What Is Product Costing

What is Product costing?
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Estimating the cost of a product is referred as product costing. Now in order to estimate cost
of any product, below information is needed
 What materials and in how much quantity are consumed in

producing finished good? List of all the materials which are
consumed is referred as Bill of Materials (BOM).
 How much is the making cost in producing finished product?
Making cost comes from activities that are being performed on
materials to produce finished product. Each and every activity
which is performed has cost associated with it. Hence if we
calculate cost of each activity and add it up, we will arrive at making
cost of finished product.
Each activity might have different cost associated with it. Hence making cost of finished
product depends upon which activity is performed in how much quantity in producing
finished product. Hence, adding up the cost of various activities in order to arrive at making
cost of finished product is referred as Activity Based Costing.
Maintaining the list of all the activities and their respective quantities which are performed in
producing finished product is referred as Routing.
 How much is the overhead cost in producing finished product.

Overhead cost is the indirect cost which is involved in producing
finished product. Example of overhead cost Electricity, Wifi,
cleaning cost, telephone bills etc.
Let’s say that over the years of experience, business has learned that overhead cost is
normally 1% of material cost and .5% of making cost. Hence overhead cost is calculated by
applying certain % on material cost and similarly on making cost.
Hence for calculating overhead cost, we can use a formula which will calculate overhead by
applying certain % on material cost and certain % on making cost. This kind of formula is
referred as Costing Sheet.
Hence to estimate cost of a finished product, we need to create BOM, Routing and Costing
sheet.
Material is created by SAP MM team.

BOM and Routing is created by SAP PP team
Costing sheet is created by finance team.
Let’s say Bom, Routing & Costing sheet is created. Then in order to estimate the cost of
finished product, we need to execute cost estimate run. The estimate run picks up the list of
materials consumed from BOM, picks up the list of activities from Routing and calculates
overhead cost using Costing sheet.
Output of cost estimate run is, estimate cost of finished product divided at lower level. Total
cost of finished product is broken down at lower level for analysis purpose. These broken
down lower level of Cost is referred as Cost Component.
In our example, total cost can be broken down into lower levels (cost components) like
Material cost, Making cost & overhead cost. These cost components add up to make cost of
finished product.
Defining the cost components into which total cost estimate is to be broken down is referred
as Cost Component Structure.
Let’s understand the above concepts along with example:

Let’s try to do cost estimate for finished product “CARROT Halva”.
Suppose for producing 1kg of Carrot Halva, estimated material consumption is Milk (1 liter),
Sugar (.5 kg), Carrot (1kg), Ghee (.2kg) and Dry fruits(.2 kg).
Activities involved for producing 1 kg of Carrot Halva are Cutting (crushing the carrot) and
then heating the material for cooking.
Overhead is 2% on raw material cost.

Above picture shown BOM for 1 kg of finished project “Carrot Halva”.
Above is routing.
Above is the costing sheet showing material overhead is 2%
How costing sheet is defined and used will be covered in detail in later articles. As of now
let’s just say that material overhead is 2% on raw material cost.
Below screenshot showing cost component structure
Above cost component structure ‘GH’ showing total cost is to be broken down into three
components namely Raw material, Making cost and Material overhead
Below is the output of cost estimate run:

Above screen showing, total estimated cost of producing 1 kg of carrot halva is 457.6
INR.
Cost of items involved is as shown below:
Product costing overview
Let’s focus on work of SAP FICO consultant in product costing.
As discussed above, cost component structure is created by finance team.

As shown above, different cost accounts need to be mapped to respective cost components.
As a result when cost estimate is run, cost is clubbed in respective cost components as
specified in cost component structure.
As discussed above, costing variant is maintained by FICO consultant. Let’s understand

what is the use of costing variant? Costing variant provides answer to below questions:
What is the purpose of cost estimate run?
How values will be arrived for material, activities, subcontracting and external processing?
Which costing sheet is going to be used for overhead calculation?
Which dates to be defaulted when running cost estimate run? E.g. Costing from date, costing
to date etc.
There can be multiple BOM and multiple Routing. Which BOM and Routing to use when
running cost estimate run?
How cost estimate is updated in material master as standard cost?
Below steps to be executed to update cost estimate in material master:
1. Cost estimate run: Run estimate run is executed so that cost

estimate is calculated using costing variant. If cost estimate is
calculate correctly (without any error), calculated cost estimate is
saved.
2. Marking: Marking refers to updating calculated cost estimate in
material master as future standard cost. As shown in above picture,
as a result of marking future cost is updated in material master.
3. Release: Release refers to making future cost as current cost
estimate and current cost become previous cost.
What happens when estimated cost is updated in material master as

standard cost?
When new standard cost is updated in material master, existing inventory is revalued at new
standard cost. The difference arising out of revaluation is posted (finance document) in
account books.
Existing quantity of material 1476 is 7000

