Expense Analysis and Splitting inManufacturing Cost Centers

Introduction

In SAP cost center works as a cost responsibility center, where all the expenses andcosts are stored and analyzed for the purpose of management decision making. Thecost could be fixed or variable in nature. The difference between variable and fixedcosts can be made in various ways in product costing in CO module. Fixed costsrepresent the static costs incurred by the organization, which dont change on thebasis on volume of manufacturing activities, which remain constant irrespective ofproduction activities, e.g. rent for the premises, salaries of office staff etc. On theother hand, variable cost varies based on the level of production activities; ifproduction activities increase then variable costs also increase like electricityconsumed, raw material cost etc. However all the variable costs dont vary in directproportion to quantity of goods produced.

In this document will try to define how expense analysis and splitting of cost is donein manufacturing cost centers.

From controlling prospective, fixed costs remain constant regardless of operatingactivities, but if this factor changes, variable costs will fluctuate. Basically rawmaterial costs represent variable cost, but in this document main focus will be givento distinguishing between fixed and variable activity cost.

The segregation between fixed and variable cost is optional and is derived from theconfiguration and master data in cost center accounting and overhead accounting.

Activity Price:

There are different methods that could be used in cost center accounting to determinethe activity price. The simple way is to manually enter Fixed and Variable Activitycost (KP26). However there are other methods used in Cost center Planning andBudgeting that automatically calculate the fixed and variable activity price. Here thefocus will be given on Planning and Budgeting activity and automatic calculation ofplan activity rate in cost center. This method aggregates planned costs by costelement and capacity by plan units to calculate the activity price. Activity independentcosts are segregated among different activities based on Splitting Structure, whileactivity dependent costs are directly used for the purpose of variable activity ratecalculation.

Fixed Activity Cost:

In product costing all those costs, which dont vary based on the activities inmanufacturing will represent fixed cost. In a manufacturing cost centers there may betwo or more activities performed. To calculate the activities rate, the fixed costs aredistributed to various activities on the basis of Splitting Structure defined for costcenter.

Variable Activity Cost:

Variable activity cost are those costs which directly depend upon the activity andfluctuate based on increase or decrease in manufacturing activities. In SAP variableactivity costs are directly linked to the respective activity.

Activity Prices: Fixed and Variable Split

In Cost Center Accounting dividing the cost between Fixed and Variable requiresappropriate split to be made in the cost entered for the activity. The process isdescribed below:

i. Variable cost would be planned at activity level and expenses should bemaintained at cost element in the manufacturing cost center by assigning activityand cost element combination. In other words, the expenses should be planned onactivity type at the time of primary cost planning (KP06). Then the variableactivity rates are calculated on total cost planned for activity divided by totalquantity of activity planned at that cost center (i.e. capacity in KP26).

ii. Fixed cost would be planned independent of activity type. These costs aremaintained in KP06 at cost element level on manufacturing cost center. Then thefixed costs are distributed on various activity types on the basis of splittingstructure defined at OKEW. In Splitting Structure we define the rules, how thefixed cost will be distributed to activities. For the purpose of this document, wecalculate the split of fixed cost on the basis of Capacity maintained in KP26.

To illustrate the scenario in more details, I have taken a hypotheticalexample.

Supposed there is a manufacturing cost center Engine Plant, in an Automobileindustry, having two activities Cutting and Maintenance for the purpose ofcreating engine parts. Before starting any batch of material to process, the machineneeds to be maintained to be ready for the process, for which it required to usecleaning oil to clean the machine and then the next process start i.e. cutting the ironpiece into the desired engine part.

Assume Cleaning oil cost as variable cost for the purpose of Maintenanceactivity, which is a manual process, and Electricity cost as variable cost for the

purpose of Cutting activity, which is automatic process. Other costs are assumedto be fixed for the purpose of activity price calculation.

There are three planned fixed expenses in engine plant, Depreciation on Machine &Equipment, Depreciation on Building and Salary. The variable cost for Cuttingactivity (defined as RRRR in SAP) is Electricity charges and for Maintenanceactivity (defined as SSSS in SAP) is Oil cost.

Cost center: Engine Plant

Activity ExpensesGL

Account

FixedCost(USD)

VariableCost(USD)

Depreciation onMachine 600001 10000Depreciation onBuilding 600002 20000Salary 600003 15000

Cutting(RRRR) Electricity charges 600004 14000Maintenance(SSSS) Oil cost 600005 15000

Maintain the Plan Activity and Capacity for the different activities on cost centerEngine Plant

Configuration of Splitting Structure

For the purpose of splitting of fixed cost to the different activities assigned to costcenter, we need to define a Splitting Structure. It includes the rules which should befollowed to distribute the fixed cost to different activities. For the purpose of Planningand Budgeting this is an important configuration.

