Document to explain the design of Product Costing in SAP for a Make to Stock scenario:

The first step to understanding costing is to understand the types of costing available in SAP:

The explanation on the type of costing:

What does SAP offer? You can create cost estimates at different times and for different purposes during the course of the fiscal year: At the beginning of the fiscal year or new season: 1. To plan and simulate costs for new products or services (base object costing) 2. To calculate prices for valuating the materials to be produced (standard cost estimate, inventory cost estimate) During the fiscal year 1. To provide information on how the costs are changing (current cost estimate) 2. To take into account technical changes and their effects on the costs (modified standard cost estimate) Before the balance sheet is prepared, to determine the valuation methods for the tax-based and commercial valuation of the materials in stock (inventory cost estimate)

What is being offered to CSG? We are offering two types of costing in SAP for this release and both are types of Material Costing: 1. Costing with Quantity Structure ( SAP T-code : CK11N) 2. Costing without Quantity Structure (SAP T-code : KKPAN)

Costing with Quantity Structure: Costing with a quantity structure is a tool for planning costs and setting prices for materials without reference to orders. It is used to calculate the cost of goods manufactured and cost of goods sold for each product unit. You can use the results of material cost estimates with a quantity structure to valuate materials at standard prices. Costing without Quantity Structure: Costing without a quantity structure is a tool for planning costs and setting prices for materials without reference to quantity structure data in Production Planning (PP and PP-PI). It is intended for materials with insufficient or no quantity structure data.

What is changing when I move on SAP?

Many companies are not used to SAPs concept of using consumption accounts to track production activity in the profit and loss (P&L) statement. The relationship of these accounts to cost of sales can also be confusing. In most legacy systems, production activity is reflected mainly on the balance sheet (at least until the product is produced and variances arise) by way of journal entries. However, in SAP systems, the accounting entries are posted automatically to inventory as well as to P&L accounts when you perform goods issues and receipts on a production order. Also, the allocation of activities and calculation of overhead are not posted to the general ledger. Because of this, it is sometimes difficult for accountants to analyze their financial statements with respect to what happened in the production process and what should be reflected in the cost of goods sold section. In an SAP system, product costing is one of the CO modules. Keep in mind that CO provides details of the activities in the P&L statement. This methodology differs from many legacy accounting systems in place for tracking production costs. In most legacy systems, inventory flows through cost centers. In SAP ERP, rather than tracking inventory, the cost centers track total available labor and machine costs as well as indirect production expenses. Instead of cost centers, the production orders capture the products total cost. In most legacy systems, until variances are recognized, production costs remain on the balance sheet. Production costs are moved from the raw materials inventory account to the work in process (WIP) balance sheet account to the finished goods inventory account. In SAP ERP, using CO, the production costs associated with an order are temporarily tracked on the P&L statement. This process allows for greater flexibility and visibility when accounting for value-added costs. At month end, these production costs are moved to the WIP balance sheet account for compliance.

Costing a Make to Stock process: The bill of material (BOM) contains the components that are required to produce the Bike. The routing contains the tasks, or steps, that must be performed to put the components together to complete the finished product, the number of hours required, and the cost or activity rate for each hour of each task. You then use these settings plus an overhead calculation to create a standard cost for the Bike.

The standard cost is used for inventory valuation. Costs incurred during production that are either above or below the standard cost are written off to the profit and loss (P&L) statement as variances when the product is completed and placed into inventory.

I will describe the postings made in the first accounting period, assuming that the production order is open (not completed) at the end of the period. Ill analyze the following controlling objects:

Production order: The production order is the primary cost collector for the costs associated with manufacturing the product. Please refer to section on Production cost center: One production cost center is used to capture the direct costs associated with production, including the Setup cost , direct labor and machine costs Overhead cost center: Overhead cost centers are used to capture indirect costs associated with production, such as costs related to support departments and central services (we are not using this functionality currently as none have been defined)

System Design diagram: Flow of Values (Currently nothing flows from overhead to Production Cost centers)

Postings that are made in the first accounting period, assuming that the production order is open (not completed) at the end of the period, are:

Postings are made to cost centers that supply resources (both direct and indirect) to the production order. The cost center structure in my example is Raw materials are issued from inventory to the production order The production cost center resources confirm activities to the production order

