Activity Based Costing in SAP

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Introduction

Activity Based Costing is a method of costing, where the cost of products, processes,
customers are determined through Activities performed in the production/ support unit. It is
more logical method of determining overhead cost for the product than the historically
method of using machine hours or man hours to distribute the cost. In activity based
costing process, first the activities are identified, which attract cost and then the total cost
are distributed to product on the basis of number of activities consumed in the
manufacturing and production processes. The purpose of this document is to explain how
we can identify key activities in any manufacturing process and what are the things that
need to be taken care while using activity based costing in SAP?       

Activity Based Costing

ABC is more logically, accurate, better way of allocating overhead cost, but on the other
hand it’s more complicated to design and implement. If we define the processes, it includes
the below steps:

a.       Determining the cost objects, the organizational unit which can be used for tracking cost
and distributing to product

b.      Identifying cost carriers or the activities performed in the cost object

c.       Bifurcation between direct and indirect costs associated with activities related to cost
object

d.      Identify linkage between overhead cost and activities 

e.      Select the method of overhead allocation, e.g. Push method (Assessment, Distribution
cycles) or Pull method (Indirect activities allocation, template allocations)

Activity based costing is activity driven concept with a key assumption that all the overhead
costs are caused by different types of activity. The main challenge of implementing this, is
to identify cost driven activities and to link the overhead cost to the specify activities and
designing the overall value flow. 

Method of allocating cost:

i.                     Push Approach (Cost flow method)

Push approach is a method of overhead allocation, where we transfer the cost from sender
cost object to receiver cost object with a flow from sender to receiver. Here the full or pre-
defined percentage of cost from sender cost center is transferred to receiver cost objects. It
is like pushing the overhead cost from sender to receiver cost object. E.g. Assessment,
Distribution

ii.                   Pull Approach (Quantity input method)

Pull approach is a method of overhead allocation, where quantities of receiver cost objects
are used as a base to take the cost from sender cost centers. For example: in case of
Indirect Activity Allocation, which is a method of pull approach, the activities on receiver
cost objects are combined and a same values are transferred to sender cost objects as
sender activity, which later on are used to transfer overhead cost from sender cost center
to receiver cost centers. Here the Quantity of receiver cost centers are used as input to
transfer the sender cost, that’s why it is called as Quantity input method. E.g. Direct/Indirect
activity allocation, template allocations

To illustrate the scenario in more details, I have taken a hypothetical example of an

automobile industry:

In general an automobile organization includes the below manufacturing departments.  

1.            Press Shop/ Stamping

Manufacturing of car start with creation of different steel plates for different parts of car, for
example doors, body of cars etc. These activities are performed in press shop, where
different pieces are made out of rolls of steels. These pieces are later converted into
different shape with help of automatic press/stamp machine. Generally both activities are
performed one after other on same or different machine. If we need to apply the concept of
Activity based costing, then we need to identify the activities which are performed in press
shop, for example

1. A) SETUP: setup is an activity of putting the iron plates on the machines in right places
to perform the cutting and stamping. In general before cutting, a lubricant is used on iron
plat so that it doesn’t get damaged while pressing. Setup is a manual process, which
involve individuals to perform the activities. 

1. B) PRESSING: pressing is an activity performed by machine to cut the iron plat in the
piece and then put the stamp to convert the iron plate into the design of different parts of
car.

How the cost will be consider as Setup and pressing, it’s depend upon the nature of the
activities, here in this example we are considering SETUP as a manual activity so all the
wages paid to the workers could be consider as Variable Setup cost and cost for lubricant
oil used in press shop could also be consider as variable cost. In this way we can decide
activity dependent and activity independent cost and in SAP it can be used to distribute the
cost to the product. The details can be seen from the below document on how to
differentiate activity dependent and activity independent cost: 

Expense Analysis and Splitting in Manufacturing Cost

Centers http://scn.sap.com/docs/DOC-46028

2.            Body Shop/ Welding

The next department in automobile organization is where welding of different body parts
are done to shape the car. After this step the structure of car is ready. For activity based
costing, we need to identify the different activities performed in body shop. Before deciding
what all activities can be there, we need to validate whether having two different activities is
going to have any impact on product cost for two or more products, if not, then there is no
point in using the second additional activity. Suppose the organization is making only two
different types of car, standard module and custom built car, suppose machines are used to
weld standard modules and individual are used to weld custom module of cars. In this way
we need to identify the different activities, as there is no specific rule for this. After
identifying the activities we need to link the cost to the activity.   

