By the end of this lesson, you will have a clear understanding of cost estimates, their purposes, and their significant role in production and pricing strategies.
Explaining Cost Estimates and Their Purpose
Objective
After completing this lesson, you will be able to describe the purpose of cost estimates in controlling
Lesson Overview
Cost Estimate
What is the Use Case for Cost Estimation?
In Bike Company, employees use Product Cost Planning to evaluate the costs of their products. It involves estimating the internal cost of creating a product, which helps with budgeting.
First, employees use Product Cost Planning to estimate the cost of creating a finished or semi-finished product. Then, during production, they record the actual costs. Finally, they calculate and analyze the difference between the estimated (planned) and the real (actual) costs. Depending on the size of this difference, the company may adjust material costs in their accounting and improve their processes.
What Type of Goods can you Calculate Costs for?
You can calculate costs for physical (tangible) and non-physical (intangible) goods.
- Tangible goods are physical items, like materials made in-house, outsourced work, or items bought from other companies. You can use cost estimates for these goods to value inventory and compare costs in Production Accounting.
- Intangible goods are services, such as shipping, telecommunications, consulting, or training.
In this course, we will focus on calculating costs for manufactured products to demonstrate different methods.
When do you need to Calculate Costs?
Product Cost Planning is based on different production strategies. The main production strategies are:
- Make-to-stock production: You produce items based on predicted customer demand. For example, you estimate how many bikes of different models you will need (manually or using Sales & Operation Planning). Then, you make these bikes and store them until customers buy them.
- Make-to-order production: You produce items only when a customer places an order, often customizing the product to their specifications. For instance, you manufacture mountain bikes with a company's logo only when that company places an order.
Understanding Product Costs in Production
Analyzing product costs can help you answer important questions, such as:
- Contribution of Manufacturing Steps: How much does each step in the manufacturing process add to the product's overall cost?
- Organizational Unit Contribution: How much of the cost can be attributed to specific departments or teams?
- Material, Production, and Overhead Costs: What are the expenses for materials, production, and overhead in this process?
- Improving Production Efficiency: How can we make our production process more efficient?
- Competitive Pricing: Is it possible to offer the product at a competitive price?
To answer these questions, evaluate the costs included in the Costs of Goods Manufactured (COGM) and Costs of Goods Sold (COGS).
The Product Cost Planning functions help you to create estimates of the cost of goods manufactured and the cost of goods sold for products, including materials and services.
Calculating COGM and COGS
In summary, the Costs of Goods Manufactured includes all costs related to materials, production, and associated overhead for materials and production.
Costs of Goods Sold includes the Costs of Goods Manufactured plus additional Sales and Administration costs.
The Costs of Goods Manufactured and the Costs of Goods Sold for materials are calculated in Material Cost Estimates, based on your configuration settings.
Cost information is essential at every stage of a product’s life cycle.
Costing Sequence
Cost Estimates Across the Product Planning and Production Cycle
In this video, we examine a suggested life cycle for producing goods and monitoring cost estimates. For each step, you can select the most suitable material costing method.
Costing sequences have the following stages:
- First prototype stage and ready-for-market stage: When you create material master data in SAP S/4HANA or if you don't handle production planning (PP) in SAP, you can manually plan the cost of goods manufactured and sold using the material cost estimate without a quantity structure.
- Saturation stage and decline stage: When the complete master data (BOM and routing) is available in the system, you can create a material cost estimate with a quantity structure. This automatically calculates the cost of goods manufactured and sold from logistics data, such as BOM and routing.
Cost Estimates Overview
Now that you know when to use each of the cost estimate methods, here is an outline of the various cost estimate calculations' characteristics.
Cost Estimates Overview
| Type of Cost Estimate | Purpose |
|---|---|
| Standard cost estimate | Valuation of the planned quantity structure with planned prices. Calculation of standard prices for the valuation of materials with price control S. |
| Modified standard cost estimate | Valuation of current quantities with planned prices. Costing of materials during the fiscal year in order to analyze changes in costs. |
| Current cost estimate | Valuation of current quantities with current prices. Costing of materials during the fiscal year in order to analyze changes in costs. |
| Inventory cost estimate | Valuation of current quantities with tax-based and commercial prices. Establishment of valuation approaches for inventory valuation. |
To get a more precise cost estimate, you may need additional information depending on the stage of the product's life cycle. For example, a quantity structure of all necessary components (Bill of Material or BOM) or details about how much time is needed for the work (Routing).
These elements are covered later in another lesson.
Quantity Structure: Bill of Material
Here is an illustration of the BOM for one of your Bike Company’s products.
Costing Methods
When costing a product throughout its lifecycle, consider different costing methods especially if your product is made of semifinished products. For example, you can use methods such as unit costing and multilevel unit costing without needing a quantity structure. Unit costing lets you plan the cost per unit of the material without detailing the cost of each production phase. Multilevel unit costing lets you plan costs at the assembly level, without requiring production BOMs.
Both methods offer flexibility and efficient data maintenance. You can refine the cost estimate as more data becomes available.
In advanced phases, the cost estimate with a quantity structure uses logistics master data and provides precise costing of individual products, and options for comparing different alternatives.
To scale this calculation for an entire range of products, you can use costing runs to process mass data (not only one product).
This method is used periodically to cost an entire range of products.
Standard Price
In accounting, it's important to have a set price for each material (raw materials, semifinished products, and finished products) for inventory valuation and stock movement. There are two methods for evaluating a product for inventory and costing purposes: the standard price and the moving average price.
A standard cost estimate establishes a standard price for your materials. The standard price must remain constant and not be affected by price fluctuations or changes in production structure during the planning phase. Set the standard cost estimate at the beginning of a fiscal year or new season and keep the established standard price unchanged for the entire year or season. Avoid altering the standard cost estimate during this period.
Now, you have identified why a cost estimate is needed and when valuation can be handled for each step of the product lifecycle. You know that different structuring elements are requested and that different costing methods are used for each stage.
Later in this course, we focus on valuation at standard price.
Summary
Cost estimates evaluate internal product creation costs.
Costs of Goods Manufactured include materials, production, and overhead costs.
Costs of Goods Sold add sales and administration costs to Costs of Goods Manufactured.
Standard cost estimates set prices for materials at the fiscal year's start.