Quantity and Value Flow in Make-to-Stock Production

This section describes the flow of quantities and values in make-to-stock production. It also discusses the integration between Cost Object Controlling and Profitability Analysis (CO-PA).

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The processing steps have been numbered (or lettered) in such a way that you can modify this documentation to suit your needs. The numbering is not continuous, to allow new processing steps to be inserted. The fact that some letters of the alphabet are missing is therefore not an error.

Prerequisites

The production example is based on production orders.
The finished products and semifinished products are valuated at standard cost.
Raw materials are valuated at the moving average price.
The flow of quantities and values is described on the basis of the manufacturing process and the resulting account activities in Financial Accounting.
In this example, the application component Profitability Analysis (CO-PA) is active. This means that Cost Object Controlling transfers data to CO-PA.
The production order is processed cumulatively. This means that variances for the production order are only determined when the full lot size of the production order has been transferred to inventory (or when the production order receives the status technically completed, which can happen in cases where the planned lot size will not be produced). Production orders are processed cumulatively if the settlement rule of the production order specifies settlement type FUL. This will be the case when default rule PP1 is specified in the default values for the order type in Customizing.
The Actual Costing/Material Ledger application component is not active.
During the manufacturing process, the production order is charged with direct costs (such as direct materials costs). Indirect costs are charged to the production order during the period-end closing process. Costs that are allocated to cost objects by period rather than through a particular business transaction are also called period costs. In Cost Object Controlling, overhead costs can be periodically allocated to cost objects with the following functions:

Dynamic template allocation (allocates process costs or activity types on the basis of templates)
Revaluation of activities at actual prices (charges the cost object with the difference between the planned price and the actual price of processes or activities)
Overhead allocation rates (allocates overhead)
In this example, period costs are only charged to the cost objects by means of overhead allocation rates. These charges allocate costs that cannot be traced directly to the cost object (material overhead and production overhead). The overhead is allocated to the production order as a percentage of the direct costs.

This example does not cover allocation with activity-based costing. Activities are not revaluated at actual prices.

The costing approach of the R/3 System differs from that of many US systems:

In SAP R/3, the inventories normally do not flow through cost centers. Cost centers are mainly used to plan and monitor labor time, machine time, and indirect production costs (such as maintenance, cleaning, storage, administration, and rent). All production costs are collected on cost objects (such as the production orders).
In many US systems, production costs are not recorded in financial accounting until variances arise. Consequently, the income statement does not reflect such costs until variances have arisen. In the R/3 System, however, the income statement reflects the costs of production even before the first variances occur. For example, the withdrawal of a material for a production order is immediately reported in the income statement as an expense. To prevent the period result reported at the end of the month from being too low, the system can determine the work in process for the production order. The work in process contains both the direct costs incurred to date (such as the direct materials costs charged to the production order through the withdrawal) and the indirect costs (such as the material overhead). When the order is settled, the work in process is transferred to financial accounting where it can be capitalized. Value-added activities are therefore reflected in the income statement.
General Information:

The Product Cost Controlling component is closely integrated into the manufacturing process. The postings in Financial Accounting and Controlling result mainly from the daily business transactions in production and materials management. The period-end closing activities in cost accounting are necessary to accomplish the following tasks:

To record costs not captured by the logistics transactions
To determine the inventory values of unfinished goods (work in process)
To determine variances
To enter essential postings in financial accounting (such as to capitalize the work in process)
In make-to-stock production, the sequence of activities in cost accounting in each period can be outlined as follows:

Overhead costs are posted to the cost centers from financial accounting.
Materials are withdrawn with reference to the production order, and the costs are allocated to the production order (direct materials costs).
Activities performed in production are allocated from the production cost centers to the production order. This allocation can be accomplished through automatic activity allocations that are triggered by confirmations in logistics.
At the end of the month, the period-closing activities are performed in Cost Center Accounting and Cost Object Controlling. These activities include:
Allocation of period costs from cost centers to cost objects
Calculation of variances for each cost center and cost object
Calculation of work in process
Transfer of variances and work in process to other application components (such as Financial Accounting)
The period-end closing activities in Cost Center Accounting are performed before the period-end closing activities in Cost Object Controlling.

The process described below provides only a basic orientation for understanding the flow of quantities and values in the R/3 System. This process may need to be modified depending on the structure of your company, your production methods, and your cost accounting requirements. This documentation provides information on many additional topics, such as Special Requirements in Joint Production or the flow of quantities and values in sales-order-related production (refer to: Product Cost by Sales Order: Scenario, Example for Product Cost by Sales Order: Quantity and Value Flow).