Post Expenses to Service and Administrative Cost Centers (NOT IN DESIGN)

Costs such as utilities, rent, maintenance, repair, and overhaul (MRO) materials, and support services are incurred in a plant throughout the period, regardless of whether the production line is running. These indirect costs are managed in cost centers. In the manufacturing process, they are ultimately treated as overhead. Good To Know: What is a Cost Element? A cost element is the representation of an account in CO that allows the tracking of costs on a detailed basis for cost center and manufacturing activities. When a posting is made to a cost element, a controlling object must be entered as part of the financial transaction. A primary cost element is the representation of a P&L account in CO. When a posting is made to a P&L account that also has a corresponding primary cost element created in it, you need to enter a controlling object. This controlling object is typically entered as part of a logistics process. For discrete manufacturing, the production order is used when issuing raw materials and components to the production floor. A secondary cost element represents postings that occur between controlling objects within CO. When costs are moved (e.g., from one cost center to another, or from a cost center to a production order), no postings are made to the FI P&L. When a posting is made to a cost center as a salary expense on the P&L, it remains there. If an allocation is made from the cost center to a production order, a secondary cost element is used for that posting. Allocate Costs from Indirect Cost Centers to Manufacturing Overhead Cost Centers (NOT IN DESIGN) Costs are allocated from the service and administrative cost centers to manufacturing overhead pools, which are also managed as cost centers. Typically, many service and administrative cost centers allocate their costs to these overhead pools. You can accomplish the allocation by direct activity postings or by using cost center assessments and distributions. In this example, the expenses incurred by the cost center are evenly allocated to all manufacturing overhead pool cost centers, as shown in posting. Because the posting only moves the original salary expense between cost centers, no postings are made directly to the General Ledger accounts. Instead, secondary cost elements are used to track the allocations between the cost centers. Post Expenses to Direct Production Cost Centers (IN DESIGN) The production cost center accumulates the direct costs associated with the production process. In this example, Ill use one of these costs as an example production line workers salaries that are directly posted to the production cost center. The production cost center supplies the direct resources (e.g., as labor and

machine time) to the production order. The cost of these resources is typically calculated as an hourly rate. You can enter this rate manually or the system can calculate it based on the planned expenses and the planned number of available hours of the resources. In the example, actual salaries are posted to the production cost center at the beginning of the period. These salaries are a direct cost for the production cost center, as well as for the overall production process. The AP account is credited on the balance sheet and is debited to the P&L salary expense account, referencing the production cost center. Issue Raw Material from Inventory to the Production Order (IN DESIGN) Raw material is issued to the production order from inventory. The quantity of finished goods to be produced, together with the BOM used in the order, defines the quantity of raw materials that will be issued. You can manually update the raw materials to reflect actual usage. The BOM might also contain a semi-finished good or a sub-assembly as a component of the finished product. In this example, the raw materials are issued from inventory to the production order through a materials movement transaction; the financial entries are made automatically, as shown in posting. The raw material is a direct cost for the production process. The raw materials inventory account is credited on the balance sheet and is debited to the P&L raw material consumption account, referencing the production order. Confirm Activities from the Production Cost Center to the Production Order (IN DESIGN) The production cost center supplies value-added resources (e.g., direct labor and machine time) to the production order. These resources are represented by system activities such as labor hours and machine hours. Each activity has a planned rate. The expected number of hours required to produce the finished product is based on the quantity of finished goods to be produced by the production order and the routing used in this order. You can manually update the number of hours that were used as each step of the production order is confirmed or completed in manufacturing. In our design, the activities are confirmed as follows:

The standard setup time is developed for a lot size, so it is spread over the entire quantity of finished products that are manufactured with the production order. If there is lot size fluctuations from the lot size used to develop the standard cost, the standard setup time still does not change. In our design, the setup hours are assumed to be labor hours.

The labor and machine hours are developed on a per-unit basis, so the standard hours required for one unit are multiplied by the number of units produced in the production order Fixed Overhead and Variable Overhead are defined as fixed percentage based on cost center & Activity Type.

