The Conversion Cycle Figure 7-1 (context-level data flow diagram)

illustrates the central role of the conversion cycle

Introduction:
and its interaction with business cycles.
A Conversion cycle is converting input resources
1. Production is triggered by customer orders
(raw materials, labor, and overhead) into finished
from the REVENUE CYCLE or the sales
products or services for sale.
forecast from MARKETING. These inputs
4 Basic Processes of Traditional Batch Production are used to set a production target and
Model: prepare a production plan, which drives
production activities.
1. Plan and control production 2. Purchase requisitions for the raw materials
2. Perform production operations needed to meet production objectives are
3. Maintain inventory control sent to the purchases procedures or
4. Perform cost accounting EXPENDITURE CYCLE which prepares
The traditional batch production model is relevant purchase orders for vendors. Labor used in
in this topic because the conversion cycle focuses production is transmitted to the payroll
on the activities, documents, and controls pertaining system (also EXPENDITURE CYCLE) for
to the traditional processes. payroll processing.
3. Manufacturing costs associated with
THE TRADITIONAL MANUFACTURING intermediate work-in-process and finished
ENVIRONMENT goods (FG) are sent to the GENERAL
Conversion cycle consists of both physical and LEDGER AND FINANCIAL
information activities. REPORTING SYSTEM.

 "Physical activities" involve hands-on tasks The company’s production method will depend on
like cutting, assembling, and packaging the type of product being manufactured.
products, BATCH PROCESSING SYSTEM
 "Information activities" focus on data
management, planning, and analysis to 4 basic processes of the batch processing system:
guide production, such as designing 1. Plan and control production
specifications, tracking inventory, and 2. Perform production operations
monitoring quality control. 3. Maintain inventory control
4. Perform cost accounting
Batch processing system also involves the
integration of activities of the primary information
flows or documents and link them to other cycles
and systems. The tasks described can be performed
manually or computerized (technology neutral) and
the system documents may be hard copy or digital.
Documents in the Batch Processing System: manufacturing.; the difference is that a route
sheet specifies the SEQUENCE of
operations (machining or assembly) and the
standard time allocated to each task, while
the BOM specifies the MATERIAL
requirements only.
 The work order (or production order) along
with move tickets initiate the manufacturing
process in the production departments.
 A move ticket
 A materials requisition usually asks for the
standard amount of materials. If more
materials are needed, a separate request is
made and marked as "extra materials." This
The manufacturing process shown in the diagram helps keep track of extra usage. If less
could be triggered either by individual sales orders material is used, the leftover materials are
from the revenue cycle or by a sales forecast the returned to the storeroom with a return
marketing system provides. The author here ticket. This way, the production process is
assumes the latter, or the sales forecast the easier to manage.
marketing system provides.
 Show production schedule, slide 7
The sales forecast predicts how much demand there  Show bill of materials, slide 8
will be for a company's finished products during a  Show route sheet, slide 9
certain time period. Some companies create a yearly  Show work order, slide 10
forecast by product, while others with seasonal sales  Show move ticket, slide 11
may make shorter forecasts (like monthly or  Show Materials Requisition, Excess
quarterly) that can be updated based on the Materials Requisition, and Materials Return
economy. Ticket, slide 12
 The production schedule tells us what BATCH PROCESSING SYSTEM (cont)
products need to be made, how many of
them to make at a time, and when to start  Batch Production Activities – consists of
and finish making them. The 3 of the 4 conversion cycle process:

