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BUS 301S – Integrated Business Experience

Chris McBride, Denise McBride, Stephen Tracy

Central Michigan University

CHAPTER 6 – MANAGING THE MONEY

Table of Contents Chapter 6 – Managing Money with Managerial Accounting ........................................................................ 3

Chapter Introduction ................................................................................................................................ 3

Definition of SAP Controlling (CO) ............................................................................................................ 3

FI and CO – FICO like peas and carrots ..................................................................................................... 4

G/Ls and Cost Objects ............................................................................................................................... 4

Organizational Structures ......................................................................................................................... 5

Client ..................................................................................................................................................... 5

Operating Concern ................................................................................................................................ 5

Controlling Area .................................................................................................................................... 5

Chart of Accounts .................................................................................................................................. 6

Company Code ...................................................................................................................................... 6

Transactional data..................................................................................................................................... 6

Master Data .............................................................................................................................................. 7

Cost Center ............................................................................................................................................ 7

Internal Order ....................................................................................................................................... 8

Primary Cost Elements .......................................................................................................................... 8

Secondary Cost Elements ...................................................................................................................... 9

Primary Revenue Elements ................................................................................................................. 10

Activity Types ...................................................................................................................................... 10

Statistical Key Figures.......................................................................................................................... 10

Profit Center ........................................................................................................................................ 11

So – How does CO Work? What does it REALLY mean? ........................................................................ 11

Posting – FI and CO ................................................................................................................................. 14

Posting a Journal Entry Using a Primary Cost Element ........................................................................... 14

Posting Using a Secondary Cost Element ............................................................................................ 15

Periodic Allocations ................................................................................................................................. 17

Distributions ........................................................................................................................................ 17

Assessments ........................................................................................................................................ 18

Budgeting in a Business .......................................................................................................................... 18

Introduction to how companies use CO ................................................................................................. 19

SAP CO Module Integration .................................................................................................................... 20

SAP @ Pen Inc. ........................................................................................................................................ 20

View from the Top .................................................................................................................................. 20

Key Terms ................................................................................................................................................ 22

Self-Assessment ...................................................................................................................................... 22

Chapter 6 – Managing Money with Managerial Accounting

Chapter Introduction

The SAP Controlling Module performs the managerial accounting functions in SAP. SAP Controlling is designed to collect the transactional data that provides a foundation for preparing internal reports that support decision-making within the enterprise. This chapter will continue to reinforce the concepts of integration and create a foundation that will explain how to manage expenses within every process within the enterprise. The supporting role of the CO module forms the basis of the day-to-day responsibilities of managers and leadership. This chapter will define how to do this and how responsibilities are tracked from a financial standpoint from financial accounting to controlling providing a seamless view of the company.

Definition of SAP Controlling (CO)

The SAP Controlling (CO) module represents an enterprise’s needs arranged by internal areas of responsibility throughout the organization. CO components form a framework that supports the planning and recording of actual activities for a business in the manner desired by management through planning, budgeting, and tracking. The proper tracking of revenues and expenses to the specific area of responsibility in the organization (department, project, process, or any other object) provides the granular level of control needed to efficiently and effectively manage the organization’s resources and activities. Configuring CO based on the requirements of the organization means the accurate and organized collection of business information. Whether employees are ordering sticky notes for their office or managing the construction of a new manufacturing plant, CO collects data in a manner so it can be properly understood and utilized by the employees of the organization. The most important purpose of Controlling in any organization, regardless of computer systems, is to support the development and presentation of relevant accounting information to track activities and enable good business decisions. Submodules of CO include the following:

• Cost element accounting

• Overhead cost accounting

• Product cost accounting

• Profit center accounting

• Profitability analysis Controlling provides reporting capabilities and tools for people at all levels of the enterprise and is organized in such a way that the needed information to make decisions are built by the organization. Examples of people in the organization that use CO reports include:

• Executives • Senior Management • Department Managers

• Controllers • Cost Accountants • Anyone with a budget

FI and CO – FICO like peas and carrots Logically thinking, you cannot have CO without FI. FI tracks value coming into and leaving the business as well as the current financial health of the company. CO represents what we do with the value within the company. Revenues and expenses are passed from FI and CO to show “ownership” for activities. FI is a corporate view; CO is a view of individual (team, organization, project, etc.) responsibility. The structures and methods that revenue and expenses are integrated between FI and CO will be explored and defined in the following sections.

