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Use the Primary Cost Component

Split to Explain the Factors
Behind Your Activity Rates
by Janet Salmon, SAP AG
You probably know that manufacturing costs are charged to
production orders using an activity rate for the time worked. What
you might not realize is that since Release 4.0, it has been
possible to set up a primary cost component split to view
primary costs1 such as energy, wages, and depreciation.
When people ask me why they can only assign six activity
types to one operation in the routing, I often find myself
pointing them to the primary cost component split.
This allows you to see the impact of any changes to your
primary costs increases in energy prices, higher wage costs, or changes in depreciation
rules on the product profitability. You can look not just at how many hours of manufacturing your product has consumed, but at a wide variety of factors that impact your
product costs in order to determine whether your product will continue to be profitable.
Without the split, these costs are subsumed in the activity rate and are simply
grouped as manufacturing costs in product costing and Profitability Analysis (PA).
This function is relatively unknown for two reasons. The first is that the documentation and Customizing steps are spread across three applications Cost Center
Accounting (CO-CCA), Product Cost Controlling (CO-PC), and Profitability
Analysis (CO-PA). Therefore, its not easy to see what needs to be set up where.
The second is that when companies start with product costing, they tend to use
externally calculated activity rates until they get comfortable with the system.
While an Excel work sheet helps you calculate a cost rate per hour, it doesnt assign
the costs underlying this rate to cost components and roll them through your
production cycle. To use this function, you need to stop having Excel calculate your
activity rates and have R/3 calculate them for you.
The primary cost component split provides more detailed information by exploding
the activity rate into its cost components. Using the example of a CD recording, Ill
show you how to set up and use this functionality. Then you can see both the costs of
Continued on page 3
1

April 2003
Volume 2, Issue 4
www.FICOExpertOnline.com

Inside This Issue

Archive Search Strategy: The

Default Setting Every FI End
User Has Active... and
Doesnt Understand

13

Speed Up Your Report

Performance by Knowing
Where Your FI Data Is Hiding

16

The Surprising Relationship

Between G/L Relevant to
Cash Flow setting and A/R
Standard Reports Showing
Customers Last Payment

19

Ask The FI/CO Expert

Improve Your Cost Center
Budgeting Speed with
Automated Dependency
Planning

Primary costs are those coming directly from FI accounts (material usage, wages, and salaries) rather
than as a result of allocations.

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From Our On-Call FI/CO Expert

I am delighted to have been asked to participate in the rollout of a newsletter
predicated on the idea that everyone can be a FI/CO expert if certain concepts and mechanics about the modules are clearly explained. The articles
Ill write or acquire from colleagues for you will answer one, two, or all three of
the questions that Ive been asking myself every day of my seven years of customizing SAP FI and CO modules for companies large and small:
(1) Whats available in FI/CO?
(2) How does it work?
(3) Why should anyone care?
My goal, and that of the other contributing experts, is to bolster every readers on-the-job productivity,
whether your role is manager, consultant, end user, or executive. My method is to clarify and
expose confusing or poorly documented functionalities, terms, and relationships, so that youthe
readercan be in a position to make your own decisions about what to use and how to use it.
Kurt Goldsmith, ICM America
About ICM America: The U.S. division of International Consulting Munich (ICM) resides in the Philadelphia Philicon Valley suburb of Malvern,
Pennsylvania. The company specializes in supporting the most difficult SAP application projects and project-related design questions in the
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Primary Cost Component

recording the CD and the costs to

provide the recording activity the
wages and salaries of the people
involved, the energy consumed by the
recording equipment, the depreciation
on the recording equipment, and more.

To bring more transparency into CO-PC,

you start in CO-CCA and explain the
activity price. This price is calculated by
taking all the costs flowing onto the
cost center, such as wages, salaries,
depreciation, energy, and operating
supplies, and dividing by the number of
hours worked in the period. This rate is
then used to place a dollar value on the
number of hours confirmed in production.

