Practical ERP Cost Management (1): Cost Flow and the Big Picture of an Integrated ERP

This series is based on a practical ERP cost management course and summarizes the cost flow of a manufacturing company and the structure of cost management in an ERP system.

Part 1 covers why cost management accounting is needed, how material cost, labor cost and overhead flow into products and cost of goods sold, and how an integrated ERP connects that flow.

Note: the actual process and master data differ by company, depending on the production method and the ERP configuration.

1. Starting point of practical ERP cost management

Cost management is not a stand-alone calculation. It links purchasing, production, inventory, sales and finance data into one flow. The series moves step by step from cost concepts to actual costing and the period-end close.

2. Structure of the course

The course has two parts. This series concentrates on the main flow of Part 1.

Part Topics Covered in this series
Part 1 Cost concepts, actual costing, manufacturing overhead allocation, period-end cost close Yes (main flow)
Part 2 Standard costing, variance analysis, profitability, budgeting and strategic cost management No

3. Sequence matters in cost management

A Korean proverb says that no matter how busy you are, you cannot sew by tying the thread to the middle of the needle. Applied to costing: instead of rushing to produce a cost result, first put the master data, the source actuals and the allocation logic in order.

Order What to prepare first Why
1 Master data (cost elements, cost centers, allocation bases) Defines where cost is collected and how it is allocated
2 Source actuals (purchasing, production, inventory, sales, FI expenses) The cost result can only be as accurate as its inputs
3 Allocation logic Decides how common cost reaches products
4 Cost result Produced last, on top of the three items above

4. Cost management accounting as the hub for management decisions

Cost management accounting collects data from every operating area and converts it into information for decision making. The point is to provide accurate information, fit for its purpose, at the right time.

Source area Data collected
Production Input quantities, working hours
Purchasing / inventory Goods receipts and goods issues
Equipment Equipment cost
Sales Revenue
Financial accounting Expenses
Output information Use
Actual data aggregation Collected actuals by cost object
Cost calculation Product and department cost
Profitability analysis Profit by product, customer or business unit

5. Financial accounting and management accounting have different purposes

Good cost information requires an understanding of the shop floor and cooperation with the operating departments; it is not produced by the accounting department alone.

Aspect Financial accounting (FI) Management accounting (CO)
Focus External reporting Internal management support
Main outputs Determination of assets and profit or loss Planning, budgets, standard cost, actual cost, profitability, performance evaluation

6. Manufacturing cost moves along the process and the inventory

Raw materials are issued to the production process and become finished products by way of work in process and semi-finished products. Material cost, labor cost and overhead accumulate as manufacturing cost along the way, and the cost is converted to cost of goods sold at the time of the sales goods issue.

Stage Inventory or cost object What happens to cost
1 Raw material Issued to the production process
2 Work in process (WIP) Material cost, labor cost and overhead accumulate
3 Semi-finished product Accumulated manufacturing cost carried forward
4 Finished product Manufacturing cost of the finished product
5 Sales goods issue Converted to cost of goods sold

7. Basic cost calculation formulas

Total manufacturing cost for the period is the sum of material cost, labor cost and overhead. Adding beginning WIP and subtracting ending WIP gives the cost of goods manufactured; applying the finished goods movements gives the cost of goods sold.

Total manufacturing cost (period) = Material cost + Labor cost + Overhead
Cost of goods manufactured        = Beginning WIP + Total manufacturing cost - Ending WIP
Cost of goods sold                = Cost of goods manufactured, adjusted for finished goods movements
                                    (beginning finished goods + goods manufactured - ending finished goods)
Formula Inputs Result
Total manufacturing cost Material cost, labor cost, overhead Cost incurred in the period
Cost of goods manufactured Total manufacturing cost, beginning WIP, ending WIP Cost of products completed
Cost of goods sold Cost of goods manufactured, finished goods movements Cost of products sold

8. ERP links master data and transaction data

Cost management functions are built on master data. The transactions from purchasing, production and sales must be accurate for the results to be reliable.

Layer Elements
Master data Cost elements, cost centers, allocation bases
Functions built on the master data Expense planning, common cost allocation, standard costing, actual costing, profitability analysis, performance management
Transaction data Purchasing, production and sales transactions

9. Process standardization is the core of an ERP implementation

From an end-to-end point of view, the flows have to be designed and turned into a company asset. A process classification framework and internal controls need to be in place for the module integration to work stably.

End-to-end process From To
Order to cash Customer order Collection of payment
Purchase to pay Purchase requisition Payment to the supplier
Prerequisite Purpose
Process classification framework Stable operation of the module integration
Internal control Stable operation of the module integration

10. Actuals from each module converge into cost and profitability

When the operating processes in SD, MM and PP are connected with FI and CO, the following results can be managed in one data flow.

Module Area
SD Sales operations
MM Purchasing and inventory operations
PP Production operations
FI Financial accounting
CO Management accounting
Result managed in one data flow Level
Cost by department Cost center
Standard cost and actual cost by product Product
Profit and loss by business unit Business unit

This is part 1 of a 3-part series on practical ERP cost management.

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