The standard cost of a product, which is used for inventory valuation, is developed based on the expected resources that are required to manufacture each unit. Direct costs include the raw materials and components, as well as the hourly rate of setup, labor, and machine resources required to produce the product. The indirect costs include overhead allocations for costs collected at a company-wide level, such as general facilities and administrative costs. The costs that are collected rarely exactly match the standard cost that has been developed for a product. 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 use a make-to-stock product as an example, in which each product is manufactured to the same specifications, to describe the postings that are made in both FI and CO. These postings originate across SAP ERP processes, including manufacturing, materials management, and sales and distribution, and are captured in the product costing (CO-PC) module. In my prior article, “Hone Your Manufacturing Cost Understanding for Better Decision Making,” I covered the postings made in the first period of a production order, with the assumption that the product was not completed at period end. In this article, I will discuss the postings that are made in the second accounting period, in which the product is completed and the variances of the manufacturing process are written off to the P&L.

Example Make-to-Stock Scenario in the Second Accounting Period

In this example scenario, the production of a music player began in the previous accounting period. The controlling objects that are used in the production process (Figure 1) include:

• Production order: The production order is the primary cost collector for the costs associated with manufacturing the product. The production order was not completed at the end of the prior period, so it still carries a balance of the costs that have been posted to it to date, which includes raw material as well as set-up, labor, and machine hours. The costs on the production order were posted to the balance sheet as work in process (WIP). This WIP posting is not reflected in the reporting on the production order to avoid any confusion for reporting of the manufacturing lines.
• Production cost center: One production cost center is used to capture the direct costs associated with production, including the direct labor and machine costs. The balance carried on the cost center, a result of the under- or over-utilization of manufacturing resources, was cleared to zero at the end of the prior period.
• Overhead cost center: Four overhead cost centers are used to capture indirect costs associated with production, such as costs related to support departments and central services. The balances carried on these cost centers, a result of under- or over-absorption of costs, were also cleared to zero at the end of the prior period.

  The letters in Figure 1 show the postings that are made in the second accounting period. I will summarize the postings that were also made previously in the first accounting period, designated by the dark blue labels. For a more detailed description of these postings, see my previous article. I will describe in detail the steps labeled in light blue, which include new period postings that did not take place in the first accounting period, and differences in the month-end postings for the completed production order.

Period Postings in Period 2

The postings that are made in the second accounting period in this example assume that the production order was open at the end of the last accounting period. In the second period, additional costs are posted to the production order, resulting in similar postings that were made in the first period. In addition, the finished product is completed and received into inventory, which also completes the production order.

Posting of Additional Material and Activity Costs to the Production Order

In the first accounting period, a series of costs was posted in the manufacturing process. In the second period, these costs are again posted to the cost centers, as well as to the production order.

• Postings are made to cost centers that supply resources (both direct and indirect) to the production order. Indirect costs are posted to General Ledger accounts, as well as to administrative cost centers using primary cost elements. These costs include utilities, rent, maintenance, repair, and overhaul (MRO) materials, and support services. These costs are then allocated to manufacturing overhead cost centers, using secondary cost elements. (For more about secondary cost elements, see the sidebar “The Role of Cost Elements” in my previous article.) Finally, direct costs of manufacturing resources, such as production worker salaries, are posted to General Ledger accounts, as well as to the production cost center using primary cost elements.
• Raw materials are issued from inventory to the production order, which results in a posting both to the General Ledger accounts, as well as to the production order using primary cost elements.
• The production cost center resources confirm activities to the production order, such as direct labor and machine time. Each activity has a planned rate. The postings to the production order are made using secondary cost elements.

Receive Finished Goods from the Production Order into Inventory

When the production of the finished goods is completed, a goods receipt is processed for the number of units produced, which moves the completed products from the production order into inventory. The inventory value is updated with the actual quantity produced, multiplied by the standard cost of the products. This goods receipt automatically posts the financial and material documents. In this example, the finished goods are received into inventory from the production order through a materials movement transaction; the financial entries are made automatically, as shown in posting E in Figure 2. The finished goods inventory account is debited on the balance sheet. The credit is posted to the P&L manufacturing output account for standard material costs; it is created as a primary cost element, referencing the production order.  

