Overhead calculation

This topic describes the typical processes for calculating and allocating overhead costs.

Term definition

Overhead costs are the costs that are incurred in order to run a business, but that can't be directly attributed to any specific business activity, product, or service. Overhead costs provide critical support for the generation of profit-making activities. Here are some examples of overhead costs:

  • Rent
  • Electricity
  • Administrative salaries

Overhead calculation overview

Overhead calculation runs the cost accounting policies in the correct order. You can run overhead calculation multiple times for the same fiscal period if cost accounting policies have been changed or specific errors have been detected. Each run of the overhead calculation is stored and receives a unique version ID that lets you compare the calculations in various versions. The cost entries that the overhead calculation generates receive an accounting date. This accounting date matches the end date of the fiscal period that is used in the calculation. The unique version ID consists of the following elements:

  • Version type
  • Date and time
  • Cost accounting ledger
  • Fiscal year
  • Fiscal period

Overhead calculation is run independently of the version. Therefore, you can calculate the Budget version before the Actual version. Overhead calculation consists of four steps, as shown in the following illustration. In each step, a journal header is created that has journal entries. This journal header keeps the input data for each calculation step. Policies and rules are applied to each journal line, and cost entries are generated as output. Therefore, you always have full traceability.

Overhead calculation

Calculate and allocate the Electricity overhead cost

In Financial accounting, some costs, such as electricity, are registered as a lump sum. Therefore, detailed managerial insight isn't provided for Cost accounting. In Cost accounting, to provide correct managerial insight across all organizational units and levels, costs must flow through the organizational units. This flow must be based on either an accurate record of the consumption or a fair assessment. In the general ledger, an electricity cost can be posted as shown in the following table.

Accounting date Cost center Main account Amount in the accounting currency
January 3, 2017 CC099 Default cost center 10001 Electricity 10,000.00

Step 1: Process the cost behavior calculation

By default, when cost entries are imported from the source data, they receive the Unclassified cost behavior classification in Cost accounting. By applying cost behavior policy rules, you can reclassify cost entries as either Fixed cost or Variable cost.

Define the cost behavior rule

In some cases, part of the cost is a fixed fee, and the remaining cost is based on consumption. Electricity bills often match this definition. After you pay a specific fixed fee, you pay for consumption per kilowatt hour (Kwh). For example, if the fixed cost fee is 1,000.00, here is how the cost behavior rule is defined:

  • Fixed amount 1,000.00
    • 0 <= 1,000.00 = Fixed
    • 1000,01 < N = Variable
Journal
Journal Journal type Fiscal calendar period Version
00001 Cost behavior calculation journal Fiscal 2017 Period 1 Overhead calculation / 01-02-2017 11:51:00 PM / Ledger /2017 / Period 1
Journal entries (Cost object balance journal entries)
Accounting date Cost object Cost element Cost behavior Amount
January 3, 2017 CC099 Default cost center 10001 Electricity Unclassified 10,000.00
Cost entries
Cost object Cost element Cost behavior Amount Accounting date
CC099 Default cost center 10001 Electricity Unclassified 10,000.00 January 3, 2017
CC099 Default cost center 10001 Electricity Unclassified -10,000.00 January 31, 2017
CC099 Default cost center 10001 Electricity Fixed cost 1,000.00 January 31, 2017
CC099 Default cost center 10001 Electricity Variable cost 9,000.00 January 31, 2017

For detailed information about cost behavior, see Cost behavior policy. (Note that this topic isn't competed yet but is coming soon.)

Step 2: Process the cost distribution calculation

Cost distribution is used to redistribute cost from one cost object to one or more other cost objects by applying a relevant allocation base. Cost distribution and cost allocation differ in that cost distribution always occurs at the level of the primary cost element of the original cost.

Define the cost distribution rule

In Financial accounting, electricity costs are often registered as a lump sum. In Cost accounting, this approach isn't detailed enough. The variable cost should be distributed to the individual cost objects on a fair basis. The most logical allocation basis is the consumption of electricity (Kwh). A statistical dimension member that is named Electricity is created, and electricity consumption is recorded. By default, all statistical dimension members become available as allocation bases.

Cost object Kwh
CC001 HR 1,000
CC002 Finance 6,000
CC003 Assembly 0

The following table shows the result when electricity consumption is applied as an allocation base for variable costs.