3.            Paint Shop

 The next department is Paint shop, where different layers of color coating are done on body
of car based as per standard procedure or requirement by customer. Then drying/ heating
activity is done to make the color permanent. All these activities like Painting activity, or
drying activity can be used in activity based costing as cost carrier and used to transfer the
cost of paint shop to different Production order and finally to the product.

4.            Engine Plant

In engine plant all different parts of engine are manufactured and assembled. After
manufacturing of engine, it is sent to assembly line to be included in car. Here we can
identify two different activities, like manufacturing of engine parts and assemble of parts.
These activities can be used to track cost. 

5.            Assembly Line

The next department is assembling line, where the painted car body and its engine are
assembled. Then car is sent for quality testing.

6.            Finish Line or Warehouse

The car is driven on a few miles test track to check for rattles or other issues. Once a car
meets all quality standards, kept in warehouse and are ready to send to customer, dealers.

Ø  Need to identify the different activities which can be used in different departments as cost
carrier

Ø  Try to keep less number of activities as possible and validate whether creating a new
activity is going to provide more accuracy in the product costing or not.

Ø  Activity based costing are beneficial to be used in more complex manufacturing processes,
so it’s advisable to use additional activities only if it has an impact on accuracy of product
cost.  

Master Data

Creation of Activity: transaction KL01

For defining the activity, the below details need to be configured

·         Name: name of activity

 ·         Description of activity  

·         Activity Unit: kg, hours etc

·         CCtr Categories: cost center categories depend upon the cost centers where this activity
will be used. For production activities, the activity categories should be “F”; for utility cost
centers it should be “U”. We can select the activity categories depending upon the nature of
cost centers

·         Activity Type Categories: this defines how we are going to put the values of plan & actual
activity and what method will be used for distributing or allocating activities. Different
standard options are:

a.       Manual entry, manual allocation (category 1): category 1 activity used plan activities to
allocate activities to receiver cost centers or objects based on manual activity planning in
KP26. Actual activities for category type 1 are determined through business transaction
(e.g. confirmation of activity in process order or production orders).  

b.      Indirect calculation, indirect allocation (category 2): category 2 activities are used in
indirect activity allocation and the price of these activities are calculated automatically
through indirect activity allocation with the help of relationship between sender & receiver
cost centers, or receiver tracing factor, or fixed quantities defined in segments. Here plan
activities are automatically reconciled with scheduled activities.     

c.       Manual entry, indirect allocation (category 3): This category activity takes the values
entered manually and the allocation happened through indirect activity allocation.

d.      Manual entry, no allocation (category 4): This category activity takes the values entered
manually and but it’s not allocated.

·         Allocation Cost element: while defining an activity in controlling, we need to define and
assign a secondary cost element with category 43 (indirect activity allocation)

·         Price indicator: price indicator represent, what method will be used to calculate activity
price. We can say this about plan activity price. For actual activity price we can define the
method in the below tab where it’s mentioned as Actual price indicator.  

i.                     Indicator 001:  if we select 001, then plan activity price are calculated automatically
based on Plan Total Cost divided by plan activity. 

ii.                   Indicator 002: in 002, the variable plan activity price is calculated based on plan
activity and fixed activity price is calculated by considering the Capacity.

iii.                  Indicator 003: here the activity price are set manually.   

·         Actual price indicator:  if we define the actual price indicator then system use this for
calculating actual price otherwise previous price indicator will be used.

iv.                 Indicator 005: here the actual activity price is calculated by considering the actual
activity.

v.                   Indicator 006: the variable portion of cost is determined through actual activity and
fixed portion is determined through actual capacity. 
  