G/Ls and Cost Objects As we know, a G/L in FI is created to track transactions (debits and credits) for a very specific asset, liability, revenue or expense. It has to be tightly defined because of the requirements of accounting standards such as Generally Accepted Accounting Principles (GAAP) or the International Accounting Standards (IAS). Everything in FI is dictated by rules. These rules ensure that all companies report in a consistent, accurate and well-documented manner. If the name of the G/L is “supplies expense” then the only thing captured in that G/L are supplies expenses. It is as simple as that; everything has a place, and it is put in its place. All postings in FI require dual entry, for every transaction, there are at least one debit and one credit entry. The debits and credits when combined, will always equal zero. This dual entry system is required because FI needs always to be in balance.

Cost objects are a completely different thing. CO postings come from posting to a general ledger account which has been assigned a primary cost element. This assignment means that costs arrive in CO as a one-sided entry. CO does not require dual entry unless the value is being moved from one cost object to another cost object. CO is all about responsibility and management. The main cost object we discuss in the CO chapter is the cost center. Cost objects, broadly defined, are objects used to collect expenses and revenues in CO. Cost objects can be used differently because not all internal departments generate revenue; in fact, there are relatively few objects that receive revenue postings when compared to the number of objects that receive cost postings.

Consider the processes that were defined as “shared services” in Chapter 1. Shared services support the business but do not generate revenue.

So, a cost object is a “bucket” that captures expenses and allows a manager to compare the plan (budgeted amounts) to actual expenses posted as they happen. Cost objects have several uses. The cost center we have already discussed is a “permanent” cost object assigned to track the long-term performance of a department, function or groups of responsibilities. There are also several kinds of temporary cost objects that are created for special purposes.

Temporary cost objects include the following:

• Internal orders

• Production orders

• Maintenance orders

• Projects

Quickly defined; internal orders are defined for a specific purpose (defined in CO chapter) that has a specific life span. Production orders are temporary cost objects used to capture the planning and actual costs associated with manufacturing activities. Maintenance orders are temporary cost objects that allow for planning and the capture of actual costs for maintenance activities such as fixing machinery, painting a room or fixing a leaky faucet. Finally, projects are temporary cost objects that allow for

planning and tracking of actual costs for a large project. Project systems in SAP use the project cost object and allow for the planning of very large capital projects, such as the construction of a building in a well-defined and tracked methodology.

How are cost object and general ledgers different? Aside from the various purposes listed above, they are structured differently. A G/L, as stated, exists for a very specific purpose; to track a well-defined type of asset, liability, revenue or expense that is aligned to the balance sheet or income statement. A cost object contains a collection of these items, not just one that is related to the responsibility delineated by the standard hierarchy of CO.

Organizational Structures Just like all other SAP modules, Controlling uses a hierarchy of organizational data objects to structure the reporting environment for the organization. Each organizational data object represents a level in the hierarchy. You should notice that some of these data objects are common to the structures already discussed in FI. You will find that these commonalities form the basis for the integration between modules in SAP. The CO organizational data objects include:

• Client

• Operating Concern

• Controlling Area

• Chart of Accounts

• Company Code

Client

A client in SAP is an independent environment in the SAP system. The client is what a user logs into, and it gives the user access to all of the needed information for a given enterprise. Master data that is needed to be shared across all organization levels is created and maintained at this level.

Operating Concern

An operating concern is the highest organizational structure in SAP Controlling. The Operating Concern supports the SAP Profitability Analysis functions in CO. Using SAP profitability analysis, a business can be divided into different external views of the company, called segments, from which profitability can be calculated and analyzed. These segments can be based on product, market or other customer-focused points of view. Each segment’s profitability can be then analyzed through this module. The Operating Concern, using the CO Profitability Analysis functions enable the collection of revenues from sales and the costs from controlling to analyze profitability by segment. The Operating Concern is used only for the CO Profitability Analysis functions. In this class, profitability segments will be used when we cover the sales functions.

Controlling Area The Controlling Area is a self-contained organizational element for which the management,

including oversite, reporting, and analysis, for revenues and costs can be performed. The controlling area provides the structure to identify and track where revenues and costs are incurred for reporting purposes. It should be noted that the controlling area is only for CO and is not considered in the

operation of FI reporting. A controlling area may include one or more company codes, however; a company code can only be assigned to one controlling area. The power of the Controlling Area structure is that it enables the enterprise to perform management accounting (CO) analyses and reports across several company codes. FI does not have cross-company code allocating capabilities. The relationships created by the Controlling Area allow data to be rolled up into a composite view of the company enterprise-wide, not just by company code.

Chart of Accounts

As defined in the SAP Financial Accounting chapter, the chart of accounts is a listing of all available general ledger account master records that can be used by one or more company codes. It is an ordered listing of the general ledger accounts that exist for an enterprise. The combination of a company code with the chart of accounts that is assigned to it is part of the structure used by CO to uniquely identify where postings will occur. The General Ledger, based on the Chart of Accounts, allow for one reconciled set of truth between FI and CO. As stated in the section above; a controlling area can contain one or more company codes. All company codes that are assigned to a controlling area must use the same chart of accounts and operate on the same fiscal year.