Transaction: OKEW (Assign the new cost center to the splitting structure)

Specify Cost center and Fiscal year

Press

Double click on splitting structure for Manufacturing cost center (FF).

Here the splitting is defined that all the cost elements on manufacturing cost centerwill be distributed to activities on the basis on Plan Capacity.

Master data requirement Activity type (TransactionKL01)

Here we can define the manufacturing activities Cutting and Maintenance in SAP.

Here activity type RRRR represents Cutting activity. The activity unit is defined asHour. For the purpose of assigning an activity to a manufacturing cost center so thatit can be used in price calculation, the cost center categories should be F i.e.manufacturing and production cost center.

Price indicator 2 indicates that to calculate Activity Plan price, system will usecapacity.

Define Plan Activity (transaction KP26):

Assume that the total capacity of Cutting (RRRR) and Maintenance (SSSS) are 700and 300 hours respectively. For the purpose of splitting fixed cost on differentactivities, maintain the rules as Capacity, so the splitting rule will follow plancapacity ratio of (7:3) to distribute fixed costs to Cutting and Maintenance activities.

In KP26 maintain the capacity as 700 Hours and 300 Hours for Cutting (RRRR) andMaintenance (SSSS) activities.

Define Plan Expenses in KP06 as fixed and variabledepending on activity.

KP06 is used for the purpose of primary expenses planning in cost center accounting.Here we can define both activity dependent and activity independent cost. For thepurpose of activity dependent cost (i.e. variable cost), need to define expenses onactivity at cost element level. In the screen below variable costs are:

Expenses on Activity RRRR (i.e. Cutting) at Cost element 600004 (i.e.Electricity charges)

Expense on Activity SSSS (i.e. Maintenance) at Cost element 600005 (i.e. OilCost)

Plan Cost Split KSS4

For the purpose of splitting fixed cost among different activities on manufacturingcost center, we need to run Plan Cost Split, which will distribute the fixed cost todifferent activities assigned to a cost center in KP26 transaction based on the ruledefined in splitting structure. Here for the purpose of simplicity we have defined thesplitting rule based on capacity to distribute all fixed cost. The splitting rule isdefined in OKEW transaction.

Run transaction KSS4, then the below screen will appear, select the below details:

Cost center/ Cost center group (for which we want to use Plan cost splitting) Version Period/ Financial Year (generally full Budget year is selected)

First execute the Plan Cost splitting with test run, if no errors occur then executewithout test run.

Total Plan fixed cost of 45000 has been distributed to two activities Cutting (RRRR)and Maintenance (SSSS) based on 7:3 ratio, i.e. on the basis of Capacity maintained inKP26. Plan cost split only distributes Fixed Cost to activities.

Plan Activity Price calculation KSPI

After Plan cost split, the next step if Plan price calculation. Plan price calculationbasically helps to calculate Plan Activity Rate. The activity rate could be in twoparts, i.e. Fixed Activity rate and Variable Activity rate.

Fixed Activity rates are calculated based on Plan Cost (Fixed) Split, during KSS4,divided by Capacity.

Variable Activity rate are calculated based on Variable Cost, assigned to activity atthe time of Primary cost planning (KP06), divided by Capacity.

Total Activity rate include both Fixed and Variable activity rate. Its calculated bydividing total cost by capacity.

Run transaction KSPI, then select the below details: Cost center/ Cost center group (for which we want to calculate Plan activity rate) Version Period/ Financial Year (generally full Budget year is selected)

First execute the Plan Price calculation on test run. If no errors occur then executewithout test run.

Report for Activity rate (KSBT): Through transaction KSBT, we can see the Plan andActual activity rate for the cost center. In the below screen variable, fixed and totalactivity rate have been displayed for activity Cutting and Maintenance for costcenter Engine Plant.

How the system is calculating the cost is explained in details in the below table.Activity rate can be cross reconciled with the Activity Type Price Report in the abovescreen.

Plan Cost AnalysisTotal

Activity Cutting Maintenance UnitA:- Capacity 1000 700 300 HoursB:- Variable Cost 29000 USD

i. Electricitycharges 14000 USD

ii. Oil cost 15000 USDC:- Fixed Cost 45000 USDD:- Fixed cost Split(Split based onCapacity) (7:3) 31500 13500 USDE:- Total Cost (B+D) 74000 45500 28500 USDF:- Variable Activityrate (B/A) 20 50 USD/HG:- Fixed Activityrate (D/A) 45 45 USD/HH:- Plan Activityrate (F+G) 65 95 USD/H

Cost Center Report

There are different cost center reports that can be used for the purpose of analyzingthe plan and actual expense in SAP. In the cost center report below, we can see theentire plan cost details. Here details of expense can be analyzed at cost element (GLaccount) level.

