe X Planned activity price/MT

Fixed Cost = Std Qty in Recipe X Planned activity price/MT

Other Variable Cost = Std Qty in Recipe X Planned activity Price/Hr

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Order Confirmation:

Upon completion, the production personnel will confirm the order. The SAP PP is
designed such that upon confirmation, goods issues, confirmation of activity and
goods receipt of the production output will be triggered at the same time.

Confirmation
Production Order Confirmation Period Cut Off
Consumption for RM &
Create & Release PM Goods Receipts for and Actual
Preliminary Costing Consumption for Activity SFG & FG Costing
Type

Goods Issue to Process Order:

Raw materials, semi-finished, chemicals or packing materials are issued via

movement type 261. The material qty consumed (via backflush in PP) and the total
material cost incurred will be posted to order. The posting is as follows:

Dr/Cr GL Account Description Cost Object

For Raw Material Issue
Consumption of Raw
Dr P&L Process Order
Materials
Cr Balance Sheet Inventory of Raw Materials
For Goods Issue of Semi Finished
Consumption of Semi
Dr P&L Process Order
Finished Materials
Inventory of Semi Finished
Cr Balance Sheet
Materials
For Chemical Issue
Dr P&L Consumption of Chemicals Process Order
Cr Balance Sheet Inventory of Chemicals
For Goods Issue of Packing Materials
Consumption Packing
Dr P&L Process Order
Materials
Inventory of Packaging
Cr Balance Sheet
Materials

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Manufacturing Process – Absorption of Utilities and Other indirect costs

Activity Confirmation:

Upon order confirmation, activities such as electricity, Steam Fixed Cost and Other
Variable Cost will also be confirmed based on the actual volume and time used in
production. Actual volume/time used will be entered in order, and valuated as
follow:

Electricity = Actual Qty X Planned activity price/KW

Steam = Actual Qty X Planned activity price/MT

Fixed Cost = Actual Qty X Planned activity price/MT

Other Variable Cost = Actual Qty X Planned activity Price/Hr

Manufacturing Process – Absorption of Utilities and Other indirect costs (FI

Posting): The postings are as follows:

Secondary Cost
Dr/Cr Cost Object
Element Description

For Electricity
Dr Electricity Process Order
Cr Electricity Cost Center
For Steam
Dr Steam Process Order
Cr Steam Cost Center
For Fixed Cost
Dr Fixed Cost Process Order
Cr Fixed Cost Cost Center
For Other Variable Cost
Dr Other Variable Cost Process Order

Cr Other Variable Cost Cost Center

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Manufacturing Process – Output Confirmation

Goods Receipts

Confirmation
Production Order Confirmation Period Cut Off
Consumption for RM &
Create & Release PM Goods Receipts for and Actual
Preliminary Costing Consumption for Activity SFG & FG Costing
Type

Upon order confirmation, goods receipt of the semi-finished or finished goods will
be performed. For packaging process, the quantity completed will be delivered to
the Warehouse. The financial posting is:

Dr/Cr GL Account Description Cost Object

For Semi Finished Goods
Inventory of Semi
Dr Balance Sheet
Finished Goods
Cr P&L COGM Process Order
For Finished Goods
Dr Balance Sheet Inventory of Finished Goods
Cr P&L COGM Process Order
For Co Products
Dr Balance Sheet Inventory of Co Products
Cr P&L COGM Process Order

Period Cut Off:

At month end, after all Production orders have been confirmed, the actual cost
calculation can proceed. A period cut-off is usually performed in SAP to cut-off
figures for the month.

Confirmation
Production Order Confirmation Period Cut Off
Consumption for RM &
Create & Release PM Goods Receipts for and Actual
Preliminary Costing Consumption for Activity SFG & FG Costing
Type

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 Month end closing steps performed
1. Cost allocations

2. WIP Calculation

3. Variance calculations

4. Settlement of variances for all production orders

Cost Allocation:

At the month end, all the cost from Service Cost Centers, Maintenace Cost
Centers, Administrative Cost Centers are allocated back to Production Cost
Centers.

The allocation will be based on Actual Production Volume at respective Production

Cost Centers.

Work in Progress:

Work in process (WIP) inventory forms a part of the working capital or current
assets of a firm appearing in their balance sheet. Work in process or
progress are partially completed goods, parts, or subassemblies that are no
longer part of the raw materials inventory and not yet part of the finished products
inventory.

With SAP, the raw materials gets transferred to finished goods via production
orders or process order. In this process, typically, the production order is created
to which raw materials are issued.Production is ongoing, and it is quite natural that
at month end, we end up with some open production orders. SAP in its product
costing functionality, provides the feature to calculate the value of WIP. The WIP
shall be the total debits cost in the order as reduced by the credits for goods
receipt.

The accounting entries during Work in Progress calculation us as follows:

Dr/Cr GL Account Description

Dr Balance Sheet Work in Progress
Cr P&L Change in WIP

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Settlement of Variances for Production Orders:

Once we do the variance calculation then variance represents the difference

between Total Cost charged to process/production order and cost of Finished
Goods receipt. These variances basically represents quantity variance of raw
material and activity, i.e. (Actual Quantity Less plan quantity) * Standard Rate.

Variance calculated at this step gets posted in Material Ledger to adjust the actual
cost of finished goods produced.

The accunting entry will be as follows:

Dr/Cr GL Account Description

Dr P&L Cost of Goods Manufacture
Cr P&L Production Variance

The production Variance are also posted to Profitability Analysis.

