Best way to find how the Product Costing in ERP works?

How Product Costing in ERP works?

Product Costing in ERP is affected by Items (Raw materials) that we purchase and how we do value addition by adding Labor, machine costs etc as part of converting this RM to a Saleable item.

Product costing is a process used by companies to determine the total cost of producing a product or service. It involves analyzing and allocating costs to various components involved in the production process, such as materials, labor, and overhead expenses. This information is crucial for decision-making, pricing, profitability analysis, and financial reporting.

Enterprise Resource Planning (ERP) plays a significant role in product costing within organizations. ERP systems are comprehensive software solutions that integrate various business functions, including finance, inventory management, production planning, and accounting. They provide a centralized platform for managing and tracking costs related to products or services.

You can have the costing methods like below for inventory valuation

1. Weighted Average costing – Gives the weighted average cost of items.  based on the bills of material structure, you can add few more direct costs like Direct labor costs, production costs, material costs, operation costs etc
2. Standard Costs model – Standard cost estimates have a different approach where customer has to give standard price for each product that’s envisaged by company. You give near best accurate cost to each parts.
3. LIFO – Last in First out
4. FIFO – First in First out. – Typically used for perishable items. Assumption here is manufacturing costs will be accurate and wastage are less as the perishable items are reduced now.

What is Product Costing in ERP works?

Costing Setup

The ERP system allows businesses to define and configure the cost elements and cost centers associated with their products or services. This includes setting up the cost components, such as raw materials, direct labor, indirect expenses, and overheads.

Bill of Materials (BOM)

The BOM is a hierarchical list of components and subcomponents required to produce a finished product. The ERP system enables companies to create and maintain BOMs, specifying the quantities and costs of each component.

Routings

Routings define the sequence of operations or processes involved in manufacturing a product. ERP systems facilitate the creation and maintenance of routings, which include the labor hours and costs associated with each step.

Cost Allocation

Once the BOM and routing information is in place, the ERP system allocates costs to individual products or services. It calculates the total cost by aggregating the costs of raw materials, labor, and overheads based on the quantities specified in the BOM and the labor hours in the routing.

Cost Analysis and Reporting

ERP systems provide various cost analysis and reporting tools to analyze product costs. Companies can generate reports that show the breakdown of costs by component, labor, or overhead. This information helps in evaluating the profitability of products, identifying cost-saving opportunities, and making informed pricing decisions.

Cost Control and Variance Analysis:

ERP systems enable companies to compare the actual costs incurred during production with the standard or expected costs. Any variances between the two can be analyzed to identify the reasons for deviations and take corrective actions to control costs.

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in summary, it’s a combination of many other factors that adds to make a Product costing in ERP.

In ERP, the Product costing is affected by following process.

1. Materials Receipt against the Purchase Order
2. Materials issues / consumption against a Work Order / Finished Goods Receipts
3. Sales / Invoices
4. Sales Returns
5. Purchase Returns
6. Inward DC and Outward DC to consume the RM to report Semi FG items.

Product Costing in ERP – Inventory Items

We capture the real time product cost that helps to manage the accuracy in the Finished Goods or Semi Finished goods Costing. It also helps to pass the right cost details to Balance Sheets to know the exact values of inventory carried in the company.

Based on the type of the items, the costing method changes.

Normal Items – Each product costs is maintained by Weighted Moving Average costing.

Example:

1. 1. We have 10 Nos of Pens at US$ 1.5 per piece in our Stock.
   2. We bought 15 Nos of Pens at US$ 2.00 per piece now.
   3. The weighted average cost of each Pen after this new purchase is USD = (10 x 1.5) + (15 x 2.00) / (10 + 15) = US$ 1.80
   4. Batch Items – Each batch items are kept with its purchase price costs. This helps to manage the Product costing based on the Batch items that are added or consumed to make it a Finished Goods.

ABC – Activity Based costing – another way to manage Product costing in ERP feature. 

ABC method gives a high probability of costing for a Semi Finished goods or a Finished Goods.

This method is used in the Manufacturing process. As the name says, we capture the costing for Semi Finished goods at each level of production reporting.  The components of a Finished Goods could be the combination of any of these cost components.

1. Raw materials costing
2. Labor costing
3. Machine Costing
4. Overhead costing
5. Electricity costing
6. Others like indirect costs.

Below few conditions where we consider these costs as part of Costing of a product.

1. RM Wastage portions are considered as CONUSMED and this cost is added to Finished Goods.
2. Reporting of FG SCRAP items, as a total RM cost is consumed to make FGs and also a SCRAP FG (rejected finished good). So the total cost is added to the total Good Finished Goods costs.
3. By-Products – One of the ways to know the actual cost of Finished goods is to reduce its cost with the Income that could have generated by selling Scrap items which are the by-products
   1. We define the %age of scrap that would generate by using STEEL Materials (RMs)
   2. We define the SELLING PRICE for this SCRAP materials that has come as by-product.
   3. This Scrap sold Amount is reduced from the TOTAL COSTS of FINISHED GOODS.
   4. Gives the actual FG Costing.

Subcontracting costing, another form of Product costing formula in ERP Systems.

One of the challenges in arriving a total Product costing in ERP is, how to add the Subcontracting operations costs to the FG. It is tricky one as the service costs needs to be added with raw materials that’s are consumed as part of this process.

A typical process is followed as below.

1. Subcontractor is identified and what services he does etc.
2. Outward Delivery Challan is created to make the list of the Raw Materials /Semi Finished Goods that are sent to Subcontractor to do the necessary work.
3. Once the work is completed, this Finished Components from Subcontractor would come back.
4. When we receive the Finished Components, the RMs at the vendor location is consumed and cost is added to Finished Components

Product Cost Examples

1. We dispatch RM / Semi Finished Components of US$ 125.50 to make an “FG-Assembly” of 100 nos. The work to be done is “FG-Assembly” and for each Assembled item, we pay US$ 1.25 per piece.
2. When the “FG-Assembly” comes back to our STORES, we receive it against the Inward Delivery Challans.

Now the costing to calculate is as below.

1. RM Cost – US$ 125.5
2. Services costs- US$ 1.25 per piece- So total cost is – US$ 125.00
3. Total cost is = US$ 250.50

So the Unit cost is US$ 2.505 per piece.

As part of ABC, we add Subcontractor costs to FG and this follows a bottom-up costing approach to arrive at the total Product Cost. These costs are automatically handled in ERP.

Good thing is these are done automatically and no need of end user intervention. 

ACTouch, a Cloud Manufacturing ERP is built with all these features and controls.

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