 The bill of materials (BOM) is like a 1. PRODUCTION PLANNING AND

shopping list that tells us all the parts and CONTROL – consists of 2 main activities: (1)
materials needed to make one product. If we specifying materials and operations
want to make more products, we simply requirements and (2) production scheduling.
multiply the list by how many we want to  MATERIALS AND OPERATIONS
make, so we know how much of each item REQUIREMENTS – The raw material
we need. needed for a batch of a product is the
difference between what is required and
 A route sheet is a document that shows the
what is already in stock. This is figured out
specific steps and processes a batch of
by looking at the current inventory, sales
products follows during production. It’s
forecasts, product specs, and the BOM. If
similar to the BOM, but instead of listing
more materials are needed, purchase
materials, it outlines the path the products
requisitions are created. The operations
take through different stages of
required for the batch involve assembling or
 manufacturing the product, based on the First – provides production planning and control
steps listed in the route sheet. with status reports on finished goods and raw
materials inventory.
 PRODUCTION SCHEDULING – this is
also the second activity of production Second – the inventory control function is
planning and control. The master schedule continually involved in updating the raw
for a production run organizes the making of material inventory records from materials
many different batches. It’s affected by requisitions, excess materials requisitions, and
things like time limits, batch size, and materials return tickets.
details from the BOM and route sheets. The
schedule also creates work orders, move Third – upon receipt of the work order from the
tickets, and material requests for each batch. last work center, inventory control records the
A copy of each work order is sent to cost completed production by updating the finished
accounting to set up a new account for the goods inventory records.
batch. These documents then move through
the production process, following the steps An objective of inventory control is to minimize
listed in the route sheet. total inventory cost while ensuring that adequate
inventories exist to meet current demand.
2. PERFORM PRODUCTION OPERATIONS Inventory models used to achieve this objective
help answer 2 fundamental questions:
 WORK CENTERS AND STOREKEEPING When should inventory be purchased?
– Production begins when workers receive How much inventory should be purchased?
raw materials from storage by submitting a
materials requisition. These materials, along A commonly used inventory model is the EOQ
with the necessary machines and labor, are model. This model is based on simplifying
then used to manufacture the product assumptions that may not reflect the economic
according to the work order. reality. These assumptions are:

Once a task is finished at a work center, the 1. Demand for the product is constant and
supervisor signs the move ticket, allowing known with certainty.
the batch to move to the next work center. A 2. The lead time (time between placing an
copy of the move ticket is sent back to order for inventory and its arrival is known
production planning to update the work and constant.
order. When the last move ticket is received,
3. All inventories in the order arrive at the
the work order is closed. The finished
same time.
product, along with a copy of the work
order, is sent to the finished goods 4. The total cost per year of placing orders is a
warehouse, and inventory control updates variable that decreases as the quantities
the records. ordered increase. Ordering costs include the
cost of preparing documentation, contacting
Work centers also track labor time costs. vendors, processing inventory receipts,
Supervisors send employee time cards and maintaining vendor accounts, and writing
job tickets to the payroll and cost accounting checks.
departments at the end of each week. 5. The total cost per year of holding
inventories (carrying costs) is a variable that
increases as the quantities ordered increase.
These costs include the opportunity cost of
3. INVENTORY CONTROL -The inventory invested funds, storage costs, property taxes,
control function consists of 3 main activities: and insurance.
 6. There are no quantity discounts. Therefore, The assumptions of the EOQ model produce the
the total purchase price of inventory for the saw toothed inventory usage pattern (fig 7-11).
year is constant.
The objective of the EOQ model is to reduce total
inventory costs. The significant parameters in this
model are the carrying costs and the ordering costs.

Each time inventory is reduced by sales or is used in

production, its new quantity on hand (QOH) is
compared to its ROP. When QOH = ROP, an order
is placed for the amount of Q (economic order
quantity). If, for example, when inventory drops to
40 units, the firm orders 346 units.
If the daily demand and lead time are stable, the
organization should receive the ordered inventories
Figure 7-10 illustrates the relationship between
just as the quantity on hand reaches zero; but if they
costs and order quantity.
are subject to variation, additional inventories or the
As the quantity ordered increases, the number of safety stock must be added to the reorder point to
ordering events decreases which also decreases total avoid unanticipated stock-out events. Fig 7-12
annual cost of ordering. This increase in quantity shows an additional 10 units of safety stock to carry
ordered increases the total annual inventory the firm through a lead time that could vary from 8
carrying cost to increase. to 10 days. The new reorder point is 50 units.

