A company can choose between different methods for manufacturing its products, depending on the type of product, complexity of the production process, and whether the product is manufactured in response to customer demand for particular options. Different cost objects are available within product costing in SAP ERP, which complement each manufacturing process.
Key Concept
A cost object is a type of controlling object that captures the costs associated with a value-added process, such as manufacturing a product. Depending on the manufacturing process, a different cost object may be used in the system to collect the costs incurred in producing a product. The costs are commonly collected by the same objects that are used to manage the manufacturing process. For example, for products that are managed by lot size, a production order is used for building discrete units of a product, and a process order is used for products that are created using recipes and formulas. In a repetitive manufacturing scenario that focuses on costs by period, a product cost collector is used to collect and manage costs. Finally, for customizable products, options for managing costs include a sales order item, a production order, and a project.
The manufacturing process that you choose to produce a particular product depends on a variety of factors, including the type of product, how many units are produced in a production run, and whether a product has configurable options. For example, the manufacturing process for an MP3 player is very different from the production of a beverage or an automobile. In addition, multiple manufacturing methods are often used within the same company for different product lines.
With the integrated nature of SAP ERP, the product costing method is closely aligned with the manufacturing process. Postings that are made in logistics, such as a goods movement, also create the corresponding financial postings in the SAP General Ledger and in the managerial accounting (CO) module. Product costing captures the costs that result from the daily production transactions, such as the cost of resources, including raw material components, labor and machine hours, as well as costs that are allocated through controlling processes, such as overhead.
To support this close alignment between production and product costing, a different cost object is used to track and manage the cost associated with each manufacturing process. In this article, I summarize the different manufacturing processes, their characteristics, and the cost objects they employ. For a summary of the manufacturing processes, and the cost objects that are most commonly used for each scenario, refer to
Table 1.
Table 1
Common manufacturing processes and their associated cost objects
Note
In the scenarios discussed in this article, direct costs refer to the resources used in producing a finished product, including the raw or semifinished material components used in production, as well as activities such as labor and machine time. Indirect costs refer to overhead allocations.
Standard Products Using Make-to-Stock
In a make-to-stock (MTS) environment, a product is manufactured and placed into unrestricted inventory. The product is standardized; it is not possible to select options, as each item is manufactured in exactly the same way. In an MTS environment, after production is complete, the finished product is received into inventory as unrestricted stock, meaning it can be sold to any customer through a sales order.
An example of an MTS product is an MP3 player: Each MP3 player is made in exactly the same way with the same specifications. An MP3 player with 8 GB of memory is considered to be a different product, or model, than a music player with 16 GB of memory. The customer does not configure the memory, but instead simply chooses between different models.
The following manufacturing processes are available within an MTS environment:
- Discrete manufacturing. In a discrete scenario, a particular quantity of units is manufactured and is specified as a lot size. The finished product is made on a particular production line; this production line can usually be used to manufacture more than one model or product, each with different standard specifications. Examples include computers and medical equipment. In SAP, the production order is used to manage the discrete production process. Product costing also leverages the production order as a cost object, to collect both the direct and indirect costs. Month-end processes, including calculating work in process and variances, are also carried out on the production order.
- Repetitive manufacturing. In a repetitive scenario, individual products are manufactured, but the product does not change frequently on the production line. Large quantities are produced in a continuous manner, often on an assembly line, such as automobile engines and appliances. The product cost collector is used in manufacturing to manage the repetitive process. In addition, the product cost collector captures primarily the direct costs associated with the manufacturing process of the finished product. The focus of repetitive manufacturing is to manage costs by period for a product, not by a lot size. For this reason, back flushing is often used in this environment. This means that periodically the quantity of completed finished goods is confirmed, which simultaneously posts the direct costs of the resources and receives that quantity of finished products into inventory. This process eliminates the need for a work-in-process calculation because there is no timing difference between the debits (resources) and credits (receipt of goods into inventory). The product cost collectors can be assigned to a cost object hierarchy. The cost object hierarchy is composed of cost object nodes, which are used to hierarchically organize product cost collectors to represent product groups. Cost object nodes are created for the combination of a material/plant, or a material/plant/production version and are assigned to the cost object hierarchy. Indirect costs are then allocated to the cost object nodes, where they can be settled to individual product cost collectors, or remain on the higher level on the cost object nodes.
Note
The cost object hierarchy can also be used in conjunction with other cost objects, such as production orders and process orders. In practice, it is primarily used for a repetitive scenario, because the focus of the cost object hierarchy is on period accounting, not on individual lot sizes that are managed by manufacturing orders.
- Process manufacturing. The process industry is characterized by products that are manufactured in a continuous flow, for example oil or chemicals or even sauces that are made in batches in the food industry. Characteristics, from the classification system, are used to manage the quality of the products. The products manufactured in the process industry are often characterized by co-products, in which an additional product results from the manufacture of the primary product and can be sold in its own right; and joint production, in which two products are produced together. For product costing, the process order is used to manage the production process, and it is also used to collect the direct and indirect costs. The process order also allows the calculation of costs, including a standard cost, for each co-product and joint product being produced.
