When your business model involves creating unique products for your customers, you need to understand the costs involved in the actual build of a product. However, you also need to include the time and costs to design and prototype the product, which is usually an iterative process. Only then can you understand the true profitability of an engineered product. An example of an engineer-to-order (ETO) project is a large construction project, such as building a bridge or highway, which is only built once. Alternately, after designing a product, such as an airplane with particular seating configuration based on the airline’s specifications, you can then build multiple airplanes based on that same configuration. Although I use a very simple example here with only one design step, the design process is typically iterative, and may involve interplay between design and production — for example, if a prototype needs to be built even before the actual product is manufactured. In the SAP system, you use Project System (PS) to track both the phases of the project as well as the individual tasks. Keep in mind that in an ETO environment, there is no standard cost; instead, you use planned costs to estimate the cost of designing and manufacturing the product. Actual costs are then posted to the project. These costs become the cost of goods sold through direct financial postings and via logistics processes, including revenue when the customer is billed and costs for both design time and manufacturing. I focus on tracing each step in an ETO manufacturing process and analyzing the postings that are made in both FI and Managerial Accounting (CO). I show both the FI and CO postings made throughout each period to the project, including cost collection and the revenue received from the customer based on intermittent billing. A complex project is normally open for many periods, so the postings that I discuss can occur in every period in which the project is open.

ETO Example Scenario

To illustrate the product costing postings made, I use a very simplified example of building an airplane (Figure 1). To start the process, you create a sales order for the engineered product. The sales order item automatically creates a network, which allows you to manage the tasks for the project. The network is created by copying a standard network, which is a template of the expected activities that you believe need to be carried out, including the resources (such as labor and machine time) that are required. You can adjust the activities in the newly created network, which does not affect the standard network. Also, in this example, the planned completion dates of selected activities in the network are defined as milestones. These milestones are updated in the sales order item’s billing plan for the finished product. This process allows invoicing to the customer to be spread throughout the life of a project. The billing is blocked on the sales order item until each relevant milestone is confirmed on the network. The network also references a bill of material (BOM) of expected components that you need to design and manufacture the product. You can make changes to the BOM during the design phase of the project; these changes also do not change the standard BOM or the standard network. The network automatically creates a WBS element structure, which is copied from a standard project structure. You can continue to make changes to the WBS elements, which also do not affect the standard project structure. The project is used to manage all costs and resources of the manufacturing process. Each WBS element, and each activity within a network, is its own controlling object that collects the costs associated with engineering and producing the finished product. The sales order is not a controlling object itself when using valuated stock, but directs the revenue to a WBS element that is designated as a billing element, which collects the revenue billed to the customer. Figure 1 illustrates a sample project:

• The project definition is the umbrella master record; WBS elements are linked to the project definition.
• The top-level WBS element is designated as a billing element, which means that it collects the revenue from the invoice process.
• The next two WBS elements are accounting elements, meaning that costs can be posted directly to the WBS elements as well as to the network activities. In this scenario, postings are made directly to the network activities.
• One network is created. The first activity, design, is linked to the first WBS element. The other activities of the network to manage the manufacturing process are linked to the second WBS element. This keeps the design and the manufacturing costs separate.

I describe the postings made in the first accounting period, assuming that the project is open (not completed) at the end of the period. I analyze the following controlling objects (Figure 2):

• Project: Three WBS elements and six activities in a network are used to capture the costs and revenues associated with the engineering project.
• Engineering and production cost centers: One engineering cost center is used to capture the direct costs associated with design of the product. One production cost center is used to capture the direct costs associated with the manufacture of the product, including the direct labor and machine costs.
• Overhead cost centers: Five overhead cost centers are used to capture indirect costs associated with engineering and production, such as costs related to support departments and central services.

The postings I cover here occur within a financial period. These postings include:

• Postings that are made to cost centers that supply resources (both direct and indirect) to the project. The cost center structure in my example is one possible design, and I use it because it includes commonly used allocations in a manufacturing company.
• Raw materials that are issued from inventory to the network.
• The engineering and production cost center resources that confirm activities to the network activities.
• Revenue postings that are made when the customer is invoiced as soon as the first milestone is reached.

I assume that the project remains open over multiple periods; therefore, these are postings that are likely to occur in each period in which the project is open.

Post Expenses to Service and Administrative Cost Centers

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 design is complete for the product and whether the production line is running. These indirect costs are managed in cost centers. In the engineering and manufacturing process, they are ultimately treated as overhead. In my example, actual salaries are posted to a utility cost center at the beginning of the period, as shown in posting A-1 in Figure 3. These salaries are a direct cost for the utility cost center, but are treated as indirect costs of the overall engineering process. The accounts payable (A/P) account is credited on the balance sheet and the salary expense account is debited to the P&L. The P&L entry references the utilities cost center.