Company Code

A company code represents an independent legal accounting unit. A balanced set of books is created at the company code level of the organization. With the addition of CO, the controlling area has been added to the organizational structure. The company code is assigned to a controlling area. The company code can be assigned to one and only one controlling area. Many company codes can be assigned to the same controlling area enabling cross-company code allocations from a cost and revenue perspective. For more than one company code to be assigned to the same controlling area, all company codes must be assigned to the same operating chart of accounts and have the same fiscal year. To allocate costs across company codes, the identity of the cost (e.g., a general ledger called labor expense) must be the same in both company codes; that is why al Company Codes assigned to a Controlling Area must use the same chart of accounts. Understanding these structures along with the FI structures and how the organizational data elements are assigned to each other defines how companies track, report, and manage their enterprises from a financial standpoint. To this point, we have only discussed FI and CO as separate structures with common organizational data elements. However, you will come to view them as one integrated set of truth where the two sides of accounting can “talk.” When we discuss T accounts, you will see how FI and CO are one integrated accounting system separated by a “wall.”

Transactional data

Transactional data in the SAP Controlling module is captured through postings – debits and credits, just like in financial accounting. The point to understand is that these postings are records of physical activities and work processes that are executed throughout the organization as they happen. Postings do not happen for the sake of making postings, but as a result of these activities. It is important for the student to remember that CO is a module, not a process – although there are certainly processes that

include CO. CO represents a set of tools to gather information but does not “do anything” without activities and business rules to trigger it.

The transactional data gathered in CO is used everywhere in the enterprise and it vital for the successful management of resources and budgets in all companies. The details of how CO works, how it integrates with FI and how we use it from a day-to-day management perspective are discussed in the following sections.

Master Data

As we continue our discussion of controlling, we need to define the master data elements used in controlling. As stated in previous chapters, master data is entered once and reused over and over again by transactions in an ERP system. We utilize master data on a daily basis to carry out transactions. Master data used by SAP Controlling in this unit includes:

• Cost Center

• Profit Center

• Primary Cost Element

• Secondary Cost Element

• Primary Revenue Element

• Activity Type

• Statistical Key Figure

• Internal Order

Cost Center

The cost center, introduced in the HCM Chapter, is a piece of master data representing a clearly delimited area of responsibility where costs (expenses) occur. What this means is that there is a person responsible for the management of the cost. In HCM, the cost center was attached to a position so wages could be sent to the Production department. Cost centers are generally permanent items of master data that are utilized month after month and year after year to capture costs associated with that area of responsibility, location, or type of activity. The ability to plan costs, capture actual costs, monitor costs, and analyze the variances provides an explanation for some of the other uses of cost centers.

To simplify our explanation of a cost center, it is sometimes easiest to view a cost center as a bucket of responsibility. An area (or bucket) is one in which you can capture all the costs associated with the activity to which you will be held responsible.

For example, if the Marketing department is your bucket of responsibility, you would capture the costs associated with wages, benefits, supplies, travel, software, and/or costs allocated to you by other departments such as rent and utilities. If you had been given a budget (planned costs), you could now analyze

the differences between your planned costs and your actual costs. By capturing costs in this manner, you now have the ability to hold managers of the cost centers (or buckets) responsible for managing their costs.

Another example is if you work as a student employee at CMU. When clocking in for work, you first swipe your card (which lets the system know which master data to use) and then using a barcode scanner, you scan some numbers on the piece of paper by the time clock. The number below the barcode is the cost center used by the department for which you work. CMU has approximately 12,000 cost centers in use for tracking cost. If a student scans the incorrect code, a transfer between the wrong cost center and correct cost center must be made to fix it. Departments review reports to make sure

they are only being charged for their students. They do not want to pay for a student that does not work for them.

Cost element groups - Cost centers, just like almost everything else in SAP are arranged in a hierarchy (grouping) to facilitate the aggregation of reporting. This grouping allows companies to run reports at any level in the hierarchy because all the cost centers below it will be included. This grouping saves time and errors that can occur if a person has to key in many cost centers for reporting. Reports can be executed to display the line items for the cost center group and its associated primary cost elements. You will review the cost center structure, or Standard Hierarchy, in your hands-on exercises for this chapter.