Cost Accounting in R/3

Using the Primary
Cost-Splitting Function

To get more than a dollar rate per hour,

you assign the cost inputs to up to 40
cost components, the cost component
split. This cost component split then
can be used to explain costs as they

Continued from page 1

To understand why you might want a

cost center split, visualize how costs
move through the Controlling modules:

occur in your organization. Every time

one cost center provides an activity to
another cost center, it passes its cost
component split to the next cost center.
When a manufacturing activity is used
in CO-PC, it passes its cost component
split to the product costs. When the
product cost estimate is used to calculate
a contribution margin in CO-PA, this
cost component split is passed along too.
The result is that you can view wages,
salaries, depreciation, energy, operating
supplies, and so on, instead of manufacturing costs in CO-PC and CO-PA. This
cost flow is illustrated in Figure 2.

CO-CCA saves where the costs are

incurred (manufacturing, maintenance,
corporate services, and so on). The
focus here is on the type of costs
(wages, salaries, facility costs,
depreciation, operating supplies) and
how these costs are passed on to
other areas of the organization (from
the maintenance to the manufacturing
cost center or from the manufacturing
cost center to the product).
CO-PC calculates the product costs,
with the raw material costs being
calculated via the bill of material and
the manufacturing costs via the routing.

Figure 1

Cost flow traditional view

Figure 2

Cost flow, primary cost component split

CO-PA looks at, among other things,

product profitability. It compares the
revenue and sales deductions for the
product with the raw materials,
manufacturing, and overhead used to
make that product.
Figure 1 shows how costs move from
CO-CCA to CO-PC and CO-PA.
You can see that as the costs move
from CO-CCA to CO-PC, the activity
type prevails. All you can analyze in
this example are the labor costs and
machine costs in CO-PC and CO-PA.
(See the sidebar, Routing in the
Production Planning Module.)

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Cost Component Splits

The cost component split is not a new concept. If you have
worked with product costing, you are familiar with the way
that the cost component split breaks out the costs for each
material in the bill of material, showing the raw material,
internal activities, and overhead inputs for each product. As
intermediate products are used in the next production level,
their costs are transferred as a cost component split, ensuring
comparability across all products.
The same concept extends to CO-CCA. Here, you take the
primary costs for the cost center (wages, salaries, benefits,
depreciation) and assign them to cost components that show
the primary costs for your manufacturing activities. As one
cost center (e.g., manufacturing) receives activity from another
cost center (e.g., maintenance), the maintenance costs appear
as secondary costs in the cost element reports, but as primary
costs in the activity rate for the manufacturing cost center.
This process of passing on the cost component split continues
throughout the allocation chain, provided that you use activities
as a basis for the allocation.

How to Use the Cost Component Split

If you have decided to use the cost component split throughout your organization, you can refer to the following
step-by-step instructions, which Ill illustrate using the
example of the production of a CD:
Define a cost component split for the activity rate. This
ensures that all costs are assigned to cost components
during activity price calculation (and process price
calculation, if you are using activity-based costing). Assign
this split to the planning version. The planning version
combines for each fiscal year all the parameters affecting
planning. It determines which methods are used for the
calculation of the activity price, whether a revaluation can
take place using actual costs, and whether the price will be
split into its primary cost components.

price (primary). Use a transfer structure to map the first

cost component split into the primary cost component split.
Extend the valuation strategy for the transfer of product costs
to CO-PA to ensure that both the cost of goods manufactured
and the primary cost component split are transferred.

Example: Cost Center Accounting

Applied to CD Production
The purpose of activity price calculation is to determine a rate
for machine hours, maintenance hours, and so on. The activity
price for recording the CD in my example (Figure 3) is 66.46
pesos per seven hours, and for CD label printing, it is 23.01
pesos per seven hours. The price unit is 10 in each case.
The primary cost components behind this activity rate include
wages, salaries, benefits, material costs, imputed costs, and
external processing. (See Figure 4.) These costs are truly
primary that is, they are a grouping of the primary cost
elements posted to the cost centers. Sometimes organizations
will choose not to break out all their activity costs into their
primary cost components. In this example, the organization has
decided that energy and maintenance are so important to their
decision making, that they want to see them unbroken in
their cost component split. For this purpose, two further cost
components, Energy by CCtr. and Maintenance by CCtr.,
have been defined to switch energy and maintenance costs,
rather than break them out into their primary costs. Finally, a
component for Other costs catches any costs that arrive on the
cost center for instance, as a result of assessment cycles.
(See the sidebar, Limitations of the Cost Component Split on
page 8.)