At cost center Engine Plant total debit amount is 74,000 /-, which includes bothFixed and Variable cost. Total cost transferred to activities Cutting andMaintenance is 45,500 USD and 28,500 USD respectively.

Actual expenses splitting for manufacturing costcenters

Till now this document explains the process of differentiating between Plan FixedCost and Plan Variable Cost and how the SAP can be used to differentiate betweenPlan Fixed and Plan Variable cost in manufacturing activities.

Now we will look the actual expenses splitting between Fixed and Variable cost. Foractual expense analysis, we need to understand two different concepts, first theposting of documents at GL accounts to represent actual expense, and the secondtransfer of actual cost from cost center to production or process order.

1. Posting of Actual Expenses at GL accounts: Accounting documents areposted only when there are events with financial impact. So to record the financialimpact of event, we need to create journal entries in accounting. These documentsin SAP could be stored through FB50 or FB01 etc. In the same way, the actualexpenses in manufacturing cost centers are also recorded through accountingdocuments. Actual expenses are recorded at GL account level we dont definewhether the expenses are activity dependent or activity independent in nature. Atthe time of actual cost split to differentiate between actual fixed and actual variable

cost, system checks the rule defined at the time of Plan splitting. It considers theGL account expense as variable expense if it has been assigned as variable/ activitydependent expense at Primary cost planning in KP06.

2. Transfer of Actual Cost from Cost Center to Process Order: This processis called secondary allocation, i.e. movement of costs within controlling moduleonly. Here no Finance documents are created. Transfer of actual cost from costcenter to process or production order happened when the plant controllersconfirm the completion of activity at order. The costs which get transferred fromcost center to process order basically represent planned cost calculated at actualactivity (i.e. plan activity rate calculated at KSPI multiplied by actual activities atprocess order) because at this time we dont have actual activities rates calculated.The actual activity rates are calculated at the time of monthly period end closingactivities, when all the actual expenses are posted on manufacturing cost centerdirectly or get transferred from support cost centers.

For illustration of actual expense analysis journal entries have been posted andactivities have been confirmed at process order level. Expenses for amount of18,548.75 /- have been posted and 150 hours of Cutting activities and 100 hours ofMaintenance activities have been confirmed at manufacturing cost center EnginePlant. The cost center reports are below:

After Activity confirmation the activity costs are calculated as (Actual Activity* PlanCost)

The cost of 150 Hours of RRRR Cutting activity is 9750 CHF (150 Hour *65CHF/Hour)

Similarly the cost of 100 Hours of SSSS Maintenance activity is 9500 CHF (100hours *95 CHF/Hour)

So it can be said that at the time of activity confirmation on process order, systemcalculates the cost of actual activity at Plan activity rate.

Actual Cost Splitting (KSS2) and Actual Activity Pricecalculation (KSII)

Enter transaction KSS2 and specified the below details before executing thetransaction:

Cost center/ Cost center group Period and Fiscal year (generally the month should be selected for which period

end closing activities should be closed)

Execute the transaction on test run first. If no errors are encountered then executethe transaction without test run.

Actual price calculation KSII

Now the Actual Activity Price

At the time of actual cost split, in order to differentiate between actual fixed andactual variable cost, the system checks the same rule defined at the time of Plan costsplitting. It considers the GL account expense as variable expense if it has beenassigned as variable/ activity dependent expense at Primary cost planning in KP06.

Finding of Actual Expenses Analysis and Splitting:

a. Actual expenses splitting works on the basis on Plan cost splitting.b. Actual expenses are divided into two parts, i.e. Fixed and Variable.c. All those GL accounts, which are planned as variable at the time of Primary cost

planning are considered as variable at actual expenses also. If any accountingdocuments are posted on these accounts by assigning same manufacturing costcenter, then system considers this as activity dependent cost and calculates actualvariable activity rate.

d. Actual activity variable rates are calculated by dividing variable cost by actualactivities confirm at process or production orders.

e. On the other hand expenses posted on other GL accounts are considered as Fixedin nature. Fixed expenses are distributed to different activities assigned to costcenter on the basis on Plan Capacity. In this example total fixed cost of 18016.25has been distributed to Cutting RRRR and Maintenance SSSS activities on thebasis of capacity ratio (7:3) maintained in KP26.

f. Actual activity fixed rates are calculated by dividing fixed costs on activity by actualactivities confirm at process or production orders.

Conclusion

With the help of this document, we have learnt how we can manage the plan andactual expenses in fixed and variable part. Deciding whether expenses will bedependent on activity or independent of activity will be a management decision,which can vary from industry to industry and company to company. Once we decidethe nature of expenses, we can use the above concept to distribute the expense on

fixed and variable activity rate, which could be further used in product costing as partof product cost.

Here the example given is for one manufacturing cost center to illustrate the concept.This can be applied on multiple manufacturing and support cost centers and can beused for the purpose of overhead management as well.