Cost Management in Indonesia

Mass production factories, such as two- and four-wheeler parts manufacturers common in Indonesia, have multiple manufacturing processes. In such cases, processing costs are calculated for each process, and the method of aggregating these costs into the product is called process costing. In this approach, labor costs and manufacturing overheads are recorded at the end of the month by the accounting department, transferred to inventory assets, and then allocated accordingly.
On the other hand, in factories producing custom-made items under individual order production, job order costing is used, where costs are aggregated by order number or project number. In this case, labor costs and manufacturing overheads are calculated by multiplying pre-determined wage rates or allocation rates by the hours worked.
The operating rate of production facilities in Indonesia’s manufacturing industry fluctuates. When the operating rate decreases, fixed costs such as labor and equipment expenses are heavily allocated to the lower production output, causing product costs to rise. Therefore, a cost calculation system that reflects fluctuations in production plans and actual results, along with a mechanism to calculate profits, becomes necessary. This requires accurate real-time data collection using IoT and a system capable of setting allocation rules that align with reality.
However, the fundamental issue is that no matter how precisely costs are tracked, profits won’t increase. To concretely improve profitability, variance analysis of costs and budget-versus-actual analysis for management decisions are essential. This necessitates setting departmental targets, monthly monitoring, and creating a system that highlights the most effective targets for profit improvement.
This blog features articles on cost management systems aimed at helping those in Indonesia’s manufacturing industry who feel the need to systematize cost management operations but are unsure where to start, offering insights into what a manufacturing system suited to Indonesia might look like.

Differences in Cost Calculation Methods Adopted by Production Management Systems

Production management packages commonly implemented in Indonesia, such as Microsoft Dynamics or Sage Accpac, adopt actual cost calculation based on the perpetual inventory method. This method performs real-time cost calculation and generates accounting entries with every inventory receipt or issuance, covering the sequence of material procurement, material input (material cost incurrence), manufacturing (transfer of material costs to products), shipping (revenue recognition), and cost of goods sold (transfer of product costs to cost of sales). As a result, no transfer entries from beginning inventory balances to ending inventory balances for cost of sales are generated.
Systems using the three-way method adopt actual cost calculation executed in batches after the accounting month-end closing, as well as standard cost calculation performed as part of managerial accounting based on next period’s production plans and fixed cost budgets.

Rolling Costing: Adding Process Costs to Preceding Process Costs to Determine Manufacturing Costs

In cases with multiple manufacturing processes, process costs are calculated for each process. There are two methods to aggregate these costs into product costs: rolling costing and non-rolling costing.

Since monthly fixed costs remain constant while production volumes adjust to market changes, calculating manufacturing costs based solely on actual production volumes leads to short-sighted cost management. Therefore, a standardized cost leveled across the year is determined before preparing the next period’s budget, forming the basis for sales and procurement plans.
Cost variance represents how much the monthly manufacturing cost deviates from this unchanging annual standard cost. Cost variance analysis breaks this down into factors such as material purchase prices, purchase quantities, and operating hours.
Cost variance indicates the degree to which the current month’s manufacturing cost deviates from the standard cost (the baseline). Naturally, inventory accumulated at the beginning of the month bears no responsibility for this cost variance. However, when shipped, both the beginning inventory and the current month’s production are lumped together and evaluated at a total average, ultimately bearing joint responsibility as the unit cost of goods sold.
The total average unit cost existing during manufacturing cost calculation is the total average unit cost of work-in-progress, while the total average unit cost of finished goods is calculated based on “beginning product inventory + current month’s product manufacturing cost,” corresponding to the unit cost of goods sold calculated after manufacturing costs.

Variance Analysis Between Actual Cost Calculation and Standard Cost Calculation

Both actual and standard costs can be analyzed for variances by treating fixed costs like variable costs using the concepts of wage rates (allocation rates) and hours worked (efficiency).

Variance Analysis Between Actual and Standard Costs of Products
■ Direct Material Cost Price Variance = (Actual Material Unit Price – Standard Material Unit Price) x Actual Usage
■ Direct Material Cost Quantity Variance = (Actual Usage – Standard Usage) x Standard Material Unit Price

■ Direct Labor Cost Wage Rate Variance = (Actual Wage Rate – Standard Wage Rate) x Actual Hours
Actual Wage Rate = Actual Direct Labor Cost ÷ Actual Working Hours
■ Direct Labor Cost Working Hours Variance = (Actual Hours – Standard Hours) x Standard Wage Rate

■ Manufacturing Overhead Variance
Using a Schlatter diagram, fixed costs are treated similarly to variable costs (allocation rate x operating hours) based on standard operating hours (target), actual operating hours, and baseline operating hours (plan), within which actual manufacturing overheads are incurred.