Configuration of Splitting Structure:

For the purpose of splitting of fixed cost to the different activities assigned to cost center,
need to define Splitting structure. It includes the rules which should be followed to distribute
the fixed cost to different activities. For the purpose of Planning and Budgeting this is an
important configuration.

Transaction: OKEW (Assign the new cost center to the splitting structure)
Specify Cost center and Fiscal year

Double click on splitting structure and assign the cost centers to the respective splitting
structure
 Here the splitting is defined that all the cost elements on manufacturing cost center will be
distributed to activities on the basis on Plan Capacity.
(Source: http://scn.sap.com/docs/DOC-46028)

Planning:

For planning and budgeting of activities, the below processes need to be followed:

a.       Define activities on the cost centers through KP26:

After designing the overall structure of value flows, activities need to be linked to cost
centers through KP26. Here we need to define Plan Activity, and Plan Capacity. Quantity
defined for plan activity or capacity are used to calculate activity prices at KSPI depending
upon price indicator set while defining master data. If we select price indicator as 002, then
fixed activity price is calculated by considering plan capacity and variable activity price is
calculated by dividing plan activity.

b.      Primary cost planning on cost centers through KP06

All the primary expenses are planned on cost centers through KP06. Here we can also
defined activity dependent cost with the combination of planning at cost element for activity
at cost center.
 c.       Allocation of expenses or activities:

i.            Indirect Activity allocations: it is one of the pull approaches of allocating the cost from sender cost
object to receiver cost object. Here overhead costs are allocated in two stapes process.
First the sender cost centers activities are determined by combining receiver cost center
activities and second the cost are allocated from sender cost center to receiver cost center/
object. It basically worked on Quantity calculated inversely. Once we execute indirect
activity allocation cycles, then only activities are allocated but no cost is transferred from
sender cost center to receiver cost centers. Transfer of cost to receiver cost center can only
be viewed after plan cost split (KSS4) and plan activity price calculation (KSPI). It doesn’t
follow the same process as assessment and distribution, for distributing the overhead cost.
In assessment and distribution the cost are transferred exactly after executing the
cycles.            

ii.            Distribution: It is a method of push cost allocation. Distribution cycles are used to distribute
primary cost from sender cost object to receiver cost object on the basis of fixed
percentage, or fix proportion, or statistical key figures.   

iii.            Assessment: It is also a method of push cost allocation. Assessment cycles are used to distribute
primary & secondary cost from sender cost object to receiver cost object on the basis of
fixed percentage, or fix proportion, or statistical key figures. In assessment cycles the
allocation of cost done through assessment cost element. 

d.      Plan Cost Splitting through (KSS4): plan cost split distribute the plan fixed cost to the
activities assigned to the cost center. The distribution of cost happened on the basis of
splitting rule defined in splitting structure. So the assignment of cost centers to the splitting
structure is important.

e.      Plan Activity Price calculation (KSPI): KSPI calculates plan activity price or activity rate.

f.        Product costing CK40N or CK11N & CK24 

Advantages of Activity based Costing:

Ø  Accurate product cost calculation based on based assigning overhead cost based on
overhead carriers as activities.

Ø  Monitoring of direct and indirect activity cost possible with the help of controlling activities. 

Ø  More accurate calculation of profitability and selling prices for multi-product organization.
 Limitations of Activity based Costing:

Ø  Not suitable and cost effective for small manufacturing organization to implement

Ø  Difficult to identify cost driver or activities performed in cost centers 

Conclusion:

With the help of this article, I have tried to focus how the concept of activity based costing
can be applied in SAP. Here we can see how to identify activities in different manufacturing
processes. By carefully analyzing the business process for manufacturing or production
organization, we can find out cost carrier activities and use activity based costing to
improve the accuracy of product costing and profitability analysis.     

Related SAP transaction codes:

0KW1 0KW2 0KW3 0KW7 0KW9 0KWD 0KWL 0KWN 0KWO 0KWP