Process Flow

Description of Quantity and Value Flow Across Two Periods

A. Postings on the Cost Centers

The cost centers are charged with actual costs during the period. These actual costs can be direct costs of production (direct labor costs; machine costs that can be traced directly to the cost objects through machine time records) or overhead (production overhead or material overhead, plus sales and administrative overhead – although the latter is not included in inventory valuation). This example uses separate cost centers for the direct costs of production and the indirect costs of production. This setup is only an example – you are free to set up your cost centers as you wish.

A.1

Postings of actual costs to service and administration cost centers

Indirect costs (such as the leasing rates for your computers or the rent for your production facilities) must be included as part of the manufacturing process and eventually allocated to the product. These costs frequently remain the same regardless of the production output (fixed costs).

Such costs can be transferred to Cost Object Controlling by means of overhead allocation rates, for example (note the proportionalization of the costs. Fixed costs can also be allocated using activity-based costing methods).

While Cost Object Controlling enables you to analyze costs by product, Cost Center Accounting enables you to analyze costs by the location at which they are incurred. Although the indirect costs are allocated to the cost objects, these costs are monitored and the variances analyzed (target-actual comparison) at the cost center.

In this example, the indirect costs that are incurred from activities such as services and administration are first allocated to service cost centers. From the service cost centers (cost centers that have no direct link to production), the indirect costs are transferred to the primary cost centers (the production cost centers) by means of assessment or distribution. From there, they flow into activity price calculation for the activity types performed at the production cost centers. Such activity types can have prices with both fixed and variable components. At the end of the period, the variances on the production cost center are determined.

In this example, the actual wages for the employees of the plant administration (such as the plant manager and the secretary) are first recorded at the service cost center administration and then allocated to the individual production cost centers on the basis of keys. From the point of view of the administration cost center, these costs are direct costs and are reported as primary costs. From the point of view of the manufacturing process, however, they are indirect costs. At the production cost center, they are reported under a secondary cost element.

A.2. Allocating from service and administrative cost centers to production cost centers

As explained under A.1 above, the indirect costs incurred by service and administration activities are transferred from the service cost centers (such as the cost center plant management) to the primary cost centers (production cost centers). In this example, the transfer is performed by means of assessment: the costs appear on the primary cost center under a secondary cost element. It would also be possible to distribute the administrative costs to the production cost centers. In that case, the costs would be reported on the production cost center under their primary cost element.

In this example, the administration expense is assessed equally to all production cost centers.

A.3. Posting costs to the production cost center

The wages of the production line workers are posted directly to the production cost center. The production cost center makes resources available to production, such as labor and machine time. The cost center manager will have determined a value for each of these resources. These values can be reported under different activity types. For example, a production cost center can have one activity type for labor costs and another activity type for machine time. A price is defined in Cost Center Accounting for each activity type. Allocations to cost objects use this price. The prices of the activity types are expressed in units of time (normally hours). The price of an activity type can be determined manually (manual data entry in Cost Center Accounting) or iteratively in dependency on the planned costs and the planned activity.

B. Raw material is issued from inventory to the production order

A raw material is withdrawn from inventory. When the goods issue is entered, the default withdrawal quantity suggested by the system is based on the quantity of the finished product being produced (that is, on the basis of the planned order quantity) and the BOM specified in the production order. You can change the withdrawal quantity suggested by the system.

In this example, the price control indicator of the raw materials is set to V (moving average price). The raw materials are consequently withdrawn from inventory at the moving average price. The price control indicator is located in the accounting view of the material’s master record.

Goods issues for raw materials can be posted in the following ways:

Manual posting of the goods issue
Backflush
A backflush can be effected in various ways, such as:

Confirmation of an operation to which particular BOM components are assigned and for which a backflush is planned (Backflush indicator)

Through a combined goods receipt/goods issue in repetitive manufacturing (you make the corresponding setting in the repetitive manufacturing profile)

In this example, all planned raw material withdrawals are made at the beginning of the first period. Additional raw materials are withdrawn at the beginning of the second period. In some industries, the planned quantities may be exceeded frequently; in others, this might happen only when the quality of the material components withdrawn does not meet standards.

In this example, no semifinished products are withdrawn from inventory. However, the withdrawal of semifinished products does not differ in principle from the withdrawal of raw materials. The only difference is that SAP strongly recommends that you set the price control indicator for semifinished products (and for finished products as well) to S (standard price).

C. Activity types are allocated from the production cost center to the production order

The production cost center provides value-adding resources for the manufacturing process, such as labor and machine time. These resources are represented in the system by activity types such as labor time and machine time. Each activity type has a planned price. The activity types utilized in production are posted to the production order. The activity type is valuated in accordance with a valuation strategy specified in a valuation variant. For example, valuation strategy could specify that the activity type is to be valuated with the planned price of the current period, or with the actual price of the previous period. The quantity consumed is valuated with the price selected by the valuation variant.

