Allocations in SAP Controlling
1. Introduction and Background
Allocations are an important part of every implementation using cost center accounting. This paper should help to make the right choice of allocation using best practices and show how to configure the SAP system. This paper primarily focuses on cost center allocations of actual costs. It is recommended that as far as possible the basis of plan allocations should be the same as for actual allocations to ensure consistency of data. In our implementation experience, the most common type of allocation is assessment. This type of allocation will be described in more detail.
2. Best Practices
Allocation is the apportionment of costs based on an estimate rather than a direct measurement. Financial accounting requires that all costs of manufacturing be included in valuing inventory and cost of sales. If the cost system is being used to value inventory for financial reporting, some allocation must be made to individual products. This allocation can be done based on units produced or inputs, such as labor or machine hours.
Allocation of overhead and other indirect costs is a necessary evil of financial accounting. For decision making purposes, though, allocated cost are often irrelevant. Allocation of overhead costs (e.g. accounting, human resources, etc.) to product line or product specific cost centers should be kept as simple as possible, if it is only an estimate to allocate costs. It is necessary to make sure there is direct relationship between additional costs and additional produced products. Any allocations could be misleading or distort decision making, if the relationship between output and overhead costs is not proportional.
If all the management accounting system is doing is taking the pool of overhead expenses and assigning it to units of output, little is accomplished. For example, overhead is often allocated based on direct labor hours. This is convenient, but does it reflect the actual relationship between activity and expenses? For companies with multiple services or products, different processes will lead to different relationships between labor and overhead. And what about other factors such as machine time, volume (short or long runs), or materials? Without the effort to uncover the true relationship between activity and cost, the time spent devising allocation formulas will succeed in spreading overhead costs, but will say nothing about what actually caused them or how you can control them.
Most companies have a large pool of expenses that do not appear directly related to the level of production or sales. In many companies this may even be the vast majority of expenses, including manufacturing overhead, such as wages for supervisors and inspectors, power, maintenance, insurance and rent. All selling, administrative, and interest expenses are also in this group. They often represent 60%, 80%, even 95% of a company's expenditures. They also are not as fixed as is often assumed. Although one additional unit of output won't change what is spent in the short term on rent, insurance, or supervisors, these expenses can change and do bear a relationship to activities. Three months, a year, or five years may pass, but all expenses become variable at some point. Since most management decisions involve some long-term commitment of resources - space, people, marketing - the impact on "fixed" costs becomes very relevant.
While the relationship maybe hard to spot, most overhead costs are driven by specific products and activities. The number of accounting clerks, purchasing agents, or warehouse personnel is often related to volume.
Because managers are allocated a portion of overhead, much of which arises in other departments and is considered beyond the line managers' control, no one is held accountable for overhead. Managers have an incentive to reduce their direct costs on which overhead expense is allocated, but no incentive to reduce overhead itself. Overhead is indeed controllable and the accounting system must reflect this. As mentioned earlier, if overhead expenses can be traced to the products or services that give rise to them, they should be. If not, recognize that not all expenses need to be allocated. If there is really no relationship between a product or service and an overhead expense, an allocation serves little purpose.
To budget and control these expenses separately is a better option, rather than create the illusion that volume or production efficiencies can change them. If the cost of the human resource department is independent of or too costly to trace to individual products, it is better to establish an operating budget and holding the department manager responsible for it. Perhaps it is possible to develop measures such as cost per applicant to measure efficiency. If costs change, the results are reported for just the department; the difference does not have to be absorbed by other departments or individual products.
The same holds true for companies that like to allocate a portion of all corporate expenses to division or product lines to create pro forma P&Ls. Although the allocation may ensure that all the costs of business are reported, it ends up assigning the costs to departments that have no control over them and the allocation is unrelated to the source of the expense.
The important thing is not to ignore the expenses or the line mangers held responsible for them. Overhead is too large to simply vanish in a series of allocations. The accounting system must ensure accountability for the level of overhead and it must be aligned with what the managers can actually control.
- Clearly the benefits of management accounting information must be weighed against the cost of collecting and compiling the information.
- There is no single way to allocate costs, but some relationships will stand out as logical. For example:
- Power can be tied to the number of machine hours a product requires.
- Expenses for the building can be allocated first to departments based on square footage and then to any products produced in that department.
- Telephone expenses can be allocated based on the headcount in different departments and then to the products produced in the departments.
Many allocations proceed in a step-down manner. For example, some portion of building costs may be allocated to a quality assurance department. These costs, added to wages in the department, are then allocated to several different assembly and packaging departments. Next total costs for these areas are allocated to products. In many companies labor hours are the basis of allocation. This scheme makes sense when production is labor intensive; however, as processes have gotten increasingly automated, many such allocations have become outdated. The best allocation scheme is one that traces costs as closely as possible to their source.