According to assumption #6. The total purchase

price of inventory is constant, we minimize total
inventory costs by minimizing the total carrying
cost and ordering cost.
The combined total cost curve is minimized at the
intersection of the ordering-cost curve and the
carrying cost curve, which is the EOQ.
Simply stated, EOQ is the number of order that
minimizes cost.
Example: A company has an annual demand of
2,000 units, a per unit order cost of 12 dollars and a
carrying cost per unit of 40 cents. How much to  Cost Accounting Activities - records the
purchase (EOQ)? Ans. 346.410 financial effects of the physical events that
When do we purchase? Reorder point (ROP). are occurring in the production process. The
Formula: ROP = Lead time x Daily demand. cost accounting process starts when
production planning department sends a
If the lead time is 8 days and the daily demand copy of the original work order to the cost
(total demand or number of working days) is 5 accounting department. This creates a new
units, the ROP is 40 units. record in the work-in-process file, which
 tracks costs for the production run in the inventory. This activity is kept separate from
general ledger. the materials storeroom and from the
finished good warehouse functions, which
have custody of these assets.
As materials and labor are used during production,
 The cost accounting function accounts for
documents like materials requisitions, job tickets,
WIP and should be separate from the work
and move tickets are sent to the cost accounting
centers in the production process.
department. These, along with standard cost file,
 To maintain the independence of the GL
help update the work-in-process (WIP) accounts
(general ledger) function as a verification
with charges for labor, materials, and overhead. Any
step, the GL department must be separate
differences from the standard are tracked as
from departments keeping subsidiary
variances. When the last move ticket is received, the
accounts. Therefore, the GL department is
production is finished, and the products are moved
organizationally segregated from inventory
to finished goods inventory. Cost accounting then
control and cost accounting.
closes the WIP account and periodically sends
summary information to the general ledger for
3. Supervision:
posting.
 The supervisors in the work centers oversee
CONTROLS IN THE TRADITIONAL the usage of raw materials in the production
ENVIRONMENT process ensuring that all materials released
from stores are used in production and that
1. Transaction Authorization: waste is minimized. Employee timecards
 In traditional manufacturing, production and job tickets must also be checked for
planning and control authorize production accuracy.
with a work order. This document outlines  Supervisors also observe and review
the production needs based on the difference timekeeping activities. This promotes
between expected demand (from the sales accurate employee timecards and job tickets.
forecast) and the finished goods inventory
available. 4. Access Control – the conversion cycle
 Move tickets, signed by the supervisor at allows both direct and indirect access to
each work center, authorize activities for assets.
each batch and the movement of products  Direct access to assets – the nature of the
between work centers. physical product and the production process
 Materials requisitions and excess materials influences the type of access controls
requisitions authorize the storekeeper to needed.
provide materials to the work centers.  Firms limit access to sensitive areas,
such as storerooms, production work
2. Segregation of Duties – an objective of this centers, and FG warehouses. Control
control procedure is to separate the tasks of methods used include identification
transaction authorization and transaction badges, security guards, observation
processing. The production planning and devices, and various electronic
control department is segregated from the sensors and alarms.
work centers.
 Standard costs help control access to
Another control objective is to segregate record resources by setting limits on the
keeping from asset custody. The following amount of material and labor
separations apply: allowed for each product. To use
 Inventory control maintains accounting more than the authorized amount,
records for raw materials and finished goods
 special approval and documentation WORLD-CLASS COMPANIES AND LEAN
are required. MANUFACTURING
 Indirect access to assets – Assets like cash
and inventories can be manipulated through The pursuit of world-class status is a journey
access to source documents such as without destination because it requires continuous
materials requisitions, excess materials innovation and continuous improvement.
requisitions, and employee time cards.
 World-class companies maintain strategic
Using prenumbered documents helps control
agility, quickly adapting to change. Top
access and provides an audit trail. management stays closely attuned to
5. Accounting Records – The goal of customer needs, avoiding rigidity and
accounting records control is to create an audit trail embracing change.
for each transaction. In the conversion cycle, this is  These companies treat employees as
valuable assets, empowering them by
done using documents like work orders, cost sheets,
making decisions at all levels of the
move tickets, job tickets, materials requisitions, and organization. This creates a flat, responsive
the WIP and FG inventory files. By prenumbering structure that fosters innovation and
documents and referencing them in the WIP engagement.
records, a company can trace finished goods back  A world-class company not only meets
through production. This helps identify errors, customer needs but strives to delight them,
locate lost batches, and conduct audits. recognizing that this is an ongoing effort.
With competitors always looking to grow,
6. Independent Verification – these companies continually seek ways to
 Independent verification involves cost exceed customer expectations.
accounting checking materials and labor  Customer satisfaction is a core philosophy,
guiding every aspect of the company—from
usage against set standards using materials
sourcing raw materials to delivering the
requisitions and job tickets. Any differences
finished product. Each department serves the
from the standards are reported as variances. next in the process, creating a seamless
These calculated variances are important chain dedicated to satisfying customers,
data for the management reporting system in culminating in the final paying customer.
traditional manufacturing.  Finally, world-class manufacturing
companies embrace lean principles, focusing
 The GL department verifies the movement on doing more with less, eliminating waste,
of products from WIP to FG by reconciling and shortening production cycles.
journal vouchers from cost accounting with
inventory summaries from inventory Summary:
control.
World-class companies are good at changing
 Internal and external auditors regularly quickly and always care about what their customers
perform physical counts of raw materials need. They treat their workers well and let everyone
and finished goods, comparing the actual help make important decisions. These companies
quantities with inventory records and try their best to make customers super happy and
making adjustments as needed. keep improving so no one else can do it better.
Every person in the company works together to help
 Show summary of IT Application controls, the next person, all the way to the customer who
slide 21 buys the product. They also embrace lean
 Show summary of conversion cycle physical manufacturing principles which focuses on
controls, slide 22 efficiency by doing more with less, minimizing
waste, and shortening production cycles.