1. Efficiency Variance (Difference on XY Graph)
   Efficiency Variance (Variable Cost Portion) = Actual Variable Costs – Standard Variable Costs
   Efficiency Variance (Fixed Cost Portion) = Actual Fixed Costs – Standard Fixed Costs
2. Budget Variance
   Actual Variable Costs – Theoretical Actual Variable Costs (based on actual operating hours), representing the excess of actual manufacturing overheads over theoretical manufacturing overheads (allocation rate x actual operating hours) due to rising material costs or wage rates (variable cost allocation rates).
3. Capacity Variance (Difference on XY Graph)
   Baseline Fixed Costs – Actual Fixed Costs, representing the loss due to the difference between baseline operating hours (full capacity) and actual operating hours

Costs Incurred Based on Production Results vs. Input Results in Cost Management Systems

Non-rolling costing can be considered as costs incurred in the current month based on production volume, while rolling costing is based on input volume. Costs incurred based on the preceding process’s production results become the input volume-based costs for the current process. Thus, material costs incurred become input volume-based costs for work-in-progress, and production volume-based costs for work-in-progress become input volume-based costs for finished goods.
The total material costs incurred for shared materials can be calculated using the three-way method by subtracting ending material inventory from the sum of beginning material inventory and current month’s material purchases. However, item-specific material costs cannot be calculated using the three-way method unless the usage (e.g., kilograms per product) is tracked, so they are calculated based on the parent-child relationship of input results.

Handling Fixed Costs in Indonesia When Production Results Span Months or When There’s No Production

Materials are not recognized as costs at the time of purchase but at the time of input, remaining as work-in-progress inventory until production results are recorded. They become manufacturing costs when production results are recorded and cost of goods sold when shipped.
When input results and production results span across months, costs incurred inevitably remain in the current month’s ending work-in-progress. If production results are still not recorded by the next month’s end, work-in-progress remains without incurred costs.
Manufacturing costs represent the costs of items manufactured in the current month (based on production results), so if production is zero, manufacturing costs are also zero. Similarly, cost of goods sold represents the costs of items sold in the current month (based on shipping results), so if sales are zero, cost of goods sold is also zero.
Regardless of production, depreciation expenses for machinery are incurred. Ideally, the portion attributable to the current month’s products should become part of manufacturing costs, but this creates a contradiction when there’s no production yet manufacturing costs exist. For tax purposes, since depreciation must be recorded monthly, it is transferred to selling, general, and administrative expenses or work-in-progress.

Understanding Standard Cost Calculation and Actual Cost Calculation Within the Same Framework

Allocation rate refers to aggregating costs to a unit (process, line, or product group) that sums items without bias toward “the value of working hours or production volume,” then dividing by total working hours to calculate a wage rate (amount per minute) or by total production volume to calculate an allocation rate (amount per unit).
In standard cost calculation, the planned production volume (sales volume) of products is used in a quantity breakdown calculation (required quantity) to determine the planned production volume of work-in-progress and planned purchase volume of materials, calculating direct material costs per product.
Additionally, a time breakdown calculation (required quantity x efficiency) determines planned direct working hours, calculating the primary allocation ratio for apportioning shared equipment depreciation to cost centers.
Budgets for direct labor costs and manufacturing overheads aggregated to cost centers are apportioned based on production volume ratios or direct working hour ratios to calculate wage rates (allocation rates), determining direct labor costs and manufacturing overheads per product.
In actual cost calculation, actual allocation rates are calculated using total average unit costs and allocation calculations.

The allocation ratio for apportioning total average unit costs (for calculating variable costs in actual cost calculation) or actual incurred amounts (for calculating fixed costs) to cost centers and then by item is the actual allocation rate. In standard cost calculation, the allocation ratio for apportioning standard unit prices (variable costs from a unit price master) or budgets (for calculating fixed costs) to cost centers and then by item is the standard allocation rate.

The Concept of Cost Management Through Wage Rates (Allocation Rates) and Hours Worked

The concept of cost management involves calculating fixed costs like labor costs using wage rate x efficiency (hours worked), similar to material costs (unit price x quantity). Originally, this was used to estimate processing fees based on hours worked (unit price x man-days).
■ Wage Rate Calculation for Cost Centers (Direct Departments)