Activity types for production orders can be posted in the following ways:

Manual activity allocation (internal activity allocation)
Automatic activity allocation, such as through confirmation of operations in Logistics or through a combined final backflush/activity allocation in repetitive manufacturing (you make the corresponding settings for repetitive manufacturing in the repetitive manufacturing profile)
The system proposes an activity quantity based on the quantity of the finished product to be manufactured and the standard values for formulas specified in the operations of the routing. The formulas are defined in Logistics.

The activity quantity proposed by the system can be changed manually if the actual quantity does not match the proposed quantity.

In this example, the activity quantities proposed for each operation are transferred as actual activity quantities. Activity types for the setup time are charged to the production order in the first period. There are no additional setup costs in the second period. Labor costs are incurred for the production order on the basis of the setup time used. Further costs for labor time and setup time are charged to the production order in the first and second period.

C.1 Setup costs are allocated to the production order

The setup time costed in the standard cost estimate for the finished product is calculated on the basis of the costing lot size, and becomes part of the standard cost of the finished product. In the actual data, the setup time is proposed on the basis of the planned order quantity. A difference between the planned order quantity and the costing lot size will not change the setup time, because each production order incurs a fixed amount of setup costs. It is assumed that the setup costs do not vary with the lot size. The actual setup costs are therefore the same as the planned setup costs.

Note: It is, of course, important to include costs that are independent of the lot size when calculating an optimum production lot size. This can be accomplished by various means, such as with a variance calculation method that compares the planned cost of the order against the standard cost. The costs that are independent of the lot size should take the lot size variance into account.

C.2. Labor hours are allocated to the production order

The labor time used by the production cost center is allocated to the production order. The labor time is calculated based on the quantity produced. You use the default quantity proposed by the system as the actual quantity. The valuation is made in accordance with the valuation variant for simultaneous costing.

C.3 Machine hours are allocated to the production order

The machine time used by the production cost center is allocated to the production order. The system calculates the machine time from the quantity produced. You use the default quantity proposed by the system as the actual quantity. The valuation is made in accordance with the valuation variant for simultaneous costing.

Postings that have not yet taken place in period 01:

E. The production order delivers the finished products to inventory

The finished products that you have manufactured with the production order are transferred to inventory. This is accomplished by entering a goods receipt for the production order. If the price control indicator is set to S, the finished products that you transfer to inventory are valuated with the standard price. The production order is credited with the same amount. On the basis of the goods receipt, the system generates a material document in the application component Materials Management (MM) and an accounting document in the application component Financial Accounting (FI). The system debits Finished Goods Inventory (balance sheet account) and credits Finished Goods Inventory Change (income statement account).

The system can also post the goods receipt automatically when the last operation is confirmed. For this to happen, the control key of the last operation must specify that an automatic goods receipt is to be generated.

The production order may have been created for more than one unit of finished product. In this case the goods receipt can also be posted for a particular number of finished products that have already been produced.

In this example, all finished products that are manufactured with a production order are transferred to inventory together. The goods receipt will be entered towards the end of the second period.

X. Deliver product to the customer

Once the product is in finished goods inventory, it can be shipped to the customer. When the product is shipped to the customer, the system debits Cost of Sales (income statement account) and credits Finished Goods Inventory (balance sheet account). Since the product is valuated at the standard price, the cost of sales is computed by multiplying the quantity shipped to the customer by the standard price. The cost of sales is not posted in Profitability Analysis (CO-PA) when the product is shipped.

Y. Invoice the customer

In most cases, the customer is only invoiced after the finished product has been shipped. At this time, the system debits Accounts Receivable (balance sheet account) and credits Sales Revenue (income statement account). At the same time, the revenues and the standard cost of sales are transferred to CO-PA, where an initial contribution margin is calculated.

In this example, the cost of sales is taken from the standard cost estimate of the finished product (since the finished product is valuated at standard price). You can analyze the cost component split of the product in CO-PA. To do this, you must create a value field in CO-PA for each cost component. If you want to analyze the data in more detail, you can create separate value fields for the fixed and variable portions of each cost component. Multiple cost components can be assigned to a single value field in CO-PA. It is also possible to transfer only the standard price from the material master record to CO-PA. Any characteristics that have been configured in CO-PA, such as the material number, production line, customer, customer group, distribution channel, and sales region, are carried over for analysis.

Period-End Processing in Period 01

Note: You perform the period-end closing activities for the production order in the application component Product Cost by Order.

