The

Conversion / Production
Cycle
AIS Module 7
Learning Objectives
• Understand the basic elements and procedures encompassing a traditional production process.
• Understand the data flows and procedures in a traditional cost accounting system.
• Be familiar with the accounting controls found in a traditional environment.
• Understand the principles, operating features, and technologies that characterize lean
manufacturing.
• Understand the shortcomings of traditional accounting methods in a world-class environment.
• Be familiar with the key features of activity-based costing and value stream accounting.
• Be familiar with the information systems commonly associated with lean manufacturing and
world-class companies.

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The Traditional Manufacturing Environment
• A company’s conversion cycle transforms (converts) input resources,
such as raw materials, labor, and overhead, into finished products or
services for sale.
• Materials requirements planning (MRP) systems are used to
determine how much raw materials are required to fulfill production
orders.
• The conversion cycle consists of both physical and information
activities related to manufacturing products for sale.

3
Conversion Cycle in Relation to Other Cycles

4
BATCH PROCESSING SYSTEM
• Documents in the Batch Processing System
• The production schedule is the formal plan and authorization to begin production.
• The bill of materials (BOM) is a document that specifies the types and quantities of the raw
materials and subassemblies used in producing a single unit of finished product.
• A route sheet is a document that shows the production path a particular batch of products follows
during manufacturing.
• The work order (or production order) is a document that draws from bills of materials and route
sheets to specify the materials and production for each batch.
• A move ticket is a document that records work done in each work center and authorizes the
movement of the job or batch from one work center to the next.
• A materials requisition is a document that authorizes the storekeeper to release materials to
individuals or work centers in the production process.

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DFD of Batch
Production
Process

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Production Schedule

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Bill of Materials

8
Route Sheet

9
Work Order

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Move Ticket

11
Materials Requisition, Excess Materials
Requisition, and Materials Return Ticket

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BATCH PROCESSING SYSTEM (continued)
• Batch Production Activities
• PRODUCTION PLANNING AND CONTROL
• MATERIALS AND OPERATIONS REQUIREMENTS
• PRODUCTION SCHEDULING
• WORK CENTERS AND STOREKEEPING
• INVENTORY CONTROL: The economic order quantity (EOQ) model is an
inventory model designed to reduce total inventory costs. The reorder point
(ROP) is the lead time multiplied by daily demand. Safety stock is additional
inventories added to the reorder point to avoid unanticipated stock-out
conditions.
• Cost Accounting Activities
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Batch
Production
Process

14
Batch
Production
Process
(continued)

15
The Relationship of Total Inventory Cost and
Order Quantity

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Inventory Usage

17
The Use of Safety Stock to Prevent Stock-Outs

18
Cost
Accounting
Procedures

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CONTROLS IN THE TRADITIONAL
ENVIRONMENT
• Transaction Authorization
• Segregation of Duties
• Supervision
• Access Control
• DIRECT ACCESS TO ASSETS
• INDIRECT ACCESS TO ASSETS
• Accounting Records
• Independent Verification

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Summary of IT Application Controls

21
Summary of Conversion Cycle Physical
Controls

22
World-Class Companies and Lean
Manufacturing
• Over the past three decades rapid swings in consumer demands,
shorter product life cycles, and global competition have radically
changed the rules of the marketplace.
• In an attempt to cope with these changes, manufacturers have begun
to conduct business in a dramatically different way.
• The term world-class defines this modern era of business.

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WHAT IS A WORLD-CLASS COMPANY?
• World-class companies must maintain strategic agility and be able to
turn on a dime.
• World-class companies motivate and treat employees like
appreciating assets.
• A world-class company profitably meets the needs of its customers.
• The philosophy of customer satisfaction permeates the world-class
firm.
• Lean manufacturing improves efficiency and effectiveness in product
design, supplier interaction, factory operations, employee
management, and customer relations.

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PRINCIPLES OF LEAN MANUFACTURING
• The Toyota Production System (TPS) is a lean manufacturing system
based on the just-in-time production model.
• The just-in-time (JIT) production model is a philosophy that addresses
manufacturing problems through process simplification.
• Pull Processing
• Pull processing is the principle characterizing the lean manufacturing
approach where products are pulled into production as capacity downstream
becomes available. Products are pulled from the consumer end (demand).
• Perfect Quality

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PRINCIPLES OF LEAN MANUFACTURING (continued)
• Waste Minimization
• Inventory Reduction
• Production Flexibility
• Established Supplier Relations
• Team Attitude

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Techniques and Technologies that Promote
Lean Manufacturing
• Modern consumers want quality products, they want them quickly,
and they want variety of choice.
• This demand profile imposes a fundamental conflict for traditional
manufacturers, whose structured and inflexible orientation renders
them ineffective in this environment.
• Manufacturing flexibility is the ability to physically organize and
reorganize production facilities and the employment of automated
technologies.