PRINCIPLES OF LEAN MANUFACTURING

Toyota Production System (TPS) is based on the inventories can lose value over time due to
JIT production model. This approach is opposite of obsolescence.
traditional manufacturing, which have high  Inventories can mask production issues. When
inventory levels, large production lot sizes, process there are bottlenecks or imbalances in capacity,
inefficiencies and waste. work-in-progress inventory piles up at the
problem spots. Additionally, mismatches
The goal of lean production is improved efficiency between customer orders and production
and effectiveness in every area, including product schedules lead to unnecessary inventory
design, supplier interaction, factory operations, buildup.
employee management, and customer relations.  A willingness to maintain inventories can lead
to overproduction. To cover setup costs,
Lean manufacturing involves getting the right companies often produce in large batches,
products to the right place, at the right time, in the which creates the illusion of efficiency.
right quantity while minimizing waste and However, the true cost of this approach is
remaining flexible. Success depends on employee hidden in the excess inventory.
understanding and embracing lean manufacturing
principles. Production Flexibility – Long machine setup times
create delays in production and often lead to
Pull Processing involves pulling products from the overproduction. Lean companies focus on
consumer end (demand), rather than pushing them minimizing setup time, enabling them to quickly
from the production end (supply). The lean produce a wider variety of products without losing
approach brings in small amounts of inventory just efficiency, even at lower production volumes.
in time for production, preventing excess
semifinished goods and bottlenecks by producing Established Supplier Relations – A lean
only when there’s available capacity. manufacturing company must maintain strong,
cooperative relationships with vendors. Late
Perfect Quality – The pull processing model deliveries, defective materials, or incorrect orders
depends on having perfect quality in raw materials, can halt production right away, as this model
work-in-progress, and finished goods. Poor quality operates with no inventory reserves to rely on.
can be very costly because quality is a major factor
in how world-class companies stay competitive. Team Attitude - Lean manufacturing depends on a
Today, quality isn’t something that’s traded off for team-oriented mindset from all employees involved
a lower price because customers want high-quality in the process, including those in purchasing,
products at the best possible price. receiving, manufacturing, and shipping. Every
employee must stay alert to any issues that could
Waste Minimization – All activities that do not disrupt the smooth flow of the production line.
add value and maximize the use of scarce resources
must be eliminated. Waste involves financial, TECHNIQUES AND TECHNOLOGIES THAT
human, inventory, and fixed assets. PROMOTE LEAN MANUFACTURING

