Apply Quantity-Based Overhead Simply and Accurately via Costing Sheets

  • by Hemendra Vartak, Manager, Clarkston Consulting
  • July 15, 2005
SAP R/3 offers more refined methods to apply overhead costs than most people use. One is the quantity-based overhead method, in which the amount charged depends on the production quantity based on a given rate. Activity consumption can be used flexibly to charge overhead based on effort or only at standard consumption quantity. Learn an easy-to-use, yet accurate, method for the treatment of overhead and gain better insight into performance and cost control.
Key Concept

Overhead costs do not scale in relation to business volume. These costs, which include supervisory salaries and quality costs, are treated as fixed based on a production level. While many businesses use a flat percentage method, overhead should be charged to product cost based on key drivers.

Overheads constitute a growing portion of product cost in many industries today. As a general rule, overhead costs are not easily traceable to units of product, so spreading them over product cost is an inherently arbitrary process. Access to the true make-up of product cost can help operations executives and plant controllers make better decisions about controlling costs, evaluating manufacturing in alternate facilities, and making or buying a product.

I'll provide insight into the method of quantity-based overhead application in SAP R/3 and Enterprise in the module Controlling — Product Cost Controlling, in which you charge overheads to product cost. The method first became available with Release 3.0 and is a mid-way offering between the percentage-based overhead method (which is easy to set up but arbitrary) and the accurate but highly complicated method of template assignments. The functionality and configuration applies to ECC 5.0 as well.

It is appropriate to use the mid-way method when overhead needs to be applied per a given quantity of an input factor of production (such as number of hours worked or quantity of raw material used). I'll use an example to walk you through the origin of costs in a cost center and their disposition to the product. Along the way, configuration is explained for the quantity-based option. Finally, I compare the various methods available to apply overhead in R/3, so users can make informed choices appropriate to their business circumstances.

In my example of the quantity-based overhead option in R/3, overhead is applied based on a rate per hour of activity consumed. Direct costs are charged from cost center to product per actual activity consumption on the routing/recipe at the standard rate for the activity. Overheads are charged at the standard rate times the standard activity consumption on the routing/recipe. In other words, overhead does not fluctuate or vary in relation to input factors (activity quantities), based on the rate for a given level of a production plan.

Hemendra Vartak

Hemendra Vartak has 10 years of experience in SAP project management and implementation of FI/CO modules across various industries. He holds an MBA in finance and has prior public accounting and industry experience. His interests are in financial planning and management accounting.

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