CONVERSION CYCLE

Generally, when we talk of the conversion cycle, we refer to manufacturing businesses where such cycle is easily
observed. However, each and every business has a conversion cycle. For merchandising businesses, when the
business transforms the goods purchased to be store ready, that in effect is conversion. They may do repacking or
relabeling of merchandise. For service businesses, the conversion can be in the preparation of materials to be
used for the service, e.g., mixing color and emulsion to create the hair dye for parlor services. For DLSUD, these
can be how professors convert information gathered from academic sources into lectures customized for classes
being handled.

 Transforms input resources, raw materials, labor, and overhead into finished products or services for sale
 Consists of two subsystems:
 Physical activities – the production system
 Information activities – the cost accounting system

Please recall in your Marketing subject the inputs used to develop a sales forecast. Historical sales data is used if
the product has been introduced in the market in previous years. To determine projected % increases, the sales
objectives as identified in the Strategic planning of the activity will be added to previous sales data. However, we
all know that company executives cannot just invent % increases without basis. They may need to do surveys,
forecast trends, consider macro and microeconomic statistics, weather patterns, psychology of the targeted buying
public and so much more. To make a sales forecast is a tough undertaking which can make or break a company.
The weight really belongs to the Marketing personnel. Accountants simply furnish data for them to analyze. There
are a lot of unknown variables that must be considered in making a sales forecast.
In this pandemic crisis, could there be a company which considered the Covid 19 in 2019 when they were
developing forecasts for 2020. If medical supplies companies could have known in 2019 that a gigantic spike in
demand for their products would happen in the 1 st half of 2020, then perhaps shortages in medical supplies would
not have happened. Only perhaps Bill Gates was able to predict what would happen. We are also having
suspicions that the Chinese government planned everything that is why their industries were ready to supply
global markets when the pandemic struck. But this is still part of a conspiracy theory which has not been proven
entirely. The results of the sales forecasts become the basis for the conversion cycle to determine how much the
company will produce and therefore determine the quantity of raw materials as well to be purchased, personnel to
be recruited and forecast other overhead expenses as well.

We have learned in Chapter 4, the Revenue Cycle, that this cycle is triggered when customer orders are received.
The Conversion cycle receives input from the Revenue cycle especially if the company does JIT processing and does
not keep huge inventories of their products.
When a customer order is received, the approved order is forwarded to production which in turn manufactures the
ordered product. Upon completion, the product is brought back to the Revenue cycle for delivery to the customer

Likewise, we have learned in the Expenditure Cycle, when inventories run low, this signals the start of the
purchasing process. Inventories are depleted because the raw materials and supplies are issued to the factory for
the Conversion Cycle.
We have also learned in the Payroll cycle, that needed manpower for production is supplied by recruiting
personnel by the HR Dept. The data for hours spent by workers are received from the Payroll cycle to be used in
Cost Accounting for the computation of manufacturing costs.

Information on Work in Process at the end of an accounting period are forwarded to the GL Accounting for setting
up the corresponding inventory account.
For Finished Goods, whenever goods are completed, GL uses the information to add to the Finished Goods
Inventory account.

Production System
 Involves the planning, scheduling, and control of the physical product through the manufacturing process
 determining raw materials requirements

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  authorizing the release of raw materials into production
 authorizing work to be conducted in the production process
 directing the movement of work through the various stages of production
Production Methods
 Continuous Processing creates a homogeneous product through a continuous series of standard
procedures.
This would be for products that do not vary or change through the years, e.g., fuel, electricity,
water, cement, raw lumber, sugar, salt. These are the basic commodities.
 Batch Processing produces discrete groups (batches) of products.
These are for products that have variants or would come in different models such as cars,
shampoos, fashion accessories, biscuits, flavored drinks, etc.
 Make-to-Order Processing involves the fabrication of discrete products in accordance with customer
specifications
These are products for which specifications are made by a customer such as wedding dresses,
cakes, streamers or tarpaulins, sculpture, painting, etc.