Define an alternative cost component split for the product

costs that handles machine hours not as internal activities
(secondary), but as the cost components behind the activity

Routing in the Production Planning Module

In the Logistics and Controlling modules, you can assign only
six activity types to one operation in the routing. In the
Production Planning module, the routing (or master recipe in
the process industry) lists the operations required to
manufacture the product. Each operation is performed at a
work center, and this work center contains a formula to
calculate the time required to perform the operation. The costs
are calculated by linking this operation with up to six activity
types, each of which carries an activity rate (a dollar value for
the time to be worked). When a company confirms completion
of an operation, it confirms the number of machine hours or
wage hours worked, and the Controlling module records
the costs associated with providing the machine hours or
wage hours.

Figure 3

Activity price for CD recording and CD label printing

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The first task is to assign all the primary cost elements to be

posted to your cost centers to cost components. To do this, in
Customizing choose menu path Cost Center Accounting>
Actual Postings>Period-End Closing>Activity Allocation>
Price Calculation>Settings for Cost Component Split>
Define Cost Component Structure. As you can see from
Figure 5, this path takes you to all the cost component splits.
In this example, Im using IE (IDES Europe) as the cost
component structure for the activity types, ML as the traditional
cost component structure for the CD product costs, and MX
as the primary cost component structure for the product costs.
To create the cost component structure IE, define a key for
the cost component split and the components you need, and
assign the relevant cost elements to the components. The
parameters for stock valuation on the cost component only
apply to product cost structures (ML and MX in my example)
and can be ignored for the activity type.

Figure 6 shows how to assign each cost element in your

chart of accounts to cost components. Dont forget to include
a final cost component for all the secondary costs arriving via
assessment cycles (cost component 90 Other Costs, in my
example).
When you have finished, set the active checkbox and assign
the split to the planning version for the next fiscal year. To do
this, in Customizing choose the menu path Controlling>
General Controlling>Organization>Maintain Versions.
Select the planning version you are using in CO-CCA and
choose Settings by fiscal year as shown in Figure 7.

Example: Product Costing

The activity price is used to value the work provided to the
product. In this example, to manufacture 100 demo CDs
requires one hour of CD recording and one hour of CD label

Figure 4

Cost component split for CD recording

Figure 5

Cost component structures

Figure 6

Assigning cost elements to cost components

Figure 7

Cost component structure in planning version

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printing. (See Figure 8.) This is calculated by defining

standard values in the routing and setting a formula in the
work center to calculate how long it takes to perform the
operation. To calculate the cost for the operation, link the
work center, at which the operation is to be performed,
with a cost center and one or more activity types.
To view the primary cost component split, click on Type
of cost component split (Figure 9) in the cost component
report and switch to Auxiliary cost component split.
After you switch to the alternative cost component split,
instead of seeing the manufacturing costs as labor, setup,
and machine costs (the activity types), you see the wages,
salaries, energy, and depreciation behind the activity prices,
as shown in Figure 10.

Figure 8

Itemization of product costs for demo CD

Figure 9

Finding the primary cost component split

Figure 10

Product costs, primary cost component split

To create this cost component structure, in Customizing

follow the menu path Controlling>Product Cost
Controlling>Product Cost Planning>Basic Settings for
Material Costing>Define Cost Component Structure.
This takes you to the same tables you used earlier for the
activity rate. However, this time you are going to look at
cost component structure MX. Note that you cannot use
exactly the same structure, because you need to capture other
costs (such as overhead) for the product that are not coming
via the activity rate.
It helps to think of three main blocks to be captured in this
structure: the raw materials issued to the production orders
(rather than operating supplies issued to the cost center),
the activities to be confirmed (now in their primary, rather
than secondary form), and the overhead surcharges
(secondary). You need to define a transfer structure, which
maps the cost component structure for the activity rate to the
cost component structure for the product. The assignment
from the cost component structure IE for the activity rate to
the cost component structure MX for the product costs in
my example is illustrated in Table 1.
Typically, the transfer structure keeps most of the detail in
the activity rate, but might group some elements more
tightly. To do this, select the cost component structure IE
and choose Transfer Structure. This is illustrated in
Figure 11.
Finally, you need to activate the second cost component
split for the company code and costing variant. To do this,
choose Assignment: Organiz. Units - Cost Component
Structure (Figure 12).