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PHYSICAL REORGANIZATION OF THE
PRODUCTION FACILITIES
• Traditional manufacturing facilities tend to evolve into snakelike
sequences of activities.
• The inefficiencies inherent in this layout add handling costs,
conversion time, and even inventories to the manufacturing process.
• The flexible production system is organized into a smooth-flowing
stream of activities.
• Computer-controlled machines, robots, and manual tasks that
comprise the stream are grouped physically into factory units called
cells.

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The Traditional Factory Layout

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Flexible Production System

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AUTOMATION OF THE MANUFACTURING
PROCESS
• Traditional Manufacturing
• Islands of Technology
• The term islands of technology describes an environment where modern
automation exists in the form of islands that stand alone within the traditional
setting.
• Computer numerical controlled (CNC) machines can perform multiple
operations with little human involvement. The computer contains programs
for all parts being manufactured by the machine.

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AUTOMATION OF THE MANUFACTURING
PROCESS (continued)
• Computer-Integrated Manufacturing
• Computer-integrated manufacturing (CIM) is a completely automated
environment.
• Automated storage and retrieval systems (AS/RS) are computer-controlled
conveyor systems that carry raw materials from stores to the shop floor and
finished products to the warehouse.
• ROBOTICS
• Computer-aided design (CAD) is the use of computers to design products to
be manufactured.
• Computer-aided manufacturing (CAM) is the use of computers in factory
automation.

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AUTOMATION OF THE MANUFACTURING
PROCESS (continued)
• Value Stream Mapping
• A company’s value stream includes all the steps in the process that are
essential to producing a product.
• A value stream map (VSM) is a graphical representation of the business
process to identify aspects that are wasteful and should be removed.

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The Automation Continuum

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Computer-Integrated Manufacturing System

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Value Stream Map

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Accounting in a Lean Manufacturing
Environment
• Lean companies require new accounting methods and new
information that:
• Shows what matters to their customers (such as quality and service).
• Identifies profitable products.
• Identifies profitable customers.
• Identifies opportunities for improvement in operations and products.
• Encourages the adoption of value-added activities and processes within the
organization and identifies those that do not add value.
• Efficiently supports multiple users with both financial and nonfinancial
information.

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WHAT’S WRONG WITH TRADITIONAL
ACCOUNTING INFORMATION?
• Inaccurate Cost Allocations
• Promotes Nonlean Behavior
• Time Lag
• Financial Orientation

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Changes in Cost Structure between Different
Manufacturing Environments

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ACTIVITY-BASED COSTING
• Activity-based costing (ABC) is an accounting technique that provides
managers with information about activities and cost objects.
• An activity driver is a factor that measures the activity consumption
by the cost object.
• Advantages of ABC
• Disadvantages of ABC

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Allocation of Overhead Costs to Products
under ABC

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VALUE STREAM ACCOUNTING
• Value stream accounting is an accounting technique that captures
cost data according to value stream rather than by department.
• Product families share common processes from the point of placing
the order to shipping the finished goods to the customer.

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Cost Assignment
to Value Stream

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Grouping Products by Families

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Information Systems That Support Lean
Manufacturing
• Materials requirements planning (MRP) are systems used to plan
inventory requirements in response to production work orders.
• Manufacturing resources planning (MRP II) is a system that
incorporates techniques to execute the production plan, provide
feedback, and control the process.
• Enterprise resource planning (ERP) is a system assembled of
prefabricated software components.

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 MATERIALS REQUIREMENT PLANNING

• MRP is an automated production planning and control system used to

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Overview of MRP
System

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MANUFACTURING RESOURCE PLANNING
• MRP II is an extension of MRP that has evolved beyond the confines of inventory
management.
• MRP II integrates product manufacturing, product engineering, sales order
processing, customer billing, human resources, and related accounting functions.
• Benefits of the MRP II:
• Improved customer service
• Reduced inventory investment
• Increased productivity
• Improved cash flow
• Assistance in achieving long-term strategic goals
• Help in managing change (e.g., new product development or specialized product
development for customers or by vendors)
• Flexibility in the production process

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The Integration of Manufacturing and Financial Systems within the
MRP II Environment

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ENTERPRISE RESOURCE PLANNING SYSTEMS
• Electronic data interchange (EDI) is an intercompany exchange of
computer-processable business information in standard format.

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