Internal Order

An internal order is similar to a cost object, except it is a temporary object with a specific start and end date associated with it. The internal order has responsibility for recording expenses and revenues in the associated time frame. An internal order has similar functionality to that of a cost center including the ability to plan, collect, and monitor the costs associated with a distinct short-term event, activity, or project. There are different types of internal orders used for different reasons. The type of internal order sets up the types of costs and revenues that can be planned for and posted to the internal order. Examples of internal orders are:

• Capturing the design costs for a new product

• Company picnic

• Trade show

• Recruiting campaign

• Courses offered at CMU Again, using our example of a bucket, an internal order is just that temporary area of responsibility for which we need to capture costs (planned and actual) and revenues. Once finished with the internal

order, because it is a temporary object, the cost and/or revenues must be settled. Settlement ensures the internal order is at a zero balance. Settlement can transfer out the revenues or expenses to another cost objects such as another internal order, a cost center, or another cost object. Once items are settled, the internal order is completed and can be closed to prevent future postings.

Primary Cost Elements

In the FI hands-on exercises, FI postings (journal entries) are credited and debited to G/Ls to complete a financial transaction. You will see the postings that include CO will require one more step. This additional step is entering a cost object as part of the journal entry to an expense account G/L. This additional step uses a “primary cost element.” Consider the graphic below. The link between FI and CO is represented by the double red arrow between Expense Accounts in FI and Primary Cost Elements in CO. We will take a moment to define this graphic as it represents a key insight into how this relationship works.

We know from the previous chapter that FI contains different kinds of general ledger accounts; Balance Sheet and Income Statement accounts. CO does not care about assets, liabilities or equity, so linkage to balance sheet accounts are not required (note there are no arrows out of the balance sheet box in the graphic). This leaves only income statement accounts – the income statement is a financial statement that shows revenues and expenses. The accounting for revenues and expenses are why we have CO. It shows where we spend money and generate revenue. The graphic shows the arrow between expense accounts in FI and primary cost elements in CO. Primary cost elements are the “vehicle” that links postings in FI G/L expense accounts to Cost elements. This linking results in postings to cost objects on the CO side. We will discuss Primary Revenue Elements in a later Chapter, but they essentially work the same way for revenue postings. The key understanding is that, from a corporate expense standpoint, CO is used to track who (which cost object) is responsible for that expense. To assign responsibility or ownership of an expense or revenue, financial postings created in FI must be passed to the proper area in CO. So how do we pass this value from FI to CO? The mechanism that supports the integration between FI and CO are called Primary Cost Elements. A primary cost element is used in controlling to identify the type of cost that was incurred in financial accounting and how it will be assigned, or received, by a cost object in controlling. The receiving cost object keeps the name of the sending G/L as the label of the posting. To put it simply, the identity of the cost in CO is the same as it was in FI. Once a general ledger expense or revenue accounts is assigned a Primary Cost Element, you can no longer create a FI posting without creating a CO posting to the cost object where the cost was incurred. In HCM, you attached a cost center to the position. The primary cost element ties the G/L for things like payroll and benefits to the cost center assigned to the individual employee for their amount of payroll and benefits. In this manner, when the general ledger account is used, the correct cost center will be charged and people assigned in HCM to that cost center will be held responsible for its proper management.

Secondary Cost Elements

In addition to primary cost elements which originate in FI, there are also secondary cost elements that exist exclusively in CO. These secondary cost elements are used to move costs between different cost objects (internally to CO only). Secondary cost elements allow us to change the identity of a cost as we move it between different cost objects. The purpose of renaming costs may not be readily apparent. Consider this - a company pays utilities (water, electricity, gas, trash pick-up, etc.). The company pays these bills from FI. These expenses are

shared across the organization so that each cost center is responsible for paying a portion of the expense. The expenses are moved from the various expense G/Ls in FI into CO using primary cost elements. These postings are made to a single cost center such as an administration cost center. From there the expenses are allocated to all the other cost centers for the portion for which they are responsible. Rather than tracking each line separately as water, electric, gas, etc. we can bundle these together into the generic name of utilities. This concept will be further defined below when discussing allocations and distributions and reinforced in the hands-on exercises.

Primary Revenue Elements Primary revenue elements are a one-to-one linkage (mapping) between general ledger revenue accounts and CO revenue elements. These primary revenue elements are established to permit the transfer of FI revenue information to CO. The establishment of the primary revenue element enables a posting in FI that impacts a revenue account that leads to an automatic posting in CO to a primary revenue element. The primary revenue elements can post to cost centers.

Activity Types

Activity Types are the productive output of a cost center. More specifically, it is how we measure or monetize activities (output). Activity types are used to internally move the productive output from one cost object to another cost object. Once we have created an activity type, a relationship between an activity type and a cost center is created, and that relationship is given a monetary value. For example, the Information Systems department provides three hours of work to assist the Maintenance Department. The output (3 hours of IT work) is considered by the company to be a direct activity allocation (internal billing), so the value (expense) of that effort is moved from the IS department cost center to the maintenance department cost center. This allocation moves the expense out of IS and into maintenance as an expense against their budget. Examples of activity types can include things such as labor time, machine time, and setup time. This breakout of cost helps the company make strategic decisions about the cost of various internal activities. You will create activity types and assign them to cost centers in the hands-on assignments for this chapter. In the exercises, you will work with the activity type of labor. Pen Inc. made a decision they wanted to break down the cost of labor. By identifying an activity type, the productive output labor (the person working in that work center) will be allocated to a cost center. You will also use activity types later in the text when discussing planning and manufacturing execution.