Previous standard cost was 557.6
Hence, inventory value = Quantity (7000) X Standard cost (557.6) = 3,90,3200
When release happen, future price is updated as current standard cost.
New standard cost is 457.6
New inventory value = Quantity (7000) X Standard cost (457.6) = 3,20,3200
Hence value of inventory is reduced by 7,00,000
As a result of revaluation, below document is posted automatically:
Since above document is posted automatically, hence system needs to be provided with GL
accounts to be picked for posting. This account determination is done in T code: OBY6
What is the use of standard cost which is
updated in material master?
Use of standard cost in purchase order:
When good receipt (GR) is done, then below document gets posted.
As you can see, any difference between purchase price and standard price is posted to price
difference account. (Assuming material is maintained at standard price and
not at moving average price).
If price difference account is posted with big value then it reflects that purchase department
has procured material at significantly high price than it should have done. Hence, price
difference account balance reflects efficiency of purchase department.
Finance controller runs report of price difference account every month and check if purchases
are being made at reasonable prices.
This way standard cost is helping in cost controlling.
Use of standard cost in sales order:

You can see above, material as well as Cost of goods sold (COGS) is valued at current
standard cost.
Later on customer invoice is posted.
Revenue is booked 1000
COGS booked is 457.6
These help in arriving at profit margin (Revenue – Expenses)
Use of standard cost in production order:
During manufacturing, cost is accumulated in production order and compared with target cost
to check the efficiency of production. High production variance means cost of production is
too high as compared to target cost. Production variance is important for cost control purpose.
Production variance is getting calculated by using standard cost.
Best practices followed in product costing?
Standard cost is updated at start of the year for the whole year.
For all the materials which are maintained at price control “s”, standard cost is updated at the
start of year and is valid for the entire year.
Cost valid from date: First day of the fiscal year
Cost valid to date: Last day of fiscal year
Only in case of fast moving consumer goods (where prices keep changing frequently), there
is need to updated standard cost of material every month. (Valid from 1st day of month to last
day of month)
Cost estimate run, Marking, Release is performed at different dates.
Let’s say new standard cost is to be updated from 1st day of the new fiscal year.
Consider a finished good which might be composed of hundreds of raw material. For finished
good costing to happen, all the involved raw materials should have standard cost. Hence
before we do standard costing of finished good, we should have completed standard costing
of all the raw materials involved.
Thank You !

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What is Product costing?

 What materials and in how much quantity are consumed in

 How much is the overhead cost in producing finished product.

Material is created by SAP MM team.

Costing sheet is created by finance team.

Let’s understand the above concepts along with example:

Overhead is 2% on raw material cost.

Below screenshot showing cost component structure

Below is the output of cost estimate run:

Product costing overview

Let’s focus on work of SAP FICO consultant in product costing.

As discussed above, cost component structure is created by finance team.

As discussed above, costing variant is maintained by FICO consultant. Let’s understand

What is the purpose of cost estimate run?

Which costing sheet is going to be used for overhead calculation?

Below steps to be executed to update cost estimate in material master:

1. Cost estimate run: Run estimate run is executed so that cost

What happens when estimated cost is updated in material master as

Existing quantity of material 1476 is 7000

Hence, inventory value = Quantity (7000) X Standard cost (557.6) = 3,90,3200

When release happen, future price is updated as current standard cost.

New standard cost is 457.6

New inventory value = Quantity (7000) X Standard cost (457.6) = 3,20,3200

Hence value of inventory is reduced by 7,00,000

As a result of revaluation, below document is posted automatically:

This way standard cost is helping in cost controlling.

Use of standard cost in sales order:

Later on customer invoice is posted.

Revenue is booked 1000

COGS booked is 457.6

These help in arriving at profit margin (Revenue – Expenses)

Use of standard cost in production order:

Cost valid from date: First day of the fiscal year

Cost valid to date: Last day of fiscal year

Cost estimate run, Marking, Release is performed at different dates.

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