Month-End Postings

At the end of the second accounting period, the production order has been completed. A series of period-end postings are made to ensure that the WIP that was posted to the balance sheet at the end of the last period is cleared, and that any variances incurred in the production process are recognized and written off. In addition to the cost center postings, month-end processing for the production order in this example is as follows:

• The WIP values are calculated for the production order. Because the order is completed, the values previously posted are canceled.
• The variance values are calculated for the production order
• A settlement is run to post the calculated WIP values and variances to the General Ledger accounts

Cost Center Postings

In the first accounting period, a series of month-end postings was made for the indirect and direct cost centers involved in the manufacturing process. In the second period, these postings are again made at the end of the second accounting period. Postings in this example are as follows:

• Overhead is applied from the manufacturing cost centers to the production order. In this example, the overhead is a percentage of the direct costs that have already been posted to the production order. Postings include overhead for machine, labor (including setup), material, and administrative costs. The overhead postings from the manufacturing overhead cost centers to the production order are made using secondary cost elements.
• Variances are written off for the direct and indirect cost centers. The balance of the cost centers is rarely zero, due to over- or under-absorption of the overhead for the indirect cost centers, and the over- or under-utilization of direct production resources for the direct production cost center. Variances are recognized on the P&L; they are also cleared from the cost centers using primary cost elements.

Cancel the WIP for the Production Order

The production order in this example was open at the end of the prior period, with a status of released (REL). The balance of the order (all costs debited minus the standard cost of completed finished goods credited) was calculated to be the WIP amount, and was posted to the balance sheet at the end of the prior period. For production orders that are completed, as indicated by a status of delivered (DEL) or technically completed (TECO), the period-end WIP process again calculates the WIP amount. In this example, since the order is completely delivered to inventory, any WIP that was posted in a prior period will be canceled. 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 that will be posted to the balance sheet. A credit indicates that a credit will be posted to the balance sheet, which cancels the prior month’s posting to WIP. Other RA cost elements contain the details of the types of costs that make up the WIP balance. In this example, the production order is closed at the end of the second accounting period. The WIP calculation indicates that WIP will be canceled. The only postings made are to the RA cost elements, as shown in posting G-2 in Figure 3. No postings are made to the production order or to General Ledger accounts when the WIP calculation is run. The financial posting will take place during order settlement.  

Calculate the Variances for the Production Order

Variances are calculated on production orders. The difference between the standard cost of the finished products and the actual costs incurred on the production order will be written off as variances. You can then classify and analyze these variances. The reason for variances may be the difference in the actual versus planned quantity of raw materials or resource hours, or a substitution of component materials. Variances are calculated when the production order’s status indicates that it is delivered (DLV) or technically completed (TECO). The production order will be credited if the variance is unfavorable (positive balance), or debited if the variance is favorable (negative balance). In this example, the actual costs to produce the finished product are higher than the standard cost. The variances are calculated in this step, but no postings are made to the production order or to General Ledger accounts (Figure 4). The actual posting takes place during order settlement.  

Run Order Settlement to Post the WIP and Production Variances to the General Ledger

The production order is now complete. After the WIP and the variances have been calculated in the prior steps, the order settlement process is run. During settlement, the calculated values for both the WIP and the variances are posted to the General Ledger accounts.

• • WIP. In the prior accounting period, all costs that were posted to the open production order were posted to the P&L statement throughout the period, as part of the controlling processes. At period end, these costs, categorized as WIP, were moved to the balance sheet so that the costs remained in inventory and were not yet written off before production was complete.In the WIP calculation at the end of the second accounting period, the RA cost elements track the posting that is made during order settlement. Because the production order is complete, the WIP balances from the prior period must be reversed. As in the first period, no postings are made directly to the production order. The impact of the posting is purely a financial transaction, which does not affect the normal production process or the order balances in a production order. For the WIP, as shown in the sample posting G-2 in Figure 5, a credit to the WIP inventory account is posted on the balance sheet and a debit 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. All costs remain on the production order for manufacturing analytics.

 

• Variances. The difference between the standard cost of the finished products and the actual costs posted to the production order were calculated as variances in the prior step.In this example, the variance is unfavorable, and the production order still carries a balance after the finished goods were received into inventory. As shown in the sample posting T in Figure 5, a credit is made to the manufacturing offset account for variances. This account is also created as a primary cost element, so it references the production order, which clears the production order balance to zero. A debit is made to the production variance account. This account is not created as a cost element and these variances are written off as the end of the period.

  Figures 6 and 7 show a summary of all postings that were made to the General Ledger accounts and to the controlling objects. The postings made to the production order cover two accounting periods. The cost centers and the production order have all been cleared to zero. The WIP posting from the prior period has been reversed, the finished product has been received into inventory, and the production variance has been written off on the P&L.