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Cost component in IE

Name

Cost component in MX

Name

10

Wages

20

Wages and salaries

20

Salaries

20

Wages and salaries

30

Employee benefits

20

Wages and salaries

40

Material costs

10

Material components

50

Imputed costs

40

Depreciation

60

External processing

10

Material components

70

Energy by CCtr

30

Energy

80

Maintenance by CCtr

20

Wages and salaries

90

Other costs

300

Other costs

Table 1

Transfer structure for product cost assignment

Figure 11

Transfer Structure from IE (activity) to MX (product)

Figure 12

Activating the auxiliary cost component structure

Figure 13

Contribution margins

Example: Profitability Analysis

Now that you have set up the primary cost component split
as a second (or auxiliary) cost component split in CO-PC,
you need to extend the valuation strategy in CO-PA, to
ensure that this second split is transferred as well.
The valuation function in CO-PA accesses the cost
component split for the product sold, in order to show the
contribution margins for variable and fixed costs. Figure 13
shows a typical contribution margin report.
If you transfer the auxiliary cost component split from
CO-PC, you need to set up a second contribution margin
structure in reporting to show the wages, salaries, and so
on behind the activity price instead of the manufacturing

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costs. (See Figure 14.)

In order to be able to build a report like this, you configure
the valuation functions to pick up both the main and the
auxiliary cost component split. To activate the transfer,
choose Profitability Analysis>Master Data>Valuation>
Set Up Valuation Using Material Cost Estimate>Define
Access to Standard Cost Estimates in Customizing. Set the
checkbox Transfer aux. CC split as shown in Figure 15.
You also need to map each of the primary cost components to
value fields. To do this, choose Set Up Valuation Using
Material Cost Estimate>Assign Value Fields. Include
these value fields in your CO-PA reports. (See Figure 16.)

Figure 14

Contribution margins, primary cost components

Figure 15

Activating the auxiliary split in CO-PA

Figure 16

Linking the cost components to value fields

Setting up the primary cost component split may seem like

a long haul through CO Customizing, but it provides a
detailed understanding of the factors driving your
manufacturing costs.

Limitations of the Cost Component Split

The cost component split can only be used to break out activity
costs. There are two situations where this can be a problem:
assessment cycles and overhead surcharges.
Most companies use assessment cycles to assign general
overhead between cost centers. General overhead appears on
the manufacturing and maintenance cost centers as secondary
costs (assessment cost elements) that cannot be exploded
further. If primary costs are your focus, then instead of using
assessment cost elements in your assessment cycles, you
should define an allocation structure that has a similar
structure to your cost component split. This ensures a
similar degree of transparency in your overhead costs.
Most companies also use a percentage overhead to assign
factory overhead to their products. This appears in the
product cost estimate as a secondary cost (overhead cost
element) that cannot be exploded further. If primary costs
are your focus, then you need to keep these percentages as
low as possible, and assign as much overhead as possible
via activity types (or processes).

Janet Salmon joined SAP AG in 1992. After six months of training on

R/2, she began work as a translator, becoming a technical writer for
the Product Costing area in 1993. As English speakers with a grasp of
Grenzplankostenrechnung were rare in the early 1990s, she began to
hold classes and became a product manager for the Product Costing
area in 1996. She has since helped numerous international organizations
set up Product Costing. More recently, she has worked on CO content
for the Business Information Warehouse and Financial Analytics. She
lives in Speyer, Germany, with her husband and two children. She
spends her free time cycling and recently competed in the Alpine
stage of the Deutschland-Tour.

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