Statistical Key Figures

Statistical key figures are used to support those internal allocations associated with settlement, assessment, and distribution. Statistical key figures provide the foundation for accurate and effective

cost allocations between various cost objects. Statistical key figures are essentially mathematic formulas based on different ways an expense can be allocated. Examples of statistical key figures include the number of employees, the square footage used, or minutes of computer usage. The example below uses the number of purchase orders as the statistical key figure. To allocate the costs

associated with purchasing activities, the number of purchase orders was used as the statistical key figure to allocated the costs to various departments. This statistical key figure was chosen as the most equitable way to share the cost of the purchasing department.

The number of total purchase orders by each department is used to divide the cost of purchasing between the different departments that used purchasing. In this case, the executive offices would bear 30%, the maintenance department 50%, and the information services department 20% of the costs associated with purchasing activities. Using statistical key figures allows each department to be charged for their portion of their individual usage of a resource.

Profit Center

The profit center is a CO Master Data element responsible for capturing the revenue generation and associated costs incurred in the generation of the revenue and cost containment. You can also examine a profit center by asking how much revenue has been created for the objects included in the profit center. You can also determine what costs are associated with the work done in the profit center. Generally, profit centers are used for the evaluation of profit or return on investment (ROI) for internally defined organizations. These internal organizations (or companies within our company) can be defined based on an area of responsibility such as a:

• Geographic Location (Region)

• Organizational Unit (Plant)

• Line of Business (Division)

So – How does CO Work? What does it REALLY mean?

Think of it this way, each manager has a budget. The manager is responsible to the company to efficiently and effectively manage the resources (budget) assigned to them. A budget has line items, which typically contain the following lines:

• Employee Salaries

• Employee Benefits

• Training

• Travel

• Memberships

• subscriptions

• Rent

• Utilities

• Office supplies expenses

• Printing expenses

• Maintenance expenses

• Information Systems expenses

• Administrative Support overhead

Here is the secret, each of these budget line items is nothing more than a derivation of the G/Ls on the FI side…primary cost elements or bundled responsibilities accepted from other CO objects in the form of secondary cost elements. This is the key to understanding CO. Consider the graphic below:

Yes, the graphic is very small, so we will break this into two pieces, first will be the FI side, which is a review of the last chapter but defines in more detail what is needed to pass expenses from FI to CO.

The graphic shows the FI side without the sub-ledgers. Sub-ledgers do not interact with CO directly, so they are removed from this picture. The Chart of Accounts is in the foreground to illustrate that the CoA is the source of the G/Ls that will be used in FI. The G/L expense accounts that are determined to be relevant for CO must be further allocated to a specific area of responsibility.

A posting to a G/L account requiring the entry of a cost object behaves the same way as “normal” FI postings except the addition of one more required field, the cost object. These postings create a financial document with a unique document number with a header and line items containing the credit and debit postings and other detail on the FI side. The creation of this document is as you would expect. Additionally, the system creates a CO document that is based on the FI posting and supports the SAP document principle. This CO document is created automatically in conjunction with the FI document. The CO document also has a header and line item detail. These postings update the cost object that was entered in the FI posting using the cost element (G/L name) line of the cost element. Review the second portion of the graphic below for how this works.

Looking at the cost object (in this example, a cost center) you will see the listing of the cost elements (categories of expenses) that the cost object is defined to receive. Each cost element defines the responsibility, or obligation to manage, defined by the scope given by the organization to the cost center manager.

Each cost element line item is then used to track postings for that specific expense. A cost object is debited when the expense is “inbound” or assigned to the cost element. The cost object is credited when an expense is allocated, or “outbound” to another cost object.

The cost elements listed in a cost object are assigned during the budget process. These cost elements are not arbitrary. They are assigned based on areas of management or responsibility. Since not all cost objects have the same responsibilities, it should make sense that each cost object may have different types of expenses to manage.

Once the responsibility has been defined, which means adding the cost elements to the cost object, the budget is applied. When the budget is applied, it gives the cost object manager a specific amount of funds to spend on each cost element. It is the manager’s responsibility to operate within the budget constraints.

The budgeted amount for a cost object represents the “planned” expense. The individual postings throughout the budget cycle (fiscal year) represents the “actual” expenses. The planned vs. actual comparison is the basis for cost center management. The manager must understand how much of their funding remains and define priorities and activities based on the remaining amount.