Allocate Costs from Indirect Cost Centers to Manufacturing Overhead Cost Centers

Costs are allocated from the service and administrative cost centers to engineering and 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 utilities cost center are evenly allocated to all engineering and manufacturing overhead pool cost centers, as shown in posting A-2 in Figure 3. I use an assessment to move the costs, which means that secondary cost elements are used to track the allocations between the cost centers. The posting moves the original salary expense only between cost centers in the CO module. No postings are made directly to the General Ledger accounts; on the P&L, the costs still reside in the salary account.

Post Expenses to Direct Engineering and Production Cost Centers

The engineering cost center accumulates the direct costs associated with the iterative design of the product. The production cost center then accumulates the direct costs associated with the production process. In this example, I use one of these costs as an example — the salaries of design experts in the engineering department and the salaries of production line workers assigned to the production cost center. The engineering and production cost centers supply the direct resources (for example, labor and machine time) to the project. 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 this example, actual salaries are posted to the engineering cost center at the beginning of the period, as shown in posting A-3 in Figure 4. In addition, actual salaries of production workers are posted to the production cost center, as shown in posting A-4 in Figure 4. These salaries are a direct cost for these two cost centers as well as for the overall engineering and manufacturing process. The A/P account is credited on the balance sheet, and the salary expense account is debited on the P&L. The P&L entry references the engineering and production cost centers, respectively.

Issue Raw Material to the Network

Raw material is issued to the network, either for a prototype (or proof of concept) or for the actual manufacturing of the finished product. The system bases the expected quantity of raw material to be issued on the components that were copied to the network from the template, or standard network, plus any changes that you made directly in the network as part of your component planning. You can manually update the raw materials to reflect actual use. In this example, raw materials are issued to the network activity at their moving average cost. You can either manually issue the raw materials from inventory or you can confirm the network activity, meaning that any material linked to that activity is automatically issued to the network. In this example, the raw materials are issued from inventory to the network through a materials movement transaction; the financial entries are made automatically as shown in posting B in Figure 5. The raw material is a direct cost for the production process. The raw materials inventory account is credited on the balance sheet and the raw material consumption account is debited on the P&L. The P&L entry references the network activity.

Confirm Activities from the Engineering and Production Cost Centers to the Network

The engineering and production cost centers supply value-added resources, such as engineering time, labor time, and machine time, to the network. From an engineering and production perspective, the resources are represented by work centers. From a costing perspective, the resources are represented as activity types (such as engineering hours and labor hours), and each activity type has a planned rate for the cost center. By linking the work center to the appropriate cost center, the activity types can then be used as resources in the network. The resources (activity types) used to design and produce the product are posted to the network. The quantity of each activity — the number of hours — is multiplied by its planned activity rate. The system expects a standard number of hours to be confirmed; they are first copied from the standard network and can be adjusted for the expected time. In the system, you can confirm the network activity manually and update the number of hours to reflect actual time spent. Alternately, you can confirm the activities through time entry in SAP ERP Human Capital Management (SAP ERP HCM). When the hours are confirmed on the network, the financial entries are made automatically, as shown in postings C-1 and C-2 in Figure 6. Because this posting moves the original salary expense only from the engineering and production cost centers to the network activities, no postings are made directly to the General Ledger accounts; these costs remain in the salary expense account. Instead, secondary cost elements track the allocations between the engineering and production cost centers, which are credited, and the network, which is debited.

Invoice the Customer

In an ETO scenario, it is unlikely that invoicing is delayed until a complete delivery has taken place, especially if prototypes of a product are delivered or if the engineering process takes months or years. In this scenario, I assume that the customer is invoiced when particular milestones are met. These milestones were defined when the sales order item originally created the network. The planned completion dates of the activities in the network that are relevant to billing in turn update the billing plan for the sales order item. When each of these network activities that are relevant to billing is confirmed, as shown in the prior step, the actual billing dates are updated in the billing plan of the sales order item, and the billing blocks for each corresponding date in the billing plan are automatically removed. When invoicing takes place, the revenue is posted to the General Ledger with a debit to the accounts receivable account on the balance sheet, a credit to the revenue account on the P&L, and a debit for any relevant sales discounts account on the P&L, as shown by posting Y in Figure 7. In an ETO scenario, the controlling object for the revenue posting is the WBS element that is identified as the billing element, which reflects the revenue and sales discount postings. The sales order item is a pointer to the controlling object, or the WBS element. Figures 8 and 9 show a summary of all postings that were made to General Ledger accounts and to the controlling objects during the period, before any period-end closing activities have taken place. After all the postings are made during the period, month-end closing activities take place to ensure correct valuation of the project. See the sidebar “Period-End Processes for Projects” for an overview of these steps.