Cost object Magnitude Allocation factor Amount
CC001 HR 1,000 (1,000 ÷ 7,000) × 9,000.00 1,285.71
CC002 Finance 6,000 (6,000 ÷ 7,000) × 9,000.00 7,714.29
CC003 Assembly 0 (0 ÷ 7,000) × 9,000.00 0.00

The fixed cost should be distributed evenly to the individual cost objects that have consumed electricity. You can achieve this result by using the Electricity statistical dimension member in a formula allocation base: (Electricity > 0.00) The following table shows the result when electricity consumption is applied as an allocation base for variable costs.

Cost object Formula Magnitude Allocation factor Amount
CC001 HR (1,000 > 0.00) 1 (1 ÷ 2) × 1,000.00 500.00
CC002 Finance (6,000 > 0.00) 1 (1 ÷ 2) × 1,000.00 500.00
CC003 Assembly (0 > 0.00) 0 (0 ÷ 2) × 1,000.00 0.00
Journal
Journal Journal type Fiscal calendar period Version
00002 Cost distribution calculation journal Fiscal 2017 Period 1 Overhead calculation / 01-02-2017 11:51:00 PM / Ledger /2017 / Period 1
Journal entries (Cost object balance journal entries)
Accounting date Cost object Cost element Cost behavior Amount
January 31, 2017 CC099 Default cost center 10001 Electricity Fixed cost 1,000.00
January 31, 2017 CC099 Default cost center 10001 Electricity Variable cost 9,000.00
Cost entries
Cost object Cost element Cost behavior Amount Accounting date
CC099 Default cost center 10001 Electricity Fixed cost -1,000.00 January 31, 2017
CC001 HR 10001 Electricity Fixed cost 500.00 January 31, 2017
CC002 Finance 10001 Electricity Fixed cost 500.00 January 31, 2017
CC099 Default cost center 10001 Electricity Variable cost -9,000.00 January 31, 2017
CC001 HR 10001 Electricity Variable cost 1,285.71 January 31, 2017
CC002 Finance 10001 Electricity Variable cost 7,714.29 January 31, 2017

For detailed information about cost distribution and allocation bases, see Cost distribution policy and Allocation bases. (Note that this topic isn't competed yet but is coming soon.)

Step 3: Process the overhead rate calculation

The overhead rate is used to charge one or more specific cost objects. The charge is based on a predetermined cost rate and the magnitude from the assigned allocation base.

Define the overhead rate

Cost object CC001 HR contributes to a set of internal projects. A statistical dimension member that is named HR projects is created to measure the consumed magnitude.

Cost object Hours
Proj 1 Project 1 3
Proj 2 Project 2 1

A predetermined cost rate for the cost projects contribution has been defined.

Cost object Cost element Cost behavior Units Rate
CC001 HR 10001 Variable cost 1 10

The following table shows the result when the HR projects are applied as an allocation base.

Cost object Magnitude Cost element Allocation factor Amount
Proj 1 Project 1 3 10001 (3 ÷ 1) × 10.00 30.00
Proj 2 Project 2 1 10001 (1 ÷ 1) × 10.00 10.00
Journal
Journal Journal type Fiscal calendar period Version
00003 Overhead rate calculation journal Fiscal 2017 Period 1 Overhead calculation / 01-02-2017 11:51:00 PM / Ledger /2017 / Period 1
Journal entries (Journal entries for overhead rate calculation)
Accounting date Cost object Magnitude
January 31, 2017 Proj 1 Internal Proj 1 3.00
January 31, 2017 Proj 2 Internal Proj 2 1.00
Cost entries
Cost object Cost element Cost behavior Amount Accounting date
CC0001 HR 10001 Electricity Variable cost -30.00 January 31, 2017
Proj 1 Internal Proj 1 10001 Electricity Variable cost 30.00 January 31, 2017
CC001 HR 10001 Electricity Variable cost -10.00 January 31, 2017
Proj 2 Internal Proj 2 10001 Electricity Variable cost 10.00 January 31, 2017

For detailed information about overhead rate policy, see Overhead rate policy and Allocation bases. (Note that this topic isn't competed yet but is coming soon.)

Step 4: Process the cost allocation calculation

Allocation is used to allocate the balance of a cost object to other cost objects by applying an allocation base. Finance and Operations supports the reciprocal allocation method. In the reciprocal allocation method, the mutual services that auxiliary cost objects exchange are fully recognized. The system automatically determines the correct order to perform the allocations in. The balance of a cost object is allocated by a single allocation base. Allocations across cost objects dimensions and their respective members are supported. The allocation order is controlled by the cost control unit.

