Understanding Production Order Variance - Part 2 The SAP Perspective
Author: Ranjit Simon John
Every PP, FI and CO user in any Manufacturing Industry will be facing a tough time during period-end processing every month. Production Order Variance posted against each process orders will have to be examined, explained & investigated thoroughly. Major questions arising will be;
- From Where the Variance has come
- How to Categorize the variance
- How to cut down the variance.
- Impact of variance on COGM, COGS & Closing Stock, has to be answered to the management.
We have faced all these scenarios and after months of deep research in this field I came across few conclusions.
For better understanding I will divide this blog into two categories;
- Category A: Basic understanding of Production Order
- Category B: Co-relating Category A scenarios with real life scenarios.
Now let us examine the main points under Category A:
The ultimate end point of any industry is sales. For selling the product several process has to be carried out. The success of any management depends on how well they forecast the sales, plan and schedules the activities.
Let us divide the process as given below;
1) Initial Planning
2) Cost Estimates
3) Actual Posting
4) Period – End Processing
1) Initial Planning:
Forecasting the sales for future. Sales and Operation Planning, Long term planning, Cost center planning should be well executed by the management.
2) Cost Estimates:
The major points to be considered here are;
a) a) Master Data:
a.1) Material Master:
All the required information to manage a material.
Transaction Codes: MM01, MM02, MM03
a.2) Bill of Material (BOM):
Structured hierarchy of raw materials necessary to create a Finished / Semi Finished Good.
Transaction Codes: CS01, CS02, CS03
List of tasks containing standard activity times required to perform operations to create a Finished / Semi Finished Good.
Transaction Codes: CA01, CA02, CA03
a.4) Product Cost Collector:
Collects actual costs during the production of a material.
Transaction Codes: KKF6N
Recipes comprise information about the products and components of a process, the process steps to be executed, and the resources required for the production.
Transaction Codes: C201, C202, C203
b) Overhead Costs:
All indirect cost like power, canteen etc.
Transaction Codes: KZS2
b.1) Calculation Base:
A base is a group of cost elements to which overhead is applied
b.2) Overhead Rate:
Overhead rate is a percentage factor applied to the value of the calculation base (group of cost elements).
b.3) Credit Key
During Overhead calculation, a manufacturing order in product cost collector is debited, and a cost center is credited. The credit key defines which cost center receives the credit.
C ) Cost Component:
The cost component split allows a cost estimate to group costs of similar types of components, such as material, labor, and overhead.
d) Costing Variant:
The costing variant contains information on how a cost estimate calculates the standard price.
e) Standard Cost Estimate:
The Standard Cost Estimate is involved in variance analysis because it is used for stock valuation. When a production or process order delivers production to inventory, it receives a credit based on standard price. Total variance is the difference between actual costs debited to the order and costs credited to the order due to deliveries to stock.
f) Preliminary Cost Estimate:
The Preliminary Cost Estimate is involved with production, variance calculation and valuating scrap variance and WIP.
g) Mixed Cost Estimate:
If there are different procurement alternatives for the same material, such as two production lines or two vendors, mixed costing can be used when inventory valuation has to reflect the mixed procurement costs.
3) Actual Postings
Plan costs are posted prior to a fiscal period. Actual costs are posted in real time during a fiscal period.
Actual Cost can be divided into two groups based on the posting origin;
- Postings to CO from external business transactions results in Primary Costs.
- Business transactions within CO results in Secondary Costs.
3.1 Primary Cost:
Primary cost will be posted to CO mainly in the following scenarios:
3.1.1 Goods Issue to Production Order:
When goods are issued from inventory, a general ledger balance sheet account is credited, and profit and loss consumption (expense) account is debited. A primary cost element with the same number and identifier as the inventory consumption is usually created in CO during initial system implementation. When the system detects a corresponding primary cost element in CO during a posting to General ledger expense account, a posting to CO cost object is also required.
Primary Cost are posted to CO from FI.
GL entry during Goods Issue
|Raw Material Consumption||XXX|
|Stock of Raw Material||XXX|
3.2 Secondary Cost:
The costs in CO are allocated from overhead cost centers to production cost centers during assessment and then onto production order during activity confirmation.
Period-end assessments move costs from overhead cost centers to production cost centers.
3.2.2 Activity Confirmation:
When production order activities are confirmed, the production or product cost collector is debited, and the production cost center is credited. There are no FI postings during activity confirmation.
3.3 Primary Credits
Primary Credits occur when production orders deliver Finished / Semi finished good into inventory.