When the hours are confirmed on the production order, the financial entries are made automatically, as shown in postings. Because this posting only moves the original salary expense from the production cost center to the production order, no postings are made directly to the General Ledger accounts. Instead, secondary cost elements track the allocations between the controlling objects and the production cost center is credited and the production order is debited. Month-End Postings At the end of the first accounting period, the order is still open. A series of periodend postings are made to ensure that the production costs of the order, which are currently on the P&L, are appropriately recognized on the balance sheet as WIP. These postings are typically scheduled to take place in batch at the end of the period as part of the month-end closing process. Postings for the production order in this example are as follows:

Overhead is applied from the manufacturing cost centers to the production order The WIP values are calculated for the production order A settlement is run to post the calculated WIP values to the General Ledger accounts

Apply Overhead from the Manufacturing Overhead Cost Centers to the Production Order (NOT IN DESIGN) Applying overhead posts additional costs to the production order. The overhead can be a percentage of the direct costs that have already been posted to the production order during the period, as in this example. It is also possible to apply the overhead based on the quantity of material components that were issued to the production order. If this step is run multiple times during the same period, only the overhead difference from the previous run is applied to the production order. The costing sheet that is associated with the production order stores the rules for applying these overhead costs. In this example, separate manufacturing overhead cost centers and separate overhead rates are used for each type of overhead applied to the production order. These four manufacturing overhead pool cost centers collected the overhead costs in a prior step (in posting):

Material overhead: A manufacturing overhead cost center collects indirect costs related to materials, such as material handling or quality inspections. In this example, the overhead percentage rate is based on the cost of the material components that were issued to the order during the period. Machine overhead: A manufacturing overhead cost center collects indirect costs, such as maintenance or utility consumption that are related to the machines on the production floor. In this example, the overhead percentage rate is based on the cost of the machine time that was confirmed for the production order during the period. Labor overhead: A manufacturing overhead cost center collects indirect costs (e.g., those for the human resources and accounting departments) that are related to production workers. In this example, the overhead percentage rate is based on the cost of the labor time that was confirmed for the production order during the period. Based on the assumptions in this scenario, this rate is used for both setup and normal labor time. Administrative overhead: A manufacturing overhead cost center also collects other indirect costs, such as facilities and administrative costs or depreciation. These costs cannot be directly associated with a specific direct cost in the production order. Instead, administrative overhead is related to all costs on the production order.

I would like, the overhead percentage rate is based on the costs posted to the production order throughout the period, as shown in postings. These overhead postings are an indirect cost for the production order, as well as for the overall production process. Because the postings only move the original cost center expenses between controlling objects, no postings are made directly to General Ledger accounts. Instead, secondary cost elements track the allocations between the controlling objects. The manufacturing overhead cost centers are credited and the production order is debited. Calculate the WIP for the Production Order (IN DESIGN) If a production order is open, the balance of the order (all costs debited minus the standard cost of completed finished goods credited) is calculated by a period-end program and is considered the WIP amount. Separate cost elements, called results analysis (RA) cost elements, track the WIP amounts. These amounts are not directly posted to the production order. The valuated RA cost element contains the total amount of WIP on the order. Other RA cost elements contain the details of the types of costs that make up that WIP balance. When the WIP process is run, the WIP is calculated for production orders with a status of Released (REL). If a production order remains open for several periods, the

WIP balance is recalculated for each period, and the adjustments are posted to the RA cost elements. In this example, the production order remains open at the end of the first accounting period. The WIP is calculated and the only postings made are to the RA cost elements, as shown in posting. No postings are made to the production order or to General Ledger accounts when the WIP calculation is run. Post the WIP to the General Ledger Because the production order costs are tracked on the P&L statement, you need to move the balance of all open production orders to the balance sheet at period end. This movement ensures that the materials issued to the production order remain in inventory and are not written off before production is complete. In the previous WIP calculation, the RA cost elements were used to capture the value of the WIP. By running the month-end settlement process, these calculated WIP amounts are posted to General Ledger accounts. If the open production order balance is positive, the P&L WIP offset account is credited and the balance sheet WIP account is debited. If this balance is negative, the P&L WIP offset account is debited and the balance sheet WIP account is credited. No postings are made directly to the production order. When the system displays production order costs, the WIP postings to the RA cost elements and to the General Ledger accounts are not displayed. This impact is purely a financial transaction, which does not affect the normal production process or the order balances in a production order. As shown in the sample posting, a debit to the WIP inventory account is posted on the balance sheet. A credit is made to the WIP offset account on the P&L. This P&L account is not created as a cost element because no posting to a controlling cost object should be made and all costs remain on the production order for manufacturing analytics. Posting Cost Center Variances The balance of the cost centers, including the manufacturing overhead cost centers that collect indirect costs and the production cost center that collects direct costs, is rarely zero. These variances result from the over- or under-absorption of the manufacturing overhead costs of the indirect cost centers and the over- or underutilization of direct production resources. Sidebar Components of Production Order For the production order to have all the cost elements listed, you must have performed goods issues and confirmation, as well as the month-end steps of overhead, work in process (WIP the valuation of unfinished products, calculated at actual cost), variance calculation, and settlement.