Information: Documents in the Batch Production System

 Sales Forecast - expected demand for the finished goods
 Production Schedule - production plan and authorization to produce
 Bill of Materials (BOM) - specifies the types and quantities of the raw materials and subassemblies used
to produce a single finished good unit. It outlines the “ingredients” like in a recipe

As discussed, Marketing establishes demand through a marketing research where they do surveys, interviews,
focus group discussions and other data gathering techniques. Results of these techniques are projected to the
intended niche market by analysts to come up with a reasonable sales forecast. This is the input for continuous
and batch processing methods. The production schedule is the formal plan and authorization to begin production.

Production schedules are not confined only to manufacturing companies. BPOs for instance have dedicated staff
to do production schedules on a daily or weekly basis. Based on the accounts handled in a BPO, the number of
calls are forecasted which in turn has to be supported by a corresponding number of call agents, equipment and
furniture. If accounts handled have seasonal products or services, number of resources will vary as to specific
times within the year. That is why there are “on call” agents or freelance agents.
For schools like DLSUD, the production schedule would be based on the projected enrollees for a semester which
has to be supported by a corresponding number of faculty, classrooms, equipment and facilities.

 Route Sheet - details the production path a particular batch will take in the manufacturing process
 sequence of operations
 time allotted at each station
 Work Order - uses the BOM and route sheet to specify the exact materials and production processes for
each batch
 Move Ticket - records work done in each work center and authorizes the movement of the batch
 Materials Requisition - authorizes the inventory warehouse to release raw materials for use in the
production process

Overview: Traditional Batch Production Model…

 consists of four basic processes:
 plan and control production
 perform production operations
 maintain inventory control
 perform cost accounting

Batch Production System

1. Production Planning and Control
 Materials and operations requirements
 Materials requirement – the difference between what is needed and what is available in
inventory. The gap is the amount of raw materials to be acquired or purchased.
Request is forwarded to the Expenditure Cycle
 Operations requirements – the assembly and/or manufacturing activities to be applied
to the product. This could include hiring of additional workers (Payroll Cycle), leasing
new floor spaces, buying new equipment (FA cycle), spending for overhead expenses,
etc.)
 Production scheduling
 Master schedule coordinates the production of multiple batches

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  Produces work orders, move tickets, and material requisitions (these are supporting
documents generated after finalizing the production schedule) for each batch with
copies of work orders sent to cost accounting.
 Influenced by constraints (could be availability of manpower, raw materials, overhead
and equipment; can even be the weather, or “acts of God”. Deadlines too), batch size,
and other specifications. (This is the reason why allowances or buffers are considered)
2. Work centers and storekeeping (2. Perform production operations):
 Production begins when workers obtain raw materials.
 When task completed move ticket authorizes batch to proceed to next work center with copy
sent to production planning.
 Finished products sent to FG warehouse and copy of work order sent to inventory control to
update FG inventory records.
 Work center supervisors send employee time cards and job tickets to payroll and cost
accounting.
3. Maintain Inventory Control
 Objective: minimize total inventory cost while ensuring that adequate inventories exist of
production demand
 Provides production planning and control with status of finished goods and raw materials
inventory
 Continually updates the raw material inventory during production process
 Upon completion of production, updates finished goods inventory

EOQ Inventory Model

 Objective of inventory control is to minimize total inventory cost while ensuring adequate
inventories to meet demand.
 When and how much inventory should be purchased?
 Economic order quantity (EOQ) model based on assumptions that may not reflect economic
reality:
 Demand is constant and known with certainty.
 Ordering lead time is known and constant.
 All inventories in the order arrive at the same time.
 Total yearly cost of placing orders decreases as order quantities increase.
 Carrying costs increase as quantity of inventory orders increases.
 No quantity discounts so purchase price is constant.
 Very simple too use, but assumptions are not always valid
 demand is known and constant
 ordering lead time is known and constant
 total cost per year of placing orders decreases as the order quantities increase
 carrying costs of inventory increases as quantity of orders increases
 no quantity discounts

This is a graphical depiction of the

relationships of documents, processes
and entities in the Conversion Cycle.
Similar to concept mapping method.