As finished goods are delivered from manufacturing order into inventory, an inventory balance sheet account is debited, and profit and loss production output account is credited. Because there is a primary cost element corresponding to the production output account, a CO object is also credited. The finished goods are delivered from a production order, so the system automatically chooses the production order or product cost collector to receive the primary credit.
The credit value is calculated by multiplying the finished goods standard price by the quantity delivered to inventory.
|Stock of Finished Good||XXX|
|COGM of Finished Good||XXX|
|Raw Material Consumption||XXX|
|Stock of Raw Material||XXX|
3.4 Secondary Credit
At period end the production order receives a secondary credit that is equal to the variance during settlement, resulting in zero balance.
During the settlement process, product cost collectors and process order variance are posted to Profitability Analysis (CO-PA) and FI.
100 Raw Material
100 Over Heads
|Credit||(250) Finished Good|
Total Variance is the difference between total production order debits and credits.
Variance calculation at period end divides the variance into categories, based on the source of the variance.
Production Variance settled to CO-PA are included at the gross profit margin level.
Cost Center under/over absorption costs assessed to CO-PA are included at the operating profit level.
3.5) Post Actual Costs
1) Period – End Processing
5.1 The three common types of variance calculation are as follows;
5.1.1) Total Variance
Total variance is the difference between the actual cost debited to the order and credits from deliveries to inventory. Total Variance is variance relevant to settlement. The variance is settled in Financial Accounting (FI), Profit Center Accounting and Profitability Analysis
5.1.2) Production Variance
Production variance is the difference between net actual costs debited to the order and target costs based on the preliminary cost estimate and quantity delivered to inventory.
Production variance is not relevant for settlement, only for information.
5.1.3) Planning Variance
Planning variance is the difference between costs on the preliminary cost estimate for the order and target costs based on the standard cost estimate and planned order quantity.
5.2) Variance Categories
During variance calculation, the order balance is divided into categories on the input and output sides. Variance category provide reasons for the cause of the variance. There are no FI posting during variance calculation.
Variance can be categorized into Input Variance and Output Variance
5.2.1) Input Variance
Variance based on Goods Issue, Internal activity allocation, overhead allocation, general ledger account postings.
Input variance is divided into the following categories during variance calculation, according to their source:
Category IV.1) Input Price Variance
Input price variance occurs as a result of material price change after the higher level material cost estimate is released.
It occurs in any of the below mentioned scenarios;
- If the material valuation is based on standard price control, a standard cost estimate for the component could be released after the cost estimate for the assembly is released.
- If the material valuation is based on Moving average price control, a goods receipt of the component could change the component price after the cost estimate for the material is released.
Input price variance = (actual price – plan price) * actual input quantity
Category IV.2) Resource – Usage Variance
Resource – Usage variance occurs as a result of substituting components. This could occur if a component is not available, and another component with a different material number is used instead.
Resource Usage variance = Actual costs –target costs – Input price variance
Category IV.3) Input quantity variance
Input quantity variance occurs as a result of a difference between plan and actual quantities of materials and activities consumed.
Input quantity variance = (actual input quantity – target input quantity) * plan price
Category IV.4) Remaining Input Variance
When input variance cannot be assigned to any other variance category. 5.2.2) Output Variance
Variance can be from too little or too much of planned order quantity being delivered, or because the delivered quantity was valuated differently.
5.2.2) Output Variance is divided into;
Category OV.1) Mixed – Price Variance
Mixed-Price variance occurs when inventory is valuated using a mixed cost estimate for the material.
Category OV.2) Output Price Variance
Output price variance can occur in the following scenarios;
1) If the standard price is changed after delivery to inventory, and before variance calculation.
2) If the material is valuated at moving average price and it is not delivered to inventory at standard price during target value calculation.
Output price variance = actual activity * (plan price – actual price)
Category OV.3) Lot Size Variance
Lot Size variance occurs if a manufacturing order lot size is different from the standard cost estimate costing lot size.
Category OV.4) Remaining Variance
Occurs if variance cannot be assigned to any other variance category.
Category OV.5) Output Quantity Variance
Represents the difference between manually entered actual costs and allocated actual quantities.
Output Quantity variance = ( actual quantity –manual actual quantity) * plan price
5.3) Period End
The most important period-end process relevant to production order variance analysis is;
- Variance Calculation
Variance can be calculated using the formula;
Variance = Actual Cost – Actual Cost Allocated (credits) – WIP – Scrap
During variance calculation, target and control costs are compared, and variance categories are assigned. Variance categories are assigned in the following sequence:
- Input price variance
- Resource – usage variance
- Input quantity variance
- Remaining input variance
- Mixed –price variance
- Output price variance
- Lot Size Variance
- Remaining Variance
Settlement of Production Orders will be executed.