The best way to do so is using activity based costing (ABC). One of the most recent developments in management accounting is the field of activity based costing. ABC is a management accounting approach that traces all indirect costs, including administrative costs, back to the products that generated them. This practice recognizes the problems traditional cost systems have with allocating overhead and with ignoring selling and administrative expenses, even though these may vary with sales or production volume.
Management accounting and correct allocation methods are critical for internal decision making and control over the organization.
3. Options and Type of Allocations
This section describes different types of allocations and their main purpose. Most allocations are used at period end.
Period end allocations are procedures which handle indirect allocation methods. Indirect allocation methods do not have the exchange of activities which are used as the basis for cost allocation, but instead have user defined keys such as percentage rates, flat amounts, statistical key figures, or posted amounts. These type of allocations are usually carried out after all the primary postings for a relevant period have been made. In addition to month end allocations there is one important method of allocation that will happen during the month. Each internal activity is valuated to determine the costs for business events (e.g. Internal cost allocation)
The following allocation methods are available for cost center accounting:
2.1 Direct Internal Activity Allocation
Internal cost allocation is used in cost center accounting. It involves measuring, entering and allocating of internal services performed. In order to use direct internal cost allocation the system requires relevant allocation bases which can be measured and used to allocate costs. These bases are known in SAP as activity types (e.g. quality control hours, maintenance hours ). The costs are allocated when operations are confirmed or activities recorded. This is a transaction -based allocation method, it does happen during the month for every transaction using activity types that is posted in cost center accounting. To obtain the costs the system multiplies the activity quantity produced by the activity price (determined for an activity). You can either set the activity rate manually when you plan the activity or let the system compute it automatically. This utility is useful in that activities on cost centers can be allocated when they occur and will be allocated on the base of utilization of activities in cost centers.
This type of allocation will be mainly used for production related cost centers, because it is not always possible to determine activities and activity rates for service and overhead cost centers as well as determine the use of activities in these cost centers.
2.2 Indirect Activity Allocation
Indirect activity allocation is a tool for automatically allocating plan and actual activities. Unlike direct activity allocation you use self-determined keys to allocate activities. Prior to allocation a fixed activity network is generated and valuation executed iteratively using it for allocation.
2.3 Calculation of Imputed Costs
Imputed costs are costs which need to be handled differently in cost center accounting and financial accounting. For example, operating costs which can be shown in financial accounting on an annual basis should be shown within management accounting on a monthly basis. Thus the process of distributing irregularly incurred expenses evenly over a number of periods is known as imputed cost calculation.
It is a method of allocating costs from one cost center to other cost centers. It allocates all costs on one primary cost element to the same primary cost element on different cost centers.
All information about the distributing posting, for example details on sender and receiver is documented in the cost accounting document.
- Original cost element on the allocated costs is retained on receiver cost center
- Total on the original (sender ) cost center is 0, due to using the original cost element for allocation
- More records are generated in the system
It is a method of allocating cots from one cost center to other cost centers. This method does not allocate using the primary cost element but transfers costs using and assessment (secondary) cost element. Therefore details of the original cost elements will not be shown on the receiver cost element. This method allows grouping together of different primary and secondary cost elements. All information about the allocation posting, for example details on sender and receiver is documented in the cost accounting document.
- Original costs remain on the cost center. So it is possible to report on just the primary costs.
- Data in the system is grouped together, for example material costs can be put to one assessment cost element.
- This method can allocate both primary and secondary cost elements on a cost center.
- The receiver cost element cannot identify the primary cost element.
4. Comparison of Allocation Types
5. Creation of an Assessment Cycle in the System
Assessment is the allocation method that is used most to allocate costs, because it shows allocated costs on another cost element. The advantage of this method is that reporting can still be done on the original cost center of all costs before allocation.
Allocation rules (cycles) are defined once in a year and can then be run on a monthly basis. A cycle groups together different sender-receiver relationships which are defined in segments. Separate allocation cycles must be created for allocating plan and actual costs, although the cycles my be copied form each other.
- Which objects have to allocate costs (senders)?
- Where are the costs to be allocated to (receivers)?
- Which costs or activities are to be allocated?
Actual / plan costs
- On what basis are the costs or activities to be allocated (tracing factors)?
Fixed amounts, fixed percentages, fixed portions (similar to fixed percentage, with the exception that the amount is not limited to 100. The sender base is derived from the total of the receiver tracing factors), variable portions (amounts are allocated based on postings in the database one the following types: cost elements, versions, activity types, statistical key figures)
When creating cycles there are various options available within the system:
Scaling negative tracing factors
A negative tracing factor can occur within the system if the tracing factors are not defined as fixed values or percentages, but are derived from objects such as statistical key figures or activity types. The problem arises only if one portion of the receivers has positive tracing factors and another portions has negative tracing factors. If the negative values are not scaled, then not only the sender is credited. Receivers with negative values are also credited and receivers with positive tracing factors are debited by a larger amount.