F. Apply overhead from the production cost centers to the production order

Overhead is applied to the production order. This overhead is a percentage of the direct costs that have already been posted to the production order. The costing sheet assigned to the production order stores rules for applying these overhead costs. The costing sheet is selected on the basis of Customizing settings.

It is also possible to apply the overhead costs based on the quantity of material components issued to the production order.

This example, however, only applies overhead as a percentage of direct costs. Other aspects of overhead cost allocation, such as the use of internal orders or template allocation (the allocation of process costs or activity types on the basis of templates) are not used in this scenario and therefore are not discussed in this section.

In this example, separate overhead cost centers and separate overhead rates are used for each type of overhead being applied to the production order. The following four primary cost centers are used to apply these different overhead types to the production order:

Material overhead
A production cost center collects all indirect costs related to the material. Examples of such costs:

Administrative costs
Storage costs
Quality inspection costs
The overhead rate is based on the cost of the material components that were issued to the order during the period (the direct materials costs).

Machine overhead
A second production cost center collects all indirect costs based on the machine time. Examples of such costs:

Setup costs
Lubricants
Maintenance
The overhead rate is based on the machine time that was confirmed for the production order in the period.

Labor overhead
A third production cost center collects all indirect costs based on the labor time. Examples of such costs:

Payroll costs (proportional to the number of production workers)
Costs for human resources (proportional to the number of production workers)
The overhead rate for personnel is based on the labor time allocated to the production order in the period.

Administrative overhead
A fourth production cost center collects all other indirect costs, such as costs for:

Research and development
Depreciation on assets such as machines and buildings
General administration
Social facilities at the company (such as a kindergarten)
Voluntary social contributions
Company pension plan
Costs for benefits such as pension plans must be based on the time period of manufacture, and are allocated on the basis of the anticipated quantity that will be produced in the period.

In this example, the administrative overhead rate is based on all direct costs allocated to the production order in the period.

b) and c) together are called production overhead costs and are based on the direct costs of production.

G. Work in process

In the R/3 System, some of the postings that debit the production order generate a corresponding expense account posting that affects the income statement. This is particularly the case for goods issues. At the end of the period, the value of all production orders that do not have final delivery status must be calculated and transferred to financial accounting. This ensures that the result shown in the income statement at the end of the month is not too low. The inventory values of the materials issued for the production order are thus reported in financial accounting, but these values are shown in a different form than before the withdrawal.

In this example, the production order has the settlement type FUL (full settlement), so the work in process is calculated at actual cost. In this case, the WIP is calculated as follows:

If the debits posted to the production order are higher than the credits from goods receipts, the system reports work in process.
If the debits posted to the production order are less than the credits from goods receipts, the system creates reserves for unrealized costs.
The following is a more detailed description of the process of calculating and settling the work in process:

If a production order has a positive balance, the following posting is made in FI:

Unfinished Goods Inventory is debited and Unfinished Goods Inventory Change is credited.

This capitalizes the work in process in financial accounting. The inventory account is a balance sheet account. The current assets are increased due to the debit posting to the inventory account.

The inventory change account is an income statement account. Crediting the inventory change account increases the profit (or reduces the loss) reported in the income statement.

A production order has a negative balance if the credits from goods receipts of finished products are greater than the debits posted to the production order. In this case, the inventory values capitalized in financial accounting due to the goods receipt postings, and the inventory increases that influence the income statement, will be too high.

If a production order has a negative balance, the following posting is made in FI:

The Expense account is debited and Reserves for Unrealized Costs account is credited.

In most cases, reserves are regarded as outside capital and appear on the liabilities side of the balance sheet. The expense account for reserves is an income statement account that reduces the profit or increases the loss.

The work in process (and in some cases the reserve for unrealized costs) is computed by the WIP calculation function. The values calculated in the WIP calculation process (such as the work in process and reserve for unrealized costs) are called results analysis data. This data is posted to the production order under what are called results analysis cost elements. You can view and analyze the results analysis data in the Product Cost Controlling Information System.

The work in process is capitalized (or the reserve is carried as a liability) in the settlement process. If results analysis data is settled to financial accounting, the production order is not credited. The posting in financial accounting is triggered by the settlement.

If a production order remains open for several periods, the results analysis data is recalculated in each period. The system settles the difference to the value of the previous period to financial accounting.

In the month in which the production order is fully delivered (status Delivered), the period-end closing process calculates zero work in process. The work in process is canceled when it is settled.

The posting record in FI for the cancellation of the work in process is: Unfinished Goods Inventory Change is debited and Unfinished Goods Inventory is credited.