Reciprocal method

Define the cost allocation

Here is a simple example that explains how you can trace the flow of cost. Cost object CC001 HR contributes to several cost objects. A statistical dimension member that is named HR services is created to measure the consumed magnitude.

Cost object HR services
CC002 Finance 35
CC003 Assembly 55
CC004 Packaging 10

Cost object CC002 Finance contributes to several cost objects. A statistical dimension member that is named Finance services is created to measure the consumed magnitude.

Cost object Finance services
CC003 Assembly 65
CC004 Packaging 35

Cost object CC003 Assembly contributes to several cost objects. A statistical dimension member that is named Assembly services is created to measure the consumed magnitude.

Cost object Assembly services (hours)
Prod 1 Product 1 60
Prod 2 Product 2 20

Cost object CC004 Packaging contributes to several cost objects. A statistical dimension member that is named Packaging services is created to measure the consumed magnitude.

Cost object Packaging services (hours)
Prod 1 Product 1 80
Prod 2 Product 2 15

Note: In Finance and Operations, statistical measures such as the production hours that a product consumes can be derived from source data. For more detailed information about statistical measure providers, see Statistical measure provider template. (Note that this topic isn't completed yet but is coming soon.) The following table shows the result when the HR services are applied as an allocation base for total cost (fixed cost and variable cost).

Cost object Magnitude Allocation factor Amount Cost behavior
CC002 Finance 35 (35 ÷ 100) × 500.00 175.00 Fixed cost
CC003 Assembly 55 (55 ÷ 100) × 500.00 275.00 Fixed cost
CC004 Packaging 10 (10 ÷ 100) × 500.00 50.00 Fixed cost
CC002 Finance 35 (35 ÷ 100) × 1,245.71 436.00 Variable cost
CC003 Assembly 55 (55 ÷ 100) × 1,245.71 685.14 Variable cost
CC004 Packaging 10 (10 ÷ 100) × 1,245.71 124.57 Variable cost

The following table shows the result when the Finance services are applied as an allocation base for total cost (fixed cost and variable cost).

Cost object Magnitude Allocation factor Amount Cost behavior
CC003 Assembly 65 (65 ÷ 100) × (500.00 + 175.00) 438.75 Fixed cost
CC004 Packaging 35 (35 ÷ 100) × (500.00 + 175.00) 236.25 Fixed cost
CC003 Assembly 65 (65 ÷ 100) × (7,714.29 + 436.00) 5,297.69 Variable cost
CC004 Packaging 35 (35 ÷ 100) × (7,714.29 + 436.00) 2,852.60 Variable cost

The following table shows the result when the Assembly services are applied as an allocation base for total cost (fixed cost and variable cost).

Cost object Magnitude Allocation factor Amount Cost behavior
Prod 1 Product 1 60 (60 ÷ 80) × (275.00 + 438.75) 535.31 Fixed cost
Prod 2 Product 2 20 (20 ÷ 80) × (275.00 + 438.75) 178.44 Fixed cost
Prod 1 Product 1 60 (60 ÷ 80) × (5,297.69 + 685.14) 4,487.12 Variable cost
Prod 2 Product 2 20 (20 ÷ 80) × (5,297.69 + 685.14) 1,495.71 Variable cost

The following table shows the result when the Packaging services are applied as an allocation base for total cost (fixed cost and variable cost).