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 4. Perform Cost Accounting Activities
 Record the financial effects of the physical events occurring in the production process.
 Begins when the production planning and control department sends the work order to cost
accounting.
 Cost accounting clerk creates a new cost record for the batch and files in WIP file.
 The records are updated as materials and labor are used.
 Deviations from standards are recorded to produce variances.
 Receipt of last move ticket signals completion of production and transfer for WIP to FG inventory.
 WIP account is closed, journal vouchers are recorded and sent to the GL department for
posting to the control accounts.
Internal Controls
 Transaction authorizations
 work orders – reflect a legitimate need based on sales forecast and the finished goods on hand
 move tickets – signatures from each work station authorize the movement of the batch through
the work centers
 materials requisitions – authorize the warehouse to release materials to the work centers
 Segregation of duties
 production planning and control department is separate from the work centers
 inventory control is separate from materials storeroom and finished goods warehouse
 cost accounting function accounts for WIP and should be separate from the work centers in the
production process
 Supervision
 work center supervisors oversee the usage of raw materials to ensure that all released materials
are used in production and waste is minimized
 employee time cards and job tickets are checked for accuracy (work center supervisors have the
primary responsibility to ensure that whatever is reflected on both documents are correct to
avoid any possibility of fraud by the employees)
 Access control
 direct access to assets
 controlled access to storerooms, production work centers, and finished goods
warehouses
 quantities in excess of standard amounts require approval
 indirect access to assets
 controlled use of materials requisitions, excess materials requisitions, and employee
time cards. (unused documents must be safeguarded to prevent misuse by unauthorized
personnel)
In my experience, theft by production employees were rampant. This was however at a time that technological
controls like CCTVs were not yet adopted in factories. There are cases of:
1. Employees taping or tying products, e.g., ham slices, to their body particularly parts that will not be
frisked by security personnel at the gates. There was one time that while frisking an employee, the
products, which were scotch taped to the inner thighs, fell out of the employees pants. Employee was
immediately terminated. For female employees, they tape it under their breasts or inside their
underwear. They would usually do this for 250 gram packages and if done regularly can amount to a
substantial quantity of products stolen.
2. To avoid the frisking of guards at the gates, employees would throw products over the walls (around 15
feet high). Accomplices would be waiting at the other side of the wall.
3. Employees would eat products inside the factory. Sometimes bringing with them bread in which the
product can be placed in. Instant sandwich. No need for “baon”.

 Accounting records (proper use of the following is a good control):

 pre-numbered documents
 work orders
 cost sheets
 move tickets
 job tickets
 material requisitions
 WIP and finished goods files
 Independent verification
 cost accounting reconciles material usage (material requisitions) and labor usage (job tickets)
with standards
 variances are investigated (Mam Bel already taught you this, right?)
 GL dept. verifies movement from WIP to FG by reconciling journal vouchers from cost accounting
and inventory subsidiary ledgers from inventory control

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  internal and external auditors periodically verify the raw materials and FGs inventories through a
physical count (for BSAs, participation in physical counts would be among the first things you will
experience as new CPAs. Usually done at year end – either last week of December or the first
week of January. For BSMs, if you are in the Accounting Department of a company, even if you
are not in Cost Accounting, you are tasked to perform inventory counts as well.)

World Class Company

 Maintains strategic agility, able to turn on a dime, aware of customer needs and not resistant to paradigm
change.
 Motivates and treats employees like appreciating assets with decisions pushed to the lowest level of the
organization.
 Profitably meets customer needs and continually delights them.
 Customer satisfaction philosophy permeates all activities.
 Manufacturers follow a philosophy of lean manufacturing.

