Practical ERP Cost Management (2): Cost Master Data, Job Costing and Manufacturing Overhead Allocation

Part 2 of this series, based on a practical ERP cost management course, covers the master data that forms the backbone of cost calculation, job costing, manufacturing overhead allocation and joint costs.

Before choosing a costing method, the first question to settle is: where is cost collected, and on what basis is it allocated to which product?

1. Cost master data determines the calculation result

Master data object Role Examples from the course
Cost center Responsibility unit that plans and collects cost —
Cost element Classifies the nature of expenses and revenues —
Activity type Expresses an activity quantity Labor hours, machine hours
Internal order Tracks cost of a specific purpose Events, campaigns

2. Cost classification criteria

Cost is classified by purpose. The direct/indirect and variable/fixed distinctions in particular have a large effect on allocation and on decision making.

Criterion Categories
Costing object Job costing, process costing
Timing of calculation Pre-calculated cost (before production), post-calculated cost (after production)
Cost basis Standard cost, normal cost, actual cost
Traceability Direct cost, indirect cost
Cost behavior Variable cost, fixed cost

3. Job costing traces cost from raw material to cost of goods sold

Job costing runs through four connected steps.

Step Activity
1 Raw material movements and material cost calculation
2 Aggregation of labor cost and manufacturing overhead
3 WIP valuation and cost of goods manufactured calculation
4 Finished goods movements and cost of goods sold calculation

4. Inventory movements and valuation methods are managed together

The ERP standardizes the inventory management structure and keeps receipts, issues and current stock up to date in real time. The valuation method has to be chosen to fit the accounting policy and the system design.

Area What the ERP standardizes
Inventory management unit Unit at which stock is managed
Organization Organizational units for inventory
Movement types Classification of goods receipts and goods issues
Real-time data Receipts, issues and current stock
Valuation method
Moving average
First-in, first-out (FIFO)
Total (weighted) average
Standard cost

5. Common cost is allocated in stages from indirect departments to products

Cost of the indirect departments is first allocated to the direct production departments, and then from the production departments to products.

Stage From To Basis
1 Indirect departments: plant accounting, labor (HR), equipment maintenance, utilities Direct production departments Allocation base designed per section 6
2 Direct production departments Products Machine hours, labor hours and similar

6. A good allocation base can be explained and verified

Allocation bases and allocation paths are designed with the following principles in mind. The method is chosen according to the company’s cost structure and management purpose.

Principle Meaning
Cause and effect Allocate to the object that caused the cost
Benefits received Allocate to the object that benefited from the cost
Ability to bear Allocate according to the object’s capacity to absorb cost
Fairness Allocation that the receiving parties accept as fair
Allocation method Description
Direct allocation Indirect department cost goes straight to production departments
Step-down allocation Indirect departments are allocated in sequence
Reciprocal allocation Mutual services between indirect departments are taken into account

7. Joint cost arises when one process yields several products

As in a petrochemical process, several joint products can be produced from the same input and the same process. Cost incurred before the split-off point is treated as joint cost and allocated to each product on a reasonable basis.

Term Meaning
Joint products Several products produced from the same input and process
Split-off point Point at which the joint products become separately identifiable
Joint cost Cost incurred before the split-off point

8. Joint cost allocation methods

Product cost and profitability change with the method selected, so consistency and explainability are important.

Method Allocation basis
Physical quantity (production volume) Output quantity of each product
Sales value at split-off point Sales value of each product at the split-off point
Net realizable value Final sales value less further processing cost
Constant gross margin percentage Equal gross margin rate for every product

This is part 2 of a 3-part series on practical ERP cost management.

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