Inventory Reduction – A key sign of successful PHYSICAL REORGANIZATION OF THE

lean manufacturing is inventory reduction. While PRODUCTION FACILITIES
other companies may hold weeks or months of
inventory, lean firms keep only a few days or even
hours of stock on hand. Inventory reduction is
important because:

 Inventories are costly because they tie up money

in materials, labor, and overhead that can only
be realized when sold. They also come with
hidden costs, such as transportation, handling,
storage, and inventory counts. Additionally,
 milling, grinding, and welding, with work-in-
progress (WIP) moving through a complex and
inefficient route across the factory floor.

Islands of Technology –refer to environments

where modern automation, such as computer
numerical control (CNC) machines, exists as
standalone systems within a traditional
manufacturing setup. These CNC machines can
perform multiple operations with minimal human
involvement, using pre-programmed instructions for
Fig 7-14 shows a traditional factory layout. The each part. While humans still set up the machines,
inefficiencies in this layout, including higher CNC technology offers a key advantage: it requires
handling costs, longer conversion times, and excess minimal setup time and cost when switching
inventory, complicate the manufacturing process. between operations.
Organizing production along functional lines often
creates division between teams, encouraging an "us- Computer Integrated Manufacturing – is a fully
versus-them" mentality that conflicts with the automated system that eliminates non-value-added
collaborative spirit needed for success. activities. It uses group technology cells with CNC
machines, along with automated storage and
retrieval systems and robotics, to produce entire
parts in one location. CIM enhances flexible
manufacturing by enabling faster production of
high-quality products, shorter cycles, lower costs,
and quicker delivery times. Fig 7-17 depicts a CIM
environment and shows the relationship between
various technologies employes.

Fig 7-15 is a much simplified facility because it

supports flexible manufacturing. The flexible
production system is organized into a smooth-
flowing stream of activities. This arrangement
shortens the physical distances between the
activities, which reduces setup and processing time,
handling costs, and inventories flowing through the
facility.

AUTOMATION OF THE MANUFACTURING

PROCESS AUTOMATED STORAGE AND RETRIEVAL
SYSTEMS (AS/RS) – Many companies have
Automation is at the heart of the lean manufacturing boosted productivity and profitability by replacing
philosophy. By replacing labor with automation, a traditional forklifts and human operators with
firm can reduce waste, improve efficiency, increase automated storage and retrieval systems (AS/RS).
quality, and improve flexibility. These computer-controlled conveyor systems
transport raw materials from storage to the shop
Traditional Manufacturing –involves machines floor and finished products to the warehouse. The
controlled by individual operators, requiring long key benefits of this technology over manual systems
setup times and large production runs to cover setup include fewer errors, better inventory control, and
costs. Machines are grouped into departments like reduced storage costs..
ROBOTICS – Manufacturing robots are needed to process a product and includes key details
programmed to perform precise, repetitive tasks and like hours worked, overtime, cycle time, and error
are commonly used for jobs like welding and rates, depending on the process being reviewed.
riveting. They are especially valuable in hazardous
environments or for handling dangerous and Fig 7-18 A Value Stream Map (VSM) of a
repetitive tasks that could lead to accidents. production process tracks the flow from receiving
an order to shipping the final product. For each
COMPUTER-ADIDED DESIGN (CAD) – processing step, the VSM details key information
Engineers use Computer-Aided Design (CAD) to such as overtime, staffing levels, work shifts,
create better products more quickly. CAD systems process uptime, and error rates. It also shows the
boost productivity, improve accuracy by automating total time for each step, as well as the time between
repetitive tasks, and help companies respond faster steps, including types of time like outbound
to market demands. CAD technology shortens the packing, transit, and inbound queue time.
time from initial to final design, enabling quick
adjustments in production and meeting customer Fig 7-18 reveals that a considerable production time
requests for custom products. CAD systems often is wasted between processing steps. The transit time
connect to external networks, allowing of raw materials from the warehouse to the
manufacturers to share and receive design production cell contributes significantly to the
specifications electronically with vendors and overall cycle time. The shipping function also
customers. Advanced CAD systems can even appears to be inefficient and wasteful, with a 16
design both products and processes at the same percent overtime rate and a 7 percent error rate. To
time, helping management assess feasibility and reduce total cycle time, perhaps the distance
manufacturability. between the warehouse and production cell should
be shortened. The shipping function’s overtime rate
COMPUTER AIDED MANUFACTURING may be due to a bottleneck situation. The high error
(CAM) – Computer-Aided Manufacturing (CAM) rate may be due to errors in the upstream order-
uses computers to assist and control the physical taking function that are passed to downstream
manufacturing processes on the shop floor. The functions.
output from the CAD system is fed into the CAM
system, which then translates designs into a
sequence of processes like drilling, turning, or
milling using CNC machines. CAM systems
monitor and control production, guiding products
through each stage. The benefits of CAM include
increased productivity, more accurate cost and time
estimates, better process monitoring and quality,
reduced setup times, and lower labor costs.