Principles of Lean Manufacturing

 Evolved from Toyota Production System (TPS) which is based on the just-in-time (JIT) production model.
 Goal is improved efficiency and effectiveness in every area.
 Pull processing involves pulling products from consumer end (demand) rather than pushing from
production end (supply). (Companies should not just produce without information as to what is the
demand from the market. There should be a correspondence between demand and production output)
 Perfect quality (zero inventory defects) is required for pull processing success.
 Waste minimization requires activities that do not add value or maximize the use of scarce resources be
eliminated.
 Involves financial, human, inventory and fixed assets.
 Inventory reduction is the hallmark of lean manufacturing.
 Inventories cost money, camouflage production problems and can precipitate overproduction.
(Inventory stored in a warehouse is “money sleeping”. It also incurs expenses like storage and
insurance. Having also large inventories may give a false sense that everything is alright since it
does not signal if there are already problems in the production process)
 Production flexibility strives to reduce setup time to a minimum, allowing for the production of a greater
diversity of products quickly, without sacrificing efficiency. (This means that should changes in customer
demand happens, a company can readily change the product by changing the related manufacturing
processes)
 Established supplier relations are mandatory as late deliveries, defective raw materials, or incorrect
orders will shut down production due to lack of inventory reserves. (There is a need for companies to do
extensive supplier accreditation and as much as possible forge partnerships with reliable suppliers for
major requirements)
 Team attitude requires each employee to be vigilant of problems that threaten the continuous flow of
production line. (Company personnel should have good personal skills to enable them to efficiently work in
teams)

Techniques and Technologies that Promote Lean Manufacturing

1. Physical reorganization of production facilities:
 Simplified facility arrangement shortens the physical distance between activities reduces setup
and processing time, handling costs and inventories.

Physical Reorganization of the Production Facilities

 Inefficiencies in traditional plant layouts increase handling costs, conversion time, and excess inventories.
 Employees tend to feel ownership over their stations, contrary to the team concept.
 Reorganization is based on flows through cells which shorten the physical distance between activities.
 This reduces setup and processing time, handling costs, and inventories.

2. Automation of the manufacturing process:

 By replacing labor with automation, firm can reduce waste, improve efficiency, increase quality
and improve flexibility.
 Traditional manufacturing consists of a range of different machines each controlled by a single
operator.
 Islands of technology is an environment where automation exists in islands of computer
numerical controlled machines that perform multiple operations with little human involvement.
Automating Manufacturing
 Traditional Approach to Automation
 Consists of many different types of machines which require a lot of setup time
 Machines and operators are organized in functional departments

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  WIP follows a circuitous route through the different operations
 Islands of Technology
 Stand alone islands which employ computer numerical controlled (CNC) machines that can
perform multiple operations with less human involvement
 Computer Numerical Controlled (CNC ) Machines
 Reduce the complexity of the physical layout
 Arranged in groups and in cells to produce an entire part from start to finish
 Need less set-up time
 Computer Integrated Manufacturing (CIM)
 A completely automated environment which employs automated storage and
retrieval systems (AS/RS) and robotics
 Automated Storage and Retrieval Systems (AS/RS)
 Replaces traditional forklifts and their human operators with computer-
controlled conveyor systems (similar to airport carousels for baggage’s;
products are transported on “wide moving belts”.)
 Reduce errors, improved inventory control, and lower storage costs

 Robotics
 Use special CNC machines that are useful in performing hazardous, difficult, and
monotonous tasks
 Computer-Aided Design (CAD) (used by architects and industrial designers to have a 3D
model of products being designed)
 Increases engineers’ productivity (as opposed to manual design; they can produce
much more)
 Improves accuracy
 Allows firms to be more responsive to market demands (when product changes are
required by customers, designers can readily come up with the new design using
technology)
 Interfaces with CAM and MRPII systems (discussed in next slides)
 Computer Aided Manufacturing (CAM)
 Uses computers to control the physical manufacturing process
 Output of the CAD system is fed to the CAM system.
 Benefits include improved process productivity, cost and time estimates, process
monitoring and quality, and decreased setup and labor costs.