KO88 - Individual Settlement
CO88 - Collective Settlement
Now let us examine the main points under Category B:
Now you will be having a basic idea about production order variance , variance calculation types & various categories. Now let us try to co-relate this with real life scenarios.
I will divide the topic into below mentioned sections;
1. How to analyze production order variance posted against production orders
2. Major Reasons for the variance
3. How to minimize the variance
4. Impact of production order variance on COGM, COGS & Closing Stock
Category B.1) How to analyze variance posted against production order
For explaining the scenarios I am taking one Semi Finished Good (SFG1– Semi Finished Good 1) which is used as a raw material for production of Finished Good.
Master Recipe of SFG1 is;
|Item||Resource||Total Value||Fixed Value||Quantity||Unit|
Process order No for SFG1 is 15000035
Variance Posted against the Process Order for the month is 128,190.87 AED
After technically completing ("TECO") the process order & before executing costing run check for the variance in transaction code KO88 (CO88 - Collective) in Test Run mode.
For analyzing the variance in detail we will use transaction codes KKBC_ORD & KOB1.
Let me explain difference between KKBC_ORD and KOB1.
KKBC_ORD is used for analyzing single order. Planned and Actual cost details relating to the production order will be recorded in KKBC_ORD.
KOB1 you can execute for single as well as bulk order. KOB1 provides the "Actual" values (cost & quantity) of raw materials and overheads used for the production of the material.
Here you can see settlement (Variance) of 128,190.87 AED.
I will explain how we are calculating the variance.
Below table shows the formula used for Variance Calculation.
All the Std. Rate, Std. Qty, Std. Cost value fields in Table 4.0 are calculated based on the master details (Material Recipe Figure 2.0).
All the Actual Rate, Actual Qty. Actual Cost vale fields in table 4.0 are extracted from KOB1.
|Std. Cost||Actual Rate|
|RAWMATERIAL1||Total value / Qty||Per Ton Qty * FG Prd. Qty||Std Qty * Std Rate||Act Cost / Act Qty||49,663.00||496,630.00||Std Cost - Act Cost|
|RAWMATERIAL2||Total value / Qty||Per Ton Qty * FG Prd. Qty||Std Qty * Std Rate||Act Cost / Act Qty||3,411.00||89,824.45||Std Cost - Act Cost|
|RAWMATERIAL3||Total value / Qty||Per Ton Qty * FG Prd. Qty||Std Qty * Std Rate||Act Cost / Act Qty||5,798.00||104,162.8||Std Cost - Act Cost|
|RAWMATERIAL4||Total value / Qty||Per Ton Qty * FG Prd. Qty||Std Qty * Std Rate||Act Cost / Act Qty||1,003.00||209,858.91||Std Cost - Act Cost|
|RAWMATERIAL5||Total value / Qty||Per Ton Qty * FG Prd. Qty||Std Qty * Std Rate||Act Cost / Act Qty||9.00||517.57||Std Cost - Act Cost|
|RAWMATERIAL6||Total value / Qty||Per Ton Qty * FG Prd. Qty||Std Qty * Std Rate||Act Cost / Act Qty||21.00||735.00||Std Cost - Act Cost|
|Labor||Total value / Qty||Per Ton Qty * FG Prd. Qty||Std Qty * Std Rate||Act Cost / Act Qty||59,900.00||119,800.00||Std Cost - Act Cost|
|Depriciation||Total value / Qty||Per Ton Qty * FG Prd. Qty||Std Qty * Std Rate||Act Cost / Act Qty||59,900.00||59,900.00||Std Cost - Act Cost|
|Administration||Total value / Qty||Per Ton Qty * FG Prd. Qty||Std Qty * Std Rate||Act Cost / Act Qty||59,900.00||59,900.00||Std Cost - Act Cost|
|MACOOH||Total value / Qty||Per Ton Qty * FG Prd. Qty||Std Qty * Std Rate||Act Cost / Act Qty||59,900.00||44,326.00||Std Cost - Act Cost|
|POWER||Total value / Qty||Per Ton Qty * FG Prd. Qty||Std Qty * Std Rate||Act Cost / Act Qty||1,609,780.00||692,205.4||Std Cost - Act Cost|
Now let us fill in values in Table 5.0 with the production order values.
|Std. Cost||Actual Rate|
Now let us categorize the variance.