In this course, we have simplified the CO postings, and you will find that many CO postings are completed automatically as part of integration with the make, buy, and sell processes. The configuration of SAP drives this automation and master data settings “wire” together through relationships to ensure the postings are correct for the business.

Posting – FI and CO

Posting a Journal Entry Using a Primary Cost Element Posting a journal entry using a G/L account that has been identified as having been assigned a primary cost element requires assignment to a cost object. In the example using the general ledger account, Supplies Expense, requires assignment to a cost object. In this case, the cost object is Cost Center A. A journal entry is created debiting the supplies expense account for $1,500 and crediting the bank account or cash for $1,500. Since the supplies expense account

has a corresponding primary cost element, a cost object must be referenced on the line item of the journal entry for supplies expense. By referencing a cost object on the line item of a journal entry, a separate CO document will be created.

As stated earlier, all postings in FI require dual entry, for every transaction, there are at least one debit and one credit entry. Controlling does not always require a double-sided entry as FI does. When moving values into CO from FI, only a single-sided entry is created. This single-sided entry is due to managerial accounting rules require only expenses and revenues balance with FI. This one-sided entry is how expenses and revenues are moved from FI into CO. When we move costs between cost objects, then debits must equal credits. We use a credit entry to move cost out of a cost object and a debit entry to move cost into an object. The total debits must equal total credits. In the example below, the integration between Financial Accounting (FI) and Controlling (CO) results in a financial accounting document (posting a; debit – supplies expense, credit – bank of $500 in each following the offset rules in FI) and a one-sided entry in controlling (posting a; debit – Sales (S005). Once costs or revenues have been posted to controlling, a movement (re-posting) to another cost object (posting b; credit – S005, debit – S010) requires a balanced transaction (debits = credits).

Posting Using a Secondary Cost Element Secondary cost elements are used only in controlling. These secondary cost elements allow us to distinguish direct expenses (expenses posted directly from FI G/L accounts using primary cost elements) from expenses that have been charged to the cost element through periodic allocations from other cost elements within CO. Secondary cost elements allow for the bundling and aggregation of expenses. It further provides the ability to assign a new name to the bundle of expenses. The new name is a descriptive identity of those costs that have been bundled together. These bundled costs are then moved, or allocated to other cost elements where the responsibility for the expenses ultimately resides. The example we will discuss is the corporate copy center at Pen Inc. Large printing and copy requests are sent from departments all over Pen Inc. to the Copy Center for printing. In turn, the Copy Center charges the requesting departments for these services. The “recharge” is based on all the various expenses that it takes to provide the printing service. We take all the costs associated with the corporate Copy Center Department, including labor, supplies, and rent (for example) and bundle them together. Look at the graphic below. The Copy Center cost center (the circle in the middle) is allocated expenses from the G/Ls on the left through primary cost elements as they spend money. At the end of the month, the Copy Center recharges for its services by bundling the expenses it incurred together and then transfers those expenses as a charge for services to the other departments (costs centers in this example) that used its services. These bundled costs are added up and renamed with a single identity. We do this so that rather than having three postings of rent, supplies, and labor, we have one called “copy center services” (the name is an example, it can be whatever we want). The name “copy center services” is the secondary cost element. These bundled costs or secondary costs elements are credited (taken out) to the Copy Center and debited (put into) to the cost centers that used the copy service.

You can see this in the t-chart below. The simplified cost elements below show how they are seen by the cost center manager. The portion that each cost center receives is determined ahead of time by management. The portions are called statistical key figures and will be covered later in the chapter.

To better understand this, consider that the Maintenance Department in the enlarged graphic below. The Maintenance Department incurs its own rent expense, supplies expense and labor expense just like the Copy Center does.

The manager of the Maintenance Department wants to track the amount of their rent they are responsible for, and only that amount of rent. Without secondary cost elements, the resulting postings in rent expense in the Maintenance Department would just show up as rent, even though it was the rent

that was incurred by the copy center that was passed along as part of the charge for copy center services. Bundling the Copy Center charges into a secondary cost element and posting to the Maintenance Department using a name other than rent (in this case copy center services) allows the manager to distinguish the source of their expenses rather than having to sort through multiple rent postings to figure out from where it came.

Periodic Allocations

The two periodic allocation techniques to be discussed in this unit are distributions and assessments. Periodic allocations allow the company to allocate or share costs collected for a cost center or group of cost centers, called senders. The allocations are then allocated to responsible parties, called receivers, according to business specifications. The type of periodic allocation determines whether 1) the identity of the cost remains the same in the receiver as it was in the sender or 2) whether the identity of the cost is different in the receiver as it was in the sender. To carry out a periodic allocation, you need to identify the sender(s), the cost element(s), the receiver(s), the receiving cost element(s), and the statistical key figure. A primary cost element or secondary cost element is used to facilitate the move.