Value Stream Mapping

The activities that constitutes a firm’s production

process are either essential or not. Essential
activities add value; non-essential activities do not
and should be eliminated. A company's value VSM is most effective in high-volume, focused
stream includes all the steps that help create a processes where even small reductions in repetitive
product or service that the customer wants and is tasks can lead to significant benefits. However, it is
willing to pay for. It focuses on the actions that add less effective in low-volume processes where
value and improve the final product, while cutting employees frequently switch between different
out anything unnecessary. Companies using lean tasks, making it harder to streamline or eliminate
manufacturing often use a tool called a value stream waste.
map (VSM) to visually represent their processes
and identify waste. A VSM outlines all actions
 ACCOUNTING IN A LEAN
MANUFACTURING ENVIRONMENT

Traditional information produced under

conventional accounting techniques does not
adequately support the needs of lean companies.
They require new accounting methods and new
information that:

1. shows what matters to their customers such

as quality and service
2. identifies profitable products
3. identifies profitable customers
4. identify opportunities for improvement in
operations and products Promotes Nonlean Behavior - Standard costing
5. encourages the adoption of value-added encourages non-linear behavior in operations by
activities and processes within the focusing on performance metrics like worker
organization and identifies those who do not efficiency, facility utilization, and overhead
add value absorption. However, it can hide waste within
6. efficiently support multiple users with both overhead allocations, making it difficult to identify.
financial and non-financial information. To improve performance measures, management
and workers may be motivated to produce large
WHAT’S WRONG WITH TRADITIONAL batches and build up inventory, which conflicts with
ACCOUNTING INFORMATION? the principles of lean manufacturing.