Note
It is possible to use a production order for both repetitive and process manufacturing scenarios. Companies may choose this method if their products do not have the aforementioned special processing requirements; for example, they do not need the capability of handling co-products even in a process industry.
Customizable Products
Different manufacturing processes are available when a finished product is customizable, meaning that customers can choose specific options during the sales order process. These options are captured by characteristics using variant configuration.
Make-to-Order (MTO)
If a company chooses a make-to-order (MTO) manufacturing strategy, a customer is allowed to choose options for a product. Once those options are chosen and captured in a sales order item, the product is made specifically with the customer’s options. The sales order item automatically creates the manufacturing and cost objects required to produce the product, most commonly the production order. The resulting product is tied to the original sales order, and it can only be delivered to the customer who placed the order. An example of an MTO product is a desktop computer. A customer can choose multiple combinations of options, such as the size of the hard drive, the monitor, and the processor speed. The desktop computer is then manufactured to the customer’s specifications.
Product variants, which are combinations of commonly chosen options, help streamline the manufacturing process. In the desktop computer example, there may be three most commonly chosen combinations of hard drive, memory, and monitor size. A retail store may order these variants, or preconfigured products, so that they are more quickly available to the customer.
Assemble-to-Order
Assemble-to-order (ATO) is a variation of the MTO process. From the customer’s perspective, the process of choosing product options is the same. From the manufacturer’s standpoint, there may be subassemblies, or components, of the product that are already manufactured. Instead of building the product from the ground up, the preassembled components are chosen and built into the finished product. An automobile can be used as an example of an assemble-to-order process; one component is the engine of the car. The engine could be a V6 or a V8; the engine itself has already been produced. The engine type that has been selected by the customer is then simply inserted into the car during the assembly of all components; the engine is not manufactured from scratch based on the sales order.
Niote
Although all cost objects — including production orders, product cost collectors, and process orders — can technically be used in an MTO process to manage the production of the demand generated by the sales order item, the most common cost object used is the production order.
Engineer-to-Order
The most complex variation of the MTO process is engineer-to-order (ETO). The product to be constructed has not yet been defined. It is designed in collaboration with the customer, which is typically an iterative process. Once the customer and the manufacturer have agreed on the design, the manufacturing company can build it. An example of an ETO project is a large construction project, such as a bridge, which is only built once. Another example is the design of an aircraft; once the new plane has been designed — for example, with a particular seating configuration — that design can be used to build multiple planes for an airline.
To manage the more complex, iterative tasks of designing and producing a large-scale project, Project System is used to manage the costs. A project has two different types of master records: a work breakdown structure (WBS) element and a network. The WBS element manages the revenue that is expected from the project and the hierarchy of tasks that need to be carried out. The network is a complex production order, which enables more detailed resource planning and provides the capability to link to operations defined in other networks. Direct and indirect costs that are captured on a network are settled to the WBS element. Further month-end processing, such as work in process, is calculated on the WBS element defined as the billing element in the project structure.
Stock Valuation for Customizable Products
The cost object used for MTO, ATO, and ETO processes depends on the configuration of inventory valuation.
Nonvaluated Stock
If nonvaluated stock is used, the sales order item is the controlling object and is used to manage the costs of the production process. Often, this creates additional steps — for example, settling the direct costs on the production orders to the sales order items so that month-end processes can be carried out on the sales order items. The finished good is never received into unrestricted stock in the system. It is issued directly to the sales order for delivery. This type of valuation is used when there are a large numbers of options, the value of the product is high, marketing and sales allocations should be made at the sales order item level, and margin analysis needs to be carried out on the sales order item level.
Valuated Stock
When you are using valuated stock, the sales order item drives the calculation of the “standard” cost of the configurable product. However, the sales order item is not used to manage the manufacturing costs. With valuated stock, the accounting entries are made in the same way the accounting entries are made for a MTS scenario. Using the most common scenario as an example, if the normal discrete scenario would use a production order, the costs for the MTO are posted to that production order. Also, the finished good is received into inventory, but is designated as sales order stock so that it can only be issued to the customer who ordered that particular configuration.
The use of valuated stock unifies the month-end processes to avoid a differentiation between the sales order item and discrete controlling processes, and ensures a more consistent view for analytics. The option to turn on valuated stock has been available since SAP R/3 4.0, and it is the option most commonly implemented.

Birgit Starmanns
Birgit Starmanns is a senior director in solution marketing at SAP for EPM (Enterprise Performance Management) and Finance solutions. Birgit has more than 20 years of experience across solution marketing, solution management, strategic customer communities, and consulting. Her functional experience is in finance, including core SAP ERP and enterprise performance management, as well as customer relationship management, which has allowed her to focus on the integration of cross-functional business processes. Prior to joining SAP, she was a principal in management consulting organizations, redesigning business processes and implementing SAP R/3 and R/2 for numerous Fortune 500 and SME companies, with a focus on management accounting. Birgit holds a BA and an MBA from the College of William and Mary.
You may contact the author at
birgit.starmanns@sap.com.
If you have comments about this article or publication, or would like to submit an article idea, please contact the
editor.