Distributions

Distributions provide a method for periodically allocating primary cost elements. This credits the sender for the entire amount that is being distributed (taken out of the sender) and debits the receiver (put into the receiver) the amount of money that is the receiver’s share of the cost. Using a distribution allocation methodology means that the identity of cost element in the sending and receiving cost centers are the same. The business determines when the period-end distributions are made. Distributions are generally done at least at the end of the month in the period closing cycle. The SAP document principle is enforced in that both the sending and receiving cost centers are fully documented with a unique CO document capturing the record of the transaction. This means that periodically distributions use the mapping of the Primary Cost Element and do the work of moving the costs. Consider the graphic below. The sending cost center is the Administration Cost Center (A010), and it is sending rent expense in the amount of $1,500. The receiving cost centers are all the cost centers in the PEN Inc. cost center group. The receiving cost centers will receive rent during the distribution cycle.

The primary cost element maintains its identity throughout the allocation process. The statistical key figure in this example is square footage. It was set up to identify the number of square feet that each cost center occupies in controlling. When the distribution cycle is executed, rent will be allocated from the administration cost center to all receiving cost centers as entered in the statistical key figure. Note that the sending cost center may keep a portion of the expense its self. This means that the full amount in a cost center is not just automatically all distributed to senders, only the amount that others have the responsibility to carry.

Assessments

Assessments provide a method for periodically allocating both primary and secondary cost elements. In periodic assessments, costs are removed from one cost center and placed (charged) to another cost center. They do not retain their original cost element definition since the detailed composition of the costs is not important to the receiver, it is just bundled with other costs. How this works is each segment of an assessment is assigned to a secondary cost element allowing costs to be grouped together and transferred to receiving cost centers through the use of that secondary cost element. As with the distribution, the assessment must be fully documented with a unique CO document to adhere to the document principle. Assessments can allocate primary or secondary cost elements that the sender contains but the output that is allocated to the receiver is always a secondary cost element.

In the graphic above, the sending cost center is the Information Services Department, and it is sending all costs (both primary and secondary) to the receivers. The receiving cost centers are all cost centers in the Pen Inc. cost center group. The receiving cost centers will receive the costs as an assessment using a secondary IT assessment cost element (the “bundled name”). In this manner, the costs in the sending cost center do not have the same identity in the receiving cost center. The statistical key figure for this assessment is a fixed percentage identified and documented when creating the periodic assessments.

Budgeting in a Business

Budgeting is the determination and allocation of funds to meet the future planning requirement. In earlier chapters, we discussed the importance of aligning activities to strategy. The strategy is the overall vision for the future. Strategy drives planning and planning provide action plans. A part of the action plan is to allocate resources where they best add value and drive strategy. This process is called budgeting.

The budget dictates how much is spent toward payroll, supplies and advertising expenses (for example). Budgets are usually based on prior years. Once allocated budgets are controlled and managed as actual costs and compared to the planned (budgeted) value to track expenses and managing the remaining available resources. How the budget is utilized will be described in greater depth in the following section.

Introduction to how companies use CO

We will reach into future chapters and pull back an example that will illustrate the power of CO and its integration with the process. The example will explain portions of the manufacturing process. The previous section mentioned the production order as a type of temporary cost object. The production order cost object is automatically created as part of the production planning process. This temporary object has an “understanding” of what the materials and labor expenses to manufacture the material are through the use of the BOM and routing based on the proposed lot size. These are the planned or budgeted amounts, for that production order. When the production order is released, the raw material value is moved (credit) from the raw material inventory G/L into the raw materials consumption G/L (debit) and then passed to the production order cost object through the primary cost element of raw materials consumption (debit). During the manufacturing process, the assembly line workers enter time in the work center which is captured in their assigned cost center. The value of the labor is moved from the cost center linked to the work center in the form of a credit and debits (moves in) the labor expense to the production order.

Upon completion of the manufacturing run, all materials have been manufactured; the output is calculated based on the quantity of material manufactured multiplied by the “standard price” which is how the company sets the value of the material they manufactured. This value is credited to the production order, and the value is transferred (Credit) to the FI G/L of factory output. Any differences between the debit (incoming) side and the credit (outbound) side of the production order cost object are captured as the “variance.” We will ignore the posting for the variance for now except to say that after the variance is applied the debit and credit sides of the production order are equal, it has a zero balance. The production order can now be closed. Temporary cost elements must always have a zero balance before they can be closed. This process of zeroing the cost element and closing it is called “settlement.” All of these steps and concepts will be reinforced in future chapters, but this example should help you understand how CO is used to manage expenses.