The traditional standard costing techniques Time Lag - Standard cost data used for
emphasize financial performance rather than management reporting is typically historical, relying
manufacturing performance. The techniques and on past activities with the assumption that control
convention use in traditional manufacturing do not can be applied later to correct mistakes. In a lean
support the objectives of lean manufacturing. environment, however, shop floor managers need
Deficiencies of standard accounting systems: real-time information about deviations, such as
machine breakdowns or malfunctioning robots.
Inaccurate Cost Allocations - Standard costing Waiting for after-the-fact data is too late to address
assumes that overhead costs should be allocated to issues promptly and make necessary adjustments.
products based on the labor required to make them.
A continuous process of automation reshapes Financial Orientation - Accounting data typically
manufacturing cost structures by reducing the uses dollars as a standard measure to compare items
reliance on labor and changing how costs are being evaluated. However, decisions related to
distributed. product functionality, quality improvement, or
reducing delivery times are not always best
Fig 7-19 Shows that As automation increases, the supported by financial data produced through
relationship between direct labor, direct materials, standard costing techniques. Trying to fit these non-
and overhead costs changes. In traditional financial issues into a financial framework can
manufacturing, direct labor makes up a larger distort the problem and lead to poor decision-
portion of total manufacturing costs compared to making.
Computer Integrated Manufacturing (CIM), where
overhead costs become more significant. Using ACTIVITY BASED COSTING (ABC)
standard costing in a lean environment can distort
product costs, making some products appear more Activity Based Costing (ABC) is a method that
expensive or cheaper than they actually are. This allocates costs to products and services to improve
can lead to poor decisions about pricing, product planning and control. It does this by assigning costs
valuation, and profitability. to activities based on the resources they consume,
and then assigning costs to products or services Disadvantages of ABC
based on the activities they use.
ABC has been criticized for being too time-
 Activities – refer to the tasks or actions consuming and complex for long-term use.
carried out to achieve specific objectives. Identifying activity costs and cost drivers can be a
For example, preparing a purchase order, major effort, and it’s not something that can be done
preparing a product for shipment, or once and forgotten. As products and processes
operating machinery like a lathe are all evolve, so do the associated costs and drivers.
considered activities that contribute to the Without dedicating enough resources to keep
overall workflow and production process. everything accurate, the cost assignments can
become incorrect. Critics argue that instead of
 Cost objects – Cost objects are the reasons fostering continuous improvement, ABC can create
activities are performed. These can include complicated systems within organizations, which
products, services, vendors, or customers. conflicts with lean manufacturing’s focus on
For instance, the activity of preparing a sales simplifying processes and eliminating waste.
order is done because a customer (the cost
object) wants to place an order. The costs  Show slide 41
associated with the activity are then assigned
to the relevant cost object using an activity VALUE STREAM ACCOUNTING
driver.
The complexity of ABC has led many companies to
Activity-Based Costing (ABC) is different from switch to a simpler approach called value stream
traditional cost accounting. Traditional accounting accounting. Instead of tracking costs by department
thinks products directly cause costs, while ABC or activity, value stream accounting focuses on
says products create a need for activities, and those costs associated with the entire value stream. A
activities cause costs. value stream includes all processes that happen
from receiving an order to delivering the finished
In ABC, the first step is to figure out how much product, cutting across different departments like
each activity costs. Then, the cost of each activity is marketing, sales, design, and distribution. One key
assigned to the product or service using something part of value stream accounting is defining product
called an activity driver. This driver shows how families, which group together products that share
much of each activity the product uses. similar processes. This helps organizations manage
costs more easily, especially when they make
Traditional accounting usually uses just one activity multiple products. Fig-21 shows value stream
driver, like using labor hours to allocate overhead accounting capturing costs by value stream rather
costs. But with ABC, companies use many different than by department or activity.
activity drivers, each for different types of
activities.

Advantages of ABC

 More accurate costing of products services

customers and distribution channels.
 Identifying the most and least profitable
products and customers and accurately
tracking cost of activities and processes.
 Equipping managers with cost intelligence
to drive continuous improvements.
 Facilitating better marketing mix.
 Identifying waste and non value added
activities
Figure 7-22 illustrates how multiple products may those activities using multiple cost pools and
be grouped into product families. activity drivers. VSA is better suited for lean
environments with minimal inventory, while ABC is
ideal for traditional manufacturing settings
requiring precise cost allocation. VSA is simpler,
while ABC is more complex and offers finer cost
breakdowns.