Variance has been posted in the following order
|Serial No||Cost Element||Variance||Variance Category||Variance Class|
|RMV2||RAWMATERIAL2||(573.45)||Category IV.3 + Category IV.1||C2|
|RMV3||RAWMATERIAL3||5,454.20||Category IV.3 + Category IV.1||C2|
|RMV4||RAWMATERIAL4||48,310.09||Category IV.3 + Category IV.1||C2|
|RMV5||RAWMATERIAL5||6,670.43||Category IV.3 + Category IV.1||C2|
Let us try to calculate Variance by applying Formula for each category.
Category IV.1: Input Price Variance = (Actual Price – Plan Price) * Actual Input Quantity
Category IV.2: Resource Usage Variance – Actual Cost – Target Cost – Input Price Variance
Category IV.3: Input Quantity Variance = (Actual Input Quantity – Target Input Quantity) * Plan Price
|Cost Elements||Plan Price||Target Input Qty||Target Cost||Actual Price||Actual Input Qty||Actual Cost||Variance Class||Variance|
Category B.2) Major Reasons for the variance
From My experience I can point out that Production order variance occur mainly from;
a) Material BOM not updated properly (Category IV.3)
b) Material Price Change after release of Standard Cost Estimate (Category IV.1)
c) Activity Price (Material Recipe) not updated properly (Category IV.2)
d) Standard Cost estimate released for one production version and confirmation done against another production order. (Category OV.3)
e) Total Planned Quantity and Actual Produced Quantity Difference (Category IV.4)
f) Material used not included in BOM ((Category IV.2)
Let us try to analyze all the scenarios.
a) Material BOM not updated properly
Explained in Category B.1
b) Activity Price (Material Recipe) not updated properly
Explained in Category B.1
Total POWER consumption as per KOB1 (Actual as per Material Recipe) and FBL3N should be approximately equal.
KOB1 -> POWER consumption for the Materials Produced
FBL3N -> Actual POWER receipt report
(Receipt = Consumption)
c) Standard Cost estimate released for one production version and confirmation done against another production order.
Costing run executed for one Production Version and Process Order created against another production version.
Let us take one example where two production versions are present Production Version 1 and Production Version 2 for Finished Good FG1. Production Version 1 will be using RM1 as raw material and production version 2 will be using RM2 as raw material.
Standard cost estimate is released against Production version 1.
Let me explain with an example;
As per Released Standard Cost Estimate Material recipe / Ton of FG1
|Production Version||Resource||Total Value||Quantity|
|PO31||GCPRODCGM1 P031 POWER||15.05||0.035|
|PO31||GCPRODCGM1 P031 ADMINI||0.50||1.00|
|PO31||GCPRODCGM1 P031 DEPRN||1.00||1.00|
|PO31||GCPRODCGM1 P031 LABOUR||0.70||1.00|
|PO31||GCPRODCGM1 P031 MACOOH||1.19||1.00|
Process Order has been Created Under production version “PO32”
The Activity Price recorded in system against “PO32” is as follows
|Production Version||Resource||Total Value||Quantity|
|PO32||GCPRODCGM2 P032 POWER||17.00||0.040|
|PO32||GCPRODCGM2 P032 ADMINI||1.00||1.00|
|PO32||GCPRODCGM2 P032 DEPRN||1.46||1.00|
|PO32||GCPRODCGM2 P032 LABOUR||1.00||1.00|
|PO32||GCPRODCGM2 P032 MACOOH||1.50||1.00|
After Settlement (For 1000 TO of FG1) entries will be in the following sequence;
|Production Version||Resource||Target Value||Actual Value||Variance|
|PO31||GCPRODCGM1 P031 POWER||15,050.00||0.00||15,050.00|
|PO31||GCPRODCGM1 P031 ADMINI||500.00||0.00||500.00|
|PO31||GCPRODCGM1 P031 DEPRN||1,000.00||0.00||1,000.00|
|PO31||GCPRODCGM1 P031 LABOUR||700.00||0.00||700.00|
|PO31||GCPRODCGM1 P031 MACOOH||1,190.00||0.00||1,190.00|
|PO32||GCPRODCGM2 P032 POWER||0.00||17,000.00||(17,000.00)|
|PO32||GCPRODCGM2 P032 ADMINI||0.00||1,000.00||(1,000.00)|
|PO32||GCPRODCGM2 P032 DEPRN||0.00||1,460.00||(1,460.00)|
|PO32||GCPRODCGM2 P032 LABOUR||0.00||1,000.00||(1,000.00)|
|PO32||GCPRODCGM2 P032 MACOOH||0.00||1,500.00||(1,500.00)|
Here if we see the total variance of POWER = 15,050 + (17,000)
Similarly for all the Material and resources.