To Summarize the Actual Cost of Material:

Indirect Splitting cost

Direct Production Activity Price
Production Cost Element to
By Activity or SKF Cost Center Calculate
Center Activity
By SKF

Revaluation
Process Order

By Activity Or SKF
Indirect
Production Cost Variance
Run Cost Actual WIP Calculate
Center Calculate

Actual Costing
Actual costing expands upon the functionality of the application components with
the purpose of determining actual costs for externally procured materials and
materials produced in-house. In addition, actual costing uses actual costs to
valuate inventories of raw materials, semifinished products, and finished products.

Actual costing calculates an actual price (periodic unit price) for each material, into
which all actual costs for the particular period flow.

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Concept behind Actual Costing:

Actual costing valuates all goods movements within a period at the standard price
(preliminary valuation). At the same time, all price and exchange rate differences
for the material are collected in the material ledger.

At the end of the period, an actual price is calculated for each material based on
the actual costs of the period. This actual price is called the periodic unit price and
can be used to revaluate the inventory for the period to be closed. In addition, you
can use this actual price as the standard price for the next period.

Price Differences:

Price Differences occur under below circumstances.

1. In-house production (settlement of Orders)

2. Procurement (Purchase Price Difference)

3. Exchange rate Variance

4. Subcontracting

5. Material to Material Transfer

Actual costing functionality enables the distribution of variances (PPV and

manufacturing) to semi-finished and finished product. Revaluation variance is
automatically recorded when the price for a material is updated. Revaluation is
also tracked at the plant/material level through the material ledger. Automated
calculation and capitalization of direct material variances.

Three steps in Actual Costing:

1. Preliminary Valuation at Standard and recording price differences.

2. Price Determination: Calcualtion of Periodic Unit Price

3. Period End Closing: Revaluation of Materials with Periodic Unit Price

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 Period 1 – Beginning Inventory Value

Real time valuation with Difference between Average Actual Price

Standard Price Standard Price and
Actual Price

Preliminary Price
Quantity Price
Valuation Difference
Beginning Inventory 1000 25000 25.00
Receipts
Other Receipts/
Consumption
Cumulative Inventory 1000 25000 25.00
Consumption
Ending Inventory 1000 25000 25.00

Multilevel Actual Costing:

Period 1 – Closing – PUP determination

Standard Price 25.00

Periodic Unit Price 26.50 = 53000 (preliminary valuation at STD + Price diff)
2000 (cumulative inventory)

Preliminary Price
Quantity Price
Valuation Difference
Beginning Inventory 1000 25000 25.00
Receipts 1000 25000 3000 28.00
Other Receipts/
Consumption 0 0 0 0.00
Cumulative Inventory 2000 50000 3000 26.50
Consumption 1300 32500 25.00
Ending Inventory 700 17500 25.00

Period 1 – Closing – Single level price determination

- Standard Price 25.00

- Inventory Value 17500 + 1050 (period end)

- Periodic Unit Price 26.50

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 Preliminary Price
Quantity Price
Valuation Difference
Beginning Inventory 1000 25000 25.00
Receipts 1000 25000 3000 28.00
Other Receipts/
Consumption 0 0 0 0.00
Cumulative Inventory 2000 50000 3000 26.50
Consumption 1300 32500 25.00
Ending Inventory 700 17500 1050 26.50
Not distributed 1950

Period 1 – Closing – Multilevel level price determination

- Standard Price 25.00

- Inventory Value 17500 + 1050 (period end)

- Periodic Unit Price 26.50

Preliminary Price
Quantity Price
Valuation Difference
Beginning Inventory 1000 25000 25.00
Receipts 1000 25000 3000 28.00
Other Receipts/
Consumption 0 0 0 0.00
Cumulative Inventory 2000 50000 3000 26.50
Consumption 1300 32500 1950 26.50
Ending Inventory 700 17500 1050 26.50

Change of Price Control in material Master:

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 Period 1 - Transactions
Difference between
Standard Price and Average Actual Price
Beginning Inventory + Actual Price
All goods receipts

Preliminary Price
Quantity Price
Valuation Difference
Beginning Inventory 1000 25000 25.00
Receipts 1000 25000 3000 28.00
Other Receipts/
Consumption 0 0 0 0.00
Cumulative Inventory 2000 50000 3000 26.50
Consumption 1300 32500 25.00
Ending Inventory 700 17500 25.00

Financial Posting – Period 1:

Procedure Inventory Inventory Value Standard

1 Beginning Inventory: 1000 EA at EUR 2 1000 25000 25.00
2 Goods Receipts: 1000 EA at EUR 28 2000 50000 25.00
3 Consumption: 1300 EA at EUR 25 700 17500 25.00
4 Invoice Receipts: 1000 EA at EUR 28 700 17500 25.00
5 ML Closing: 700 EA at EUR 1.5 700 18550 25 (Pup 26.50)

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Summary of Accouting Entries are as follows:

Dr/Cr GL Account Description

Dr Balance Sheet Inventories Finished Goods
Dr Balance Sheet Inventories - SFG
Dr P&L COGS/ Revaluation of Consumption
Dr Balance Sheet Work in Progress
Dr P&L Production Variance – FG
Dr P&L Production Variance – SFG

Period 2 – Period 1 closing posted

Preliminary Price
Quantity Price
Valuation Difference
Beginning Inventory 700 18200 26.50
Price Change (ML Closing) 350
Receipts
Cumulative Inventory 700 18550 26.50
Consumption
Ending Inventory 700 18200 350 26.50

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