Sender cost center (CC 1) allocates $1000 to 2 receivers (CC 2, CC 3). The tracing factors (e.g. statistical key figures or activities) posted for the receivers are:+100 for CC 2, -90 for CC 3. The sender base is the total of the tracing factors: +100 - 90 = 10.
Without scaling of the tracing factors the allocated amounts are calculated as follows:
- CC 2 receives $1000 * (+100)/10 = $10000
- CC 3 receives $1000 * (-90)/10 = $-9000
- CC 3 is thus credited with $9000 at the expense of CC2.
The scaling process works as follows:
- The lowest tracing factor is set to 0.
- The other tracing factors are increased accordingly.
Then the newly calculated tracing factors for our example are:
- CC 3 is 0. CC 2 is increased by the scaling amount of 90. Sender CC 1 would now be credited 100% to CC 2 and CC 3 would be neither credited nor debited.
- You must define scaling for single segments or for a segment and a cycle.
When a cycle is processed iteratively, all segments are processed one at a time. The result of one segment is then used by the next segment in the cycle. Note however that this indicator only applies to other senders within the cycle. If a later segment uses 'posted amounts' as a basis of receiving, then results of earlier segments are not taken into consideration. This indicator should only be used if really necessary, since it will run the cycle until all the costs in a sender are allocated, it may have an impact on runtime of the cycles. Depending on the sizes of the created cycles the runtime could be an issue.
If this field is set all the sender values in the object currency are computed separately and distributed in separate fields. This facility only functions when the object currency of all objects is the same because no translation will take place during processing.
If this indicator is not set it will result in the object currency being determined by the controlling area currency.
In indicating the transaction currency posted sender values are computed separately and the receiver is updated in the posted transaction currency. In setting this indicator the allocation will create more records for each receiver and sender relationship. If you don't set this indicator the allocations will be carried out using the controlling area currency.
A segment is a way of grouping together related sender-receiver relationships. Each segment defines the cost elements and cost centers to be allocated. The receivers can be cost centers, orders or WBS elements. Each segment has to have one assessment cost element assigned.
Sender cost centers, where the values to be allocated are calculated using the same rules, and the corresponding receiver cost centers, where the tracing factors are determined using the same rules, are combined in a segment.
The segments are processed sequentially during an allocation run.
Sender values are either actual or planned. If not the total amount, but a fixed predefined amount or percentage should be allocated it can be defined here.
Tracing Factors: The tracing factors within a segment control how the system will compute allocation. The system has four possible tracing factors:
Variable Portions - this tracing factor computes the allocation from the total file. In order to tell the system which totals file to access, the appropriate field group must be chosen. The field group indicates what the allocation base is for the segment. The following groups are available:actual costs, planned costs, actual consumption, planned consumption, actual statistical key figures, planned statistical key figures, actual activity, planned activity
Fixed Amounts- within the tracing factor screen the receivers are selected and charged directly with a fixed amount. The amount credited to the sender is derived from the total of the receiver debits.
Fixed Percentages - the value form the sender is allocating according to the percentages on the receivers. The percentage value must not exceed 100. Where the percentage value is less than 100 the remainder stays on the sender.
Fixed Portions - the value form the sender is allocated according to the total number of receiver portions. Unlike the percentage allocation the value can be a maximum of 999.99.
The use of allocation base only arises of the tracing factor '1' - variable portions is chosen. Then it is important to decide which of the field groups will be used to make the most meaningful allocation. If the field group entered is incorrect it may override any selection criteria chosen (e.g. if the field group actual costs is used but with a statistical key figure entered in the selection criteria the statistical key figure will be ignored. The allocation will be made on the basis of actual costs present on the receivers.)
Use of Statistical Key Figures in Assessments
There are two types of statistical key figures within SAP: a fixed value and total value key figure.
- The fixed value key figure (type 1) indicates that a key figure is fixed from the initial month for all subsequent months of the current fiscal year.
- A total value key figure (type 2) indicates that the amount of the key figure is set for the respective month and not carried forward to the subsequent months.
Statistical key figures can be incorporated in assessment cycles when the allocation is based on ratios like headcount square footage, telephone units etc.
6. Processing Allocations
Cycles can be processed directly on-line or as a background job. They can be processed in a test mode or an updated mode and with/without a detailed list display. Usually allocation cycles are processed at the end of each month for the period that has to be financially closed.
The use of background jobs is recommended however it is imperative that these jobs are scheduled after all the statistical key figures have been input into the system.
If errors are found after the cycle has been run, provided the CO posting period is still open, the cycle can be reversed. It can be corrected if necessary and re-executed. This generates more records (one record for each posting, one for each reversal) on the database but is the safest way to perform corrections as no direct posting is permitted on assessment cost elements.