In order to avoid the Over head Variance input same activity price for all the production versions,
- i.e. the net difference will be then POWER = 17,000 + (17,000) = 0
Let us see a LIVE Process Order
Product : FG1
Standard Cost Estimate Released for Production Version "PO31"
Material Recipee for FG1 (CK13N)
|Production Version||Resource||Total Value||Fixed Value||Quantity|
Process Order is Created under production Version "PO32"
When a Process order is created for Material FG1 system calculates Planned cost as follows;
Quantity Produced -> 25,302.00 TO
Use the same calculation logic used in Table 1.0;
Planned Cost for Producing 25,302.00 TO of FG1
Process Order has been created in Production version "PO32". During Confirmation System calculates actual cost as follows;
d) Total Planned Quantity and Actual Produced Quantity Difference
We came across this production order variance in few process orders only. While doing final confirmation of process orders user made mistake by not allowing system to re calculate the activity prices.
Total Process Order Quantity: 93,000 TO
Quantity Produced: 8,865.00 TO
The total quantity produced is 8,865.00 TO against which the activities booked are;
|LABOR||8,865 * 2 DH / TON||17,730.00|
|DEPRIN||8,865 * 1 DH / TON||8,865.00|
|MACOOH||8,865 * 0.74 DH / TON||6,560.10|
|ADMIN||8,865 * 1 DH / TON||8,865.00|
|POWER||8,865 * 0.03 * 1000||265,950.00|
Since during final confirmation of the Order, re calculation of activities were bypassed (by user) system calculated the activities against the production order as below;
|LABOR||93,000 * 2 DH / TON||186,000.00|
|DEPRIN||93,000 * 1 DH / TON||93,000.00|
|MACOOH||93,000 * 0.74 DH / TON||68,820.00|
|ADMIN||93,000 * 1 DH / TON||93,000.00|
|POWER||2,857,172.00 (User Entered)||1,228,583.96|
A Variance of 440,820.00 - 42,020.00 = 39,880.00 TO was posted against all the activities
Note: While doing final confirmation ensure that all the activity prices are recalculated as per the new output.
e) Variance Due to Price change
Price change of material due to execution of standard cost estimate will be posted with document type "PR"
3) How to reduce variance
For reducing production order variance
a) Material BOM should be up to date;
User should not be modifying the material quantity manually while confirmation (COR6N)
b) Activity Price should be Updated periodically
c) Confirm activity getting booked while doing final confirmation
d) Try to ensure that process order for Finished Good is created on the same production version released in standard cost estimate.
4) Impact of the variance on COGM, COGS, Closing Stock
Variances posted with document type "SA", "AB", should have been part of COGM, COGS and Closing Stock. Because of variance material movement cannot be analysed correctly, material value can either Overestimated or under estimated. In order to figure out how much portion of variance should be allocated to COGM,COGS & closing stock We are following manual calculation.
Step1: List down all the Semi Finished and Finished Goods.
Step 2: Record total variance posted against each material (FBL3N) (Document type "SA" & "AB")
Step 3: Record total quantity produced (MB5B with movement types 101 & 102)
Step4: Variance Per Ton = Step3 / Step 2
Step5: Record closing stock of Material (MB5B)
Step6: Closing Stock Variance Allocation = Step5 * Step4
Step7: Record COGM Quantity (MB5B with movement type 201 + 202 & 261 + 262)
Step8: COGM Variance Allocation = Step7 * Step4
Step9: Record COGS Quantity (MB5B with movement type 601 + 602)
Step10: COGS Variance Allocation = Step9 * Step4
Variance / Ton
Closing Stock Qty
Closing Stock Variance
|MATERIAL1||V1||P1||VT1 = P1 / V1||C1||C1 * VT1||COGM Qty * VT1||S1||S1 * VT1|
|MATERIAL2||V2||P2||VT2 = P2 / V2||C2||C2 * VT2||COGM Qty * VT2||S2||S2 * VT2|
|MATERIAL3||V3||P3||VT3 = P3 / V3||C3||C3 * VT3||COGM Qty * VT3||S3||S3 * VT3|
Few Important Document Types Posted in Production Order Variance GL are;
AB -> Reversal of Production Order Settlement
SA -> Production Order Settlement
PR -> Price Change
WA -> Confirmation Reversal (If Price Changed after Confirmation)
WL -> Sales Reversal (If Price Changed after Sales)
Few Important Transaction Codes
Reference: Production Variance Analysis in SAP Controlling By John Jordan, Published by SAP Galileo PresAlso refer s