Value Stream Mapping

 Essential activities add value; nonessential activities do not and should be eliminated.
 Company’s value stream includes all steps essential to producing a product.
 Companies pursuing lean manufacturing use a value stream map (VSM) to identify business process
aspects that are wasteful and should be eliminated.
 Works best in focused, high-volume processes which benefit from reducing repetitive processes
by even small amounts of time.
 Less effective in low-volume processes in which employees frequently switch between multiple
tasks.
 Captures costs by value stream rather than by department or activity making it simpler than ABC
accounting.
 Value streams cut across functional and departmental lines and includes non-manufacturing costs.
 Essential aspect is defining the product family.
 Makes no distinction between direct and indirect costs.
 Raw materials based on purchases and all employee labor costs of employees in the value stream
are included.
 Typically only allocated cost is a charge for the facility
 Overhead costs which cannot be controlled are not allocated.

Achieving World-Class Status

 The world-class firm needs new accounting methods and new information systems that:
 show what matters to its customers
 identify profitable products
 identify profitable customers
 identify opportunities for improving operations and products
 encourage the adoption of value-added activities and processes and identify those that do not
add value
 efficiently support multiple users with both financial and nonfinancial information

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What’s Wrong with Traditional Accounting Information?
 Inaccurate cost allocations occur because overhead is assumed to be directly related to direct labor.
 Automation changes the relationship between direct labor, direct materials, and overhead costs
which becomes more significant.
 Using standard costs leads to distortions in a lean environment.
 Promotes non-lean behavior due to incentives to produce large inventories and conceal waste in
overhead allocations.
 Time lags as standard cost data are historic in nature.
 After-the-fact info is too late to be useful in a lean environment. (before you can compute
variances, you have to wait for the end of the period for the information to be finalized)
 Financial orientation is not always suitable for evaluations pertaining to functionality and improvements.
(Traditional accounting tends to quantify by using amounts such as dollars or pesos rather than other
units)

Activity Based Costing (ABC)

 Method that allocates costs to facilitate planning and control by assigning costs to activities and cost
objects.
 Activities describe work performed in a firm.
 Cost objects are the reasons for performing activities.
 Assumes that activities cause costs and that products (and other cost objects) create a demand for
activities.
 First step is to determine the cost of an activity and an appropriate activity driver that measures
consumption.
 ABC uses multiple activity drivers, whereas traditional accounting has only one, e.g. machine or
labor hours.
 Advantages
 More accurate costing of products/services, customers, and distribution channels
 Identifying the most and least profitable products and customers (we can generate mini income
statements per product as well as per customer. Having such information, a company can focus
on the products and customers which can generate the most profits)
 Accurately tracking costs of activities and processes
 Equipping managers with cost intelligence to drive continuous improvements
 Facilitating better marketing mix (i.e., combination of products in terms of sales percentages)
 Identifying waste and non-value-added activities
 Disadvantages
 Too time-consuming and complicated to be practical. (ABC can only be implemented if a
company uses an ERP such as SAP or Oracle. Non integrated systems do not allow the use of
ABC)
 Promotes complex bureaucracies in conflict with lean manufacturing philosophy

Information Systems that Support Lean Manufacturing

 Materials Requirement Planning (MRP) is an automated production planning and control system used to
support inventory management. (in other words, automated system for managing inventories only)
 Ensures adequate raw materials for production process.
 Maintains the lowest possible level of inventory on hand.
 Produce production and purchasing schedules and other information needed to control production.
 Manufacturing Resource Planning (MRP II) is an extension of MRP that has evolved beyond inventory
management.
 Coordinates a wide range of manufacturing activities.
 Benefits include improved customer service and cash flow, reduced inventory, increase
productivity, help in achieving long-term goals and managing change and production flexibility.
(Bigger in scope than MRP)
 Enterprise Resource Planning (ERP) Systems are software suites that integrate the entire organization
into one system connected to a single common database.
 An electronic data interchange (EDI) communication link allows firm to interact with customers
and suppliers via Internet or direct connection.