I will group the list of cost elements into five categories and explain what they represent and how they are set up: 1. Input materials 2. Activities 3. Overhead 4. Production output 5. Variance offset

1. Input Materials These could be raw materials such as packaging materials, semi-finished goods, finished goods, and co-products. Basically, these are the components on the bill of material (BOM a list of the required parts) of a product that is being produced.

These Cost Elements would have their FI Accounts defined in Transaction OBYC under VBR Account determination for components on BOM

ZOF Account determination for Co-Products

Valuation class is entered in the Accounting 1 view of the material master, and is used to group materials with similar characteristics (e.g., raw materials, trading goods, semi-finished materials, and finished materials). By using valuation classes, you can assign different general ledger accounts to different groups of materials under the same transaction key. (In the screenshot above, it is 3000, 3001, 7920 etc.) 2. Activities These are operations such as processing time, packaging time, quality inspection, and machine time that you perform in the production process.

You set up the activity types in transaction KL01 by assigning them to allocation cost elements. These allocation cost elements are secondary cost elements (i.e., there is no related general ledger account) and they are used to transfer costs between cost objects. You create these cost elements in transaction KA06 using an agreed-upon number range (which should not conflict with the numbers in the general ledger) and specifying cost element category 43.In our design, we have created them as Setup, Labor, Fixed O/H, and Material O/H.

3. Overhead (NOT IN DESIGN) Overhead is normally calculated on a quantity or percentage basis on one or many of the components of the product. For example, it could be based on material costs, labor costs, machine costs, or all costs. We can use costing sheets to calculate the basis of the overhead costs, and link them to overhead cost elements in transaction KZE2 by entering the material overhead into the Credit field (e.g., Z01) in the costing sheet table These overhead cost elements are also secondary cost elements (of cost element category 41) that do not have corresponding general ledger accounts.

4. Production Output After you receive confirmation or goods receipt of the quantity produced, you create production output. This represents the actual quantity multiplied by

the standard cost of the product, and is always represented as a credit on the order.

5. Variance Offset Variance offset is the offset amount of the difference between the debits and credits on the production order if the order is either delivered (status DLV) or technically completed (status TECO). If a variance is calculated, then the order normally becomes zero upon settlement.

6. Other Accounts Related to Cost of Sales and Production Three other accounts that are part of the production and cost of sales process do not appear on the production order: Change in WIP account: This is the difference between the debits and credits on the production order if the order is either released (status REL) or partially released (status PREL). If WIP is calculated, the order has a balance upon settlement that represents the amount that has been transferred to the WIP account. I need this P&L account, which is configured in transaction OKG8 under the WIPR key production order as it is not set up as a cost element.

Variance account: This represents the variance on the production order. When a production order is settled, this account is credited (for a favorable variance) or debited (for an unfavorable variance) with the balance on the production order. This account is set up in transaction OBYC under transaction key PRD and is not to be created as a cost element. The variance offset account mentioned above is the offsetting entry to this account. .

Cost of sales account: This is the account posted to when a product is delivered from inventory to sales. A post goods issue is performed for the quantity to be sold and the cost of sales account is configured as below:

Key Point of Reconciliation: Because the balance on the production order is made up of the general ledger accounts (primary cost elements) and the secondary cost elements, it means that the total of all the general ledger accounts on the production order (including the change in WIP account, if the order is not complete) represent the opposite amount of the total of the secondary cost elements.

Freight/Duty and Customs Entry Fees Expense: In order to provide you a comparison with the actual cost we are implementing the "Delivery Costs" option into the design. I have mapped the following condition type to origin group for the same.