If a production order is created, released, and closed all in the same period, no WIP will be calculated. Consequently, settlement will not post any WIP to FI.

Since CO-PA generally calculates the profit using cost-of-sales accounting, no WIP is settled to CO-PA.

In this example, the work in process is posted to the production order under a results analysis cost element. The total work in process is transferred to financial accounting, and an inventory account and an inventory change account are posted.

a) Calculate WIP

When the WIP calculation function is run, WIP is calculated for the production orders whose status is REL (Released). This is the case at the end of the first period. This settlement capitalizes the work in process in financial accounting.

b) Cancel WIP

When the WIP calculation function is run, WIP is canceled for production orders whose status is DLV (Delivered) or TECO (Technically completed). In this example, WIP is canceled in the period-end closing process of the second period. The WIP calculation function calculates a value of zero; the settlement process reverses the posting in the first period.

R. Variances on the cost center (this function is performed during the period-end closing process of the cost center)

The balance on the cost centers will rarely be zero. The differences between the debit and credit on the costs centers result from over- or underutilization of the cost center resources. The variance calculation process for the cost centers enables you to analyze the causes of the differences. The difference is broken down into variance categories.

At the end of the period, the variance categories can be transferred from Cost Center Accounting (CO-OM-CCA) to CO-PA. In CO-PA, the variances can be allocated to products, customers, sales regions, or other combinations of characteristics. The assessment takes place only in Controlling (CO); no posting is made to Financial Accounting.

The assessment of the variances to CO-PA credits the cost centers.

The variance categories that can be assigned in Cost Center Accounting include:

Input price variances (difference between the planned price and the actual price of an activity)
Input quantity variances (when a quantity other than the planned quantity of a resource was used)
Etc.
It is also possible to allocate the balance of a cost center to the cost object. In this case:

Determine actual prices in Cost Center Accounting
Revaluate activities at actual prices in Cost Object Controlling
Once you have revaluated the activities at actual prices, the balance on the cost center is reduced to zero.

This example does not revaluate activities at actual prices. All cost centers have a nonzero balance. The balances on the cost centers are assessed to CO-PA.

T. Variances on production orders

Variances on production orders are caused by differences between the actual costs incurred and the standard cost. The variance calculation function in Cost Object Controlling enables you to analyze these differences. This function breaks down the variance into detailed variance categories. The variance categories reveal the cause of the difference. The variance categories that can be assigned in Cost Object Controlling include:

Input price variances (caused for example when the planned price of an activity differs from the actual price, or when the moving average price of a raw material has changed by the time it is used)
Input quantity variances (caused for example when the quantity of an activity or material used does not equal the planned quantity)
Resource-usage variances (caused for example when a material is replaced by a different material)
Etc.
Variances may be calculated for a production order with the settlement type FUL if the production order has the status DLV or TECO.

The variances are settled to CO-PA.

In this example, the variances on the production order are calculated at the end of the second period. In the first period, the production order still has the status REL.

Settlement (posting of G and T)

Work in process and variances have been posted to the production order but have not been transferred to other application components. The results analysis data, the variances, and the balance of the production order can be settled to other application components.

The settlement process transfers the following data:

WIP is transferred to Financial Accounting (and to Profit Center Accounting (EC-PCA) if active). This example does not discuss transfer to Profit Center Accounting.
The balance is transferred to Financial Accounting (and to Profit Center Accounting (EC-PCA) if active).
If the Actual Costing/Material Ledger component is active, the balance is also transferred to that component.

The system finds the account to which the difference is settled through the valuation class and the material account determination as specified in the accounting view of the material master record. The posting also depends on the setting of the material’s price control indicator. With price control indicator S (standard price), the posting is as follows:

If the balance is positive (debit greater than credit): The Expense account (from price difference) is debited and the Finished Goods Inventory Change account is credited.
If the balance is negative (debit less than credit): The Inventory Change account is debited and the Revenue account (from price difference) is credited.
This posting does not affect net income. The inventory account is not posted. The inventory value does not change: the inventory continues to be valuated at the standard price. To be able to adjust the inventory change account (the account posted at delivery) to the inventory account, you can settle the difference to a different price difference account. The production order itself is credited by the settlement of the balance.

Variances are transferred to CO-PA (broken down into variance categories)
Settlement also transfers the variance categories to CO-PA. You can transfer the variances by variance category and cost element, and separated into fixed and variable costs, to value fields in CO-PA. This settlement process transfers the data to a profitability segment which is based on the characteristics (such as product or plant) that you selected in Customizing for CO-PA and that are derived from the production order. The settled variances can be included in the standard cost of sales in CO-PA to calculate a second contribution margin.