SAP CO Module Integration

Controlling is fully integrated with other SAP modules including, but not limited to:

• Financial Accounting (FI) - in this unit, we have seen the integration between financial accounting and controlling. The primary way in which controlling receives its data is from financial accounting.

• Materials Management (MM) - when goods are issued for consumption in material management, a controlling document will be created indicating what object consumed the value of those materials.

• Sales and Distribution (SD) - when goods are issued for a sales order and revenue results from invoicing the sales order, controlling documents will be created indicating what object receives both the revenue and costs associated with that order.

• Production Planning (PP) and Manufacturing Execution (ME) - we will see in production planning and manufacturing execution that a production order is a temporary cost object, a type of internal order, which allows us to capture costs associated with the production of a finished good.

SAP @ Pen Inc.

At Pen Inc., Controlling (CO) is used to assign costs to appropriate cost centers. Prior to implementing Controlling, Pen Inc. had no ability to evaluate costs by department or assign responsibility. Following the implementation, individual managers are held responsible for the costs they have incurred and are evaluated on how well they control their costs. Each department has a budget and must stay within those limits. Operational processes are also tracked in a better manner such as the management of production orders. Production orders are tracked in CO to help determine the profitability. CO is used to track all activities that have any costs associated with them, which is everything. CO is the primary financial management tool used by all managers and helps the company invest in the resources that most directly add value and drive the strategy.

View from the Top

by Art Worster, President, Worster Associates, LLC Author: "Maximizing Return on Investment Using ERP Applications," John Wiley & Sons

In this chapter, we move on from talking about managerial accounting purely in relationship to financial accounting. In the last chapter, we discussed the importance of accounting in general as the foundation for all economic activity across the enterprise, and the structures created were somewhat limited in scope by the legal reporting needs of the business, as well as, the logical relationship that comes from recording and using numbers.

Now, we are going to design a system to use the numbers we have collected which represent the financial impact of everything that we do and to report on the business internally. In doing this, we will expand the flexibility of how we use these numbers, but at the same time, we will require the way we use these to conform to general standards. For example, if your business reports to the SEC based upon several product lines and how these lines are both performing and expected to perform into the future, it is important that the analyses developed to manage internally provide accurate numbers reflecting how those elements are performing. When internal controls are not properly designed and implemented, it may become possible to create inaccurate results which may reflect on basic performance numbers, and the inaccurate results may create incorrect analyses of the financial impact of future actions. For example, if you develop Cost Accounting for products you produce (one of the CO sub-modules) and in creating the cost objects, you incorrectly report the consumption of other costs such as materials, labor, or capital assets (machinery), you may very well make unwise pricing and other market decisions that will have a negative (or possibly disastrous) effect on future profitability. This is not a result that comes from FI but is purely determined by how the managerial accounting tools are defined, implemented, and used. While this may seem, particularly to non-accounting majors or minors, to be of less interest than basic financial accounting, I have found that it is far from that. In one instance, the managerial accounting rules for how costs incurred from various departments managing resources were assigned as part of

final product costing, the arbitrary assignment of these to other product lines created what could have resulted in a case of fraud with the SEC. In another, the incorrect assignment of certain products to one business area, as opposed to another, resulted in pricing and ultimately investment decisions which had negative impacts on the larger business. This included some of the business areas that were performing considerably better than reported and others that appeared to be worse than actual. In the

latter case, it resulted in a business decision to divest that business to another company. However, once the divested company was gone, results from the business areas that had shown false results suddenly became weaker and caused some serious discussions about the viability of both businesses. It could have resulted in a decision to divest the other business and retain the one they thought was performing poorly if the management accounting designs had been better designed. There are many more examples of disasters that have been caused by poorly designed and implemented CO elements including not only cost accounting, but cost center or profit center accounting and other CO elements. It is key that anyone who will be working in a business of any size understands the importance of these accounting structures and reporting. While it is ultimately the management accountants who will work with the results and produce the analyses, it can only be accurate if the integrated business process produces accurate results.

Key Terms Activity types Operating concern Allocation Primary cost elements CO Primary revenue elements Controlling area Profit center Cost center Secondary cost elements Distributions Statistical key figures Internal order

Self-Assessment Can you answer the following? Review the following questions. If you can’t answer them, go back to that section and re-read to make sure you understand the topic.

• CO is arranged by internal areas of responsibility. Who makes this decision?

• Why do you need FI if you want to use CO?

• The organizational structure seems to vary between modules. Why?

• Should companies limit how many cost centers they create?

• How does a cost center differ from a cost element?

• Profit centers provide information. What is that information?

• Why would distribution and assessment make some department state that it is not fair to split up cost?

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