Applying Overhead Costs to a Product

The parameters for overhead costing are summarized in a costing sheet. Overhead rates are used to pass on costs to cost centers that do not directly reference the production process. This way you can, for example, distribute the costs from a warehouse cost center to production orders for which the material was taken from the relevant warehouse.

More specifically, the costing sheet determines the following parameters:

• The direct costs to which the overhead is to be applied (calculation base).

• The conditions under which the overhead is to be calculated (dependency). For example:

  • You can have different overhead %'s by material

  • You have the same overhead %'s for all materials within a plant

• Whether the overhead is allocated on a percentage or a quantity basis.

• The percentage amount or the amount per unit (overhead rate).

• The period of validity for the overhead.

• Which object (cost center, process, or order) is to be credited and by which cost element.

The overhead key determines the overhead percentage rate which will burden the cost of the product. You use the overhead key to apply different rates to different groups of products. You define it in customizing and enter it in the costing sheet.

Costing sheets offer a low cost of development alternative versus activity prices. Costing sheets aren't as accurate as activity prices are but when the indirect costs cannot be associated with an activity, costing sheets provide a very good alternative.

Explain the basic structure of the costing sheet and how it is organized to identify direct costs, indirect costs, and the totals for cost of goods manufactured (COGM) and cost of goods sold (COGS). Mention that there is no inherent logic provided with a costing sheet. The costing sheet is structured to recognize direct costs and indirect costs. There is no recognition within the costing sheet of details such as item category. The control and organization are based on cost elements and origin groups.

Costing sheets are organized to identify direct costs, indirect costs, and the totals for COGM and COGS. Mention that there is no inherent logic provided with a costing sheet. The costing sheet is structured to recognize direct costs and indirect costs. There is no recognition within the costing sheet of details such as item category. The control and organization are based on cost elements and origin groups.

Overhead costing is one of the methods to allocate indirect costs to cost estimates. Overhead costing applies a percentage or quantity-based fixed amount to a specified cost base. To determine overhead, you use the direct costs that were posted to the order as a basis for distributing indirect costs. In the manufacturing industry, for example, direct costs are usually labor and material costs.

The rules to apply overhead are summarized in the overhead costing sheet.

The basic components of the costing sheet are as follows:

• Calculation base:

  You can combine cost elements in base rows. You can also split cost elements by origin such as raw materials with origin XYZ only. Also, you can divide the calculation base as fixed and variable costs. The base defines cost elements that are used to recognize a category of direct costs such as direct material costs. The origin group is useful if only specific types of materials in a cost element should be considered as the surcharge base. A good example of this is warehousing overhead.

  Automatic account determination may use the same cost element to recognize purchased material consumption, but various types of purchased materials may require expensive warehousing, such as items that require a climate-controlled environment or refrigeration. To apply the premium warehousing expenses back to those materials, the origin group should be used to locate the specific items for base calculation. The base can further be defined as total cost, only fixed costs or variable costs, with the cost element range.

• Overhead:

  You calculate overhead on the calculation base. You can define the overhead percentage so that it differentiates among planned costs, actual costs, and area of validity based on specific fields. You can also allocate quantity-based overhead such as USD 100 for every 30 pieces.

  The overhead (or surcharge) key defines the rate of overhead to be applied against the value calculated in the base. The rate can be defined as a percentage of input costs or as an absolute value of input quantity. Quantity-based surcharges are a good method of applying machine overhead, because most machine overhead costs such as maintenance are incurred as a result of operating time and not operating expense. The overhead key can be defined using various dependencies, such as plant, company code, order type, or overhead key.

  The overhead key is derived from the overhead group, which is found in the material master of the product being produced. This is a good method to change the overhead applied based on the product that is manufactured.

  For example, two products are manufactured. Product A has an inspection operation defined within its routing, so that quality inspection costs are recognized through a direct activity allocation. Product B is not inspected during production, but only after receipt in the warehouse. Inspection costs for product B can be considered overhead. By constructing a dependency for the overhead key assigned to product B, the system has to apply inspection surcharges to product B and not to product A.

• Credit:

  You assign a credit key to each overhead line in the costing sheet. The amount of the overhead is credited to a cost center, business process, or order under a secondary cost element. The cost element is important in Product Cost Planning (PCP) because it controls overhead costs. You can specify the percentage of the overhead that is fixed costs.

  The credit defines the secondary cost element for the credit of the overhead calculation. This cost element is then mapped to the cost component structure to define the overheads that are considered COGM and the overheads that are considered sales and administration. It also defines an overhead cost center, an overhead order, or a business process to receive the credit posting during actual production. It is also possible to define the percentage of the calculated surcharge value that should be considered fixed costs. If this is not defined, it uses the same split between fixed and variable as determined for the base.

The costing sheet should be sufficiently flexible to support all the products manufactured within a single company code, because it is possible to use only one costing variant for standards, per company code, per period.

• Learn the concept of overhead costs and its application in product cost estimation using costing sheets.
• Identify direct and indirect costs, and understand how costing sheets organize these costs for COGM and COGS.
• Explore how costing sheets define the overhead calculation parameters, i.e. the calculation bases, the overhead rates, and conditions for overhead application.
• Discover how overhead keys apply different rates to product groups, influencing cost allocation.
• Learn how credits are assigned to overhead lines, impacting cost centers and business processes.