Cost object Magnitude Allocation factor Amount Cost behavior
Prod 1 Product 1 80 (80 ÷ 95) × (50.00 + 236.25) 241.05 Fixed cost
Prod 2 Product 2 15 (15 ÷ 95) × (50.00 + 236.25) 45.20 Fixed cost
Prod 1 Product 1 80 (80 ÷ 95) × (2,852.60 + 124.57) 2,507.09 Variable cost
Prod 2 Product 2 15 (15 ÷ 95) × (2,852.60 + 124.57) 470.08 Variable cost
Journal entries (cost object balance journal entries)
Journal Journal type Fiscal calendar period Version
00004 Cost allocation journal Fiscal 2017 Period 1 Overhead calculation / 01-02-2017 11:51:00 PM / Ledger /2017 / Period 1
Journal lines
Accounting date Cost object Cost element Cost behavior Amount
January 31, 2017 CC001 HR 10001 Electricity Fixed cost 500.00
January 31, 2017 CC001 HR 10001 Electricity Variable cost 1,245.71
January 31, 2017 CC002 Finance 10001 Electricity Fixed cost 675.00
January 31, 2017 CC002 Finance 10001 Electricity Variable cost 8,150.29
January 31, 2017 CC003 Assembly 10001 Electricity Fixed cost 713.75
January 31, 2017 CC003 Assembly 10001 Electricity Variable cost 5,982.83
January 31, 2017 CC003 Packaging 10001 Electricity Fixed cost 286.25
January 31, 2017 CC003 Packaging 10001 Electricity Variable cost 2,977.17
January 31, 2017 Prod 1 Product 1 10001 Electricity Fixed cost 776.36
January 31, 2017 Prod 1 Product 1 10001 Electricity Variable cost 6,994.21
January 31, 2017 Prod 2 Product 1 10001 Electricity Fixed cost 223.64
January 31, 2017 Prod 2 Product 1 10001 Electricity Variable cost 1,965.79
Cost entries
Cost object Cost element Cost behavior Amount Accounting date
CC001 HR 10001 Electricity Fixed cost -500.00 January 31, 2017
CC002 Finance 10001 Electricity Fixed cost 175.00 January 31, 2017
CC003 Assembly 10001 Electricity Fixed cost 275.00 January 31, 2017
CC004 Packaging 10001 Electricity Fixed cost 50,00 January 31, 2017
CC001 HR 10001 Electricity Variable cost -1,245.71 January 31, 2017
CC002 Finance 10001 Electricity Variable cost 436.00 January 31, 2017
CC003 Assembly 10001 Electricity Variable cost 685.14 January 31, 2017
CC004 Packaging 10001 Electricity Variable cost 124.57 January 31, 2017
CC002 Finance 10001 Electricity Fixed cost -675.00 January 31, 2017
CC003 Assembly 10001 Electricity Fixed cost 438.75 January 31, 2017
CC004 Packaging 10001 Electricity Fixed cost 236.25 January 31, 2017
CC002 Finance 10001 Electricity Variable cost -8,150.29 January 31, 2017
CC003 Assembly 10001 Electricity Variable cost 5,297.69 January 31, 2017
CC004 Packaging 10001 Electricity Variable cost 2,852.60 January 31, 2017
CC003 Assembly 10001 Electricity Fixed cost -713.75 January 31, 2017
Prod 1 Product 1 10001 Electricity Fixed cost 535.31 January 31, 2017
Prod 2 Product 2 10001 Electricity Fixed cost 178.44 January 31, 2017
CC003 Assembly 10001 Electricity Variable cost -5,982.83 January 31, 2017
Prod 1 Product 1 10001 Electricity Variable cost 4,487.12 January 31, 2017
Prod 2 Product 2 10001 Electricity Variable cost 1,495.71 January 31, 2017
CC003 Assembly 10001 Electricity Fixed cost -286.25 January 31, 2017
Prod 1 Product 1 10001 Electricity Fixed cost 241.05 January 31, 2017
Prod 2 Product 2 10001 Electricity Fixed cost 45.20 January 31, 2017
CC003 Assembly 10001 Electricity Variable cost -2,977.17 January 31, 2017
Prod 1 Product 1 10001 Electricity Variable cost 2,507.09 January 31, 2017
Prod 2 Product 2 10001 Electricity Variable cost 470.08 January 31, 2017

Conclusion

In Financial accounting, a cost of 10,000.00 for Electricity is posted to a dummy cost center ID. Therefore, cost accountants will know that this cost must be allocated. In Cost accounting, the costs flow across organizational units and levels, based on the policies and rules that are applied. Each cost has been associated with an allocation base that provides the best assessment for the allocation of costs.

Cost element Cost object Total
CC099 CC001 CC002 CC003 CC004 Proj 1 Proj 2 Prod 1 Prod 2
10001 Electricity 0.00 0.00 0.00 0.00 30.00 10.00 7,770.57 2,189.43 10,000.00
Unclassified 0.00
Fixed cost 0.00 0.00 0.00 0.00 0.00 776.36 223.64 1,000.00
Variable cost 000 0.00 0.00 0.00 0.00 30.00 10.00 6,994.21 1,965.79 9,000.00
Note

This topic shows how a primary cost element, 10001 Electricity, flows through the cost objects. Therefore, this overhead cost is allocated to the lowest level in the organization. In other words, the cost objects at the lowest level bear the cost. If you require a visual flow of the cost between the cost objects, you can use the cost roll-up policy rules to visualize the flow of the cost. For more detailed information, see Cost roll-up policy. (Note that this topic isn't competed yet but is coming soon.)