Understanding Plan, Actual and Target Cost in Manufacturing Orders

[Jyotika_Bhatia]

In this blog, we are going to understand in simple terms about Plan Cost, Target Cost and Actual Cost in a manufacturing order.

Instead of going an obvious route that is starting through definitions, let’s try to understand this via an example and then we conclude by the definitions.

Let us consider there is a Finished product FG-0100 which is say a Door. To manufacture the door, we require 1 quantity of Frame (RM001), 1 quantity of Glass (RM002) and it involves 2 hours to Setup the glass in the frame, it uses 4 hours of machine time and 5 hours of labor. (The resources represent the activity types).

Say, the Standard Cost for a Frame is 50 USD, Cost for Glass is 30 USD.

The Set-up Cost is 4 USD per hour, Machine Cost is 3 USD per hour and Labor is 6 USD per hour.

Based on above information, the Standard Cost Estimate for the door would like as below:                                     

	Standard Cost       In USD	Qty for Std Costing of material/resource	Std Cost In USD
RM001	50	1	50
RM002	30	1	30
SETUP	4	2	8
MACHIN	3	4	12
LABOR	6	5	30
Total Cost (Cost of FG-0100)			130

The Standard Cost of the Door FG-0100 is 130 USD.

Plan Cost:

Now, say you have a production order created for production of 10 Doors. When the order is created, the system calculates a planned cost. As we must produce 10 Doors which are the output once the order is completed, in this case Planned Output Quantity is 10.

 Also, the planned cost is estimated cost created based on the previous actual postings. In this case, we assume it is same as standard cost estimate.

If we do a simple math, to produce 1 qty of FG-0100 if we require, 1 Qty of RM001, 1 Qty of RM002, 2 Hours of Setup time, 4 Hours of Machine time and 5 Hours of Labor time, then to calculate 10 Qty of FG-0100 we will require 10x of all above quantities. The Cost will be calculated as 10x of all quantity’s times Standard Cost.

Thus, the formula to calculate Planned Cost for input materials/resources is- Planned Input Qty * Standard Cost. 

The planned cost estimate for the order will be calculated as below:

	Standard Cost       In USD	Plan Qty	Plan/Preliminary Cost In USD
RM001	50	10	500
RM002	30	10	300
SETUP	4	20	80
MACHIN	3	40	120
LABOR	6	50	300
Total Cost (Cost of FG-0100)		-10(Plan Output Qty)	1300

Actual Cost:

Now, let us talk about the actual quantity and actual cost. When we manufactured the doors, say because of any reason, shortage of material or resources, we produced only 5 doors instead of 10.

So, the actual output quantity is 5.

During the manufacturing of 5 Quantities of door, the cost of RM001(Frame) changed from 50 USD to 45 USD and Labor rate changed from 6 USD to 8 USD. Also, the actual qty of RM001 is 5, RM002 is 5, Setup hours were 10, Labor hours were 25 and Machine hours used were 18 Hours.

The actual cost would be calculated by just multiplying the actual cost to the actual input quantity for material/resources.

Thus, the formula to calculate Actual Cost for input materials/resources is- Actual Input Qty * Actual Cost.

The Actual Cost estimate would like below:

	Standard Cost       In USD	Actual Qty	Actual Cost In USD
RM001	45	5	225
RM002	30	5	150
SETUP	4	10	40
MACHIN	3	18	54
LABOR	8	25	200
Total Cost (Cost of FG-0100)		-5 (Actual Output Qty)	669

Target Cost:

If we understand via basic English, the term target translates to what we have to achieve and this is in most cases with reference to a base, right? Example: Our current operating income is XX and our target is to increase it 1.5X by end of this fiscal year. We have a base as our current OI.

Similarly, the foremost thing to understand about the target cost is that it is calculated in reference to a standard cost estimate of the material. If the standard cost estimate is not available for the material, the target cost will be 0.

Now, let’s get back to the production of the door. We planned to produce 10 Qty (Planned Output Qty) of doors, however we produced 5 Qty (Actual Output Qty).

Now, how do we calculate the target input quantity? If we do a simple Math, if to produce 10 Qty of doors, we need 10 Qty of RM001(Planned Input Qty), then to produce 5 Qty of doors we would need- (10/10) *5= 5 Qty. Similarly for Setup time, to produce 10 Qty of doors, we need 20 Hours of Setup time, then to produce 5 Qty we will need- (20/10) *5= 10 Hours.

Thus, the formula to calculate Target Input Qty is-

(Planned Input Quantity/Planned Output Qty) * Actual Output Qty.

The Target Input cost will be calculated by multiplying Target Input Qty to Standard Cost of the material.

The Target Cost estimate would like below:

	Standard Cost       In USD	Target Qty	Target Cost In USD
RM001	50	5	250
RM002	30	5	150
SETUP	4	10	40
MACHIN	3	20	60
LABOR	6	25	150
Total Cost (Cost of FG-0100)		-5(Target Output Qty)	650

The Variance is always posted as a difference of Actual Vs Target. Will cover that in a separate blog.

Below is the Plan/Actual/Target Comparison for the order:

In a nutshell, below is the summary of what we discussed above:

1. Plan Costs are the base costs of the material. Plan Input Cost are calculated as Planned Qty * Standard Cost of the material/resources.
2.  Actual Costs are the costs resulting from an actual transaction posting on an order such as confirmation of order, goods movement posted on an order. The actual costs are calculated as Actual Qty * Actual Cost of the material/resources.
3. Target Costs are calculated based on the standard cost estimate for the actual produced quantity. The Target input Qty is calculated as Planned Input Qty/Planned Output Qty * Actual Output Qty. And Target Cost is Standard Cost* Target Qty on the order.