INFORMATION SYSTEM THAT SUPPORT

LEAN MANUFACTURING

MRP focuses on determining the raw materials

Value stream accounting includes all costs related needed for production, while MRP II expands on
to a product family, without separating direct and this by integrating sales, marketing, and accounting
indirect costs. Instead of tracking raw materials for functions. ERP takes it further, integrating all
each specific product, the total cost of materials is business functions into one unified system using a
calculated based on the amount purchased for the common database to streamline operations across
entire value stream. This approach works well in the entire organization.
lean manufacturing because inventory levels are
low, typically only 1-2 days' worth. It wouldn't Materials Requirement Planning (MRP) – Is an
work in traditional environments with large automated production planning and control system
inventories carried over from one period to the next. used to support inventory management. Its
objectives are:
Labor costs for employees working in the value
stream are included, whether they're involved in  Ensure that adequate raw materials are
design, production, or moving products between available to the production process
work cells. These costs are not allocated based on  Maintain the lowest possible level of
time spent on specific tasks. Instead, the total wages inventory on hand
and benefits for all employees in the value stream  Produce production and purchasing
are charged to it. Support labor (e.g., for schedules and other information needed to
maintenance, planning, and selling) is also included control Production.
when possible, with each employee assigned to a  Fig 7-23 illustrates key features of an MRP
single value stream. system. MRP systems use inputs like sales
forecasts, finished goods inventory, raw
The only allocated cost in value stream accounting materials inventory, and the bill of materials
is the cost per square foot for the facility, covering to calculate production requirements. It
rent and maintenance. This encourages teams to use compares available materials with the
space efficiently. General overhead costs outside needed levels based on forecasts and
the value stream are not allocated to the product determines when to order raw materials. The
family but are accounted for separately. system generates raw material purchase
requisitions, production schedules, work
Summary orders, move tickets, and management
reports as outputs.
Value Stream Accounting (VSA) simplifies cost
tracking by focusing on the entire value stream of a
product family, allocating costs based on the total
value stream rather than individual activities. It
groups labor and material costs for the entire
stream, minimizing the complexity of traditional
cost allocations. In contrast, Activity-Based Costing
(ABC) provides a more detailed approach, tracking
specific activities and allocating costs based on
 MRP II is a system that creates a Bill of Materials
(BOM) for products, integrates production into a
master schedule, and generates capacity plans based
on machine and labor availability. It manages raw
material and finished goods inventories, scheduling
raw material deliveries on a Just-In-Time (JIT)
basis to avoid waste and stockouts. By coordinating
these processes, MRP II helps manufacturing firms
improve efficiency and avoid disruptions, providing
significant benefits through integration.

 Improved customer service

 Reduced inventory investment
 Increase productivity
 Improved cash flow
 Assistance in achieving long term strategic
goals
 Helps in managing change such as new
product development or specialized product
development for customers or by vendors
 Flexibility in the production process

Enterprise Resource Planning Systems - MRP II

has evolved into ERP systems, which integrate
Manufacturing Resource Planning (MRP II) - various departments and functions across a
MRP II is an advanced version of MRP that extends company into a unified system with a shared
beyond inventory management. It integrates various database. ERP systems consist of function-specific
manufacturing activities, including product modules that follow industry best practices,
manufacturing, engineering, sales order processing, allowing departments to communicate and share
customer billing, human resources, and accounting information. ERP systems support the entire
functions, creating a comprehensive system and organization's needs, not just manufacturing, by
philosophy for coordinating these processes. calculating resource requirements, scheduling
production, managing product configurations, and
Fig 7-24 shows the functional integration under an monitoring shop floor production. Additionally,
MRP 2 environment. ERP systems handle order entry, procurement, cash
disbursements, and provide financial and
managerial reporting capabilities.

A lean manufacturing company will have an ERP

system that is capable of external communications
with its customers and suppliers through electronic
data interchange EDI. The Edi Communications
link via Internet or direct connection will allow the
firm to electronically receive sales order and cash
receipts from customers, send invoices to
customers, send purchase orders to vendors, and
receive invoices from vendors and pay them, as
well as send and receive shipping documents. EDI
is a central element of many electronic commerce
systems.
ERP and MRP II systems share many similarities in
functionality, particularly in manufacturing
processes. However, a key distinction is that ERP
has expanded beyond the manufacturing sector to
also cater to non-manufacturing companies. Some
critics argue that renaming MRP II as ERP was a
strategic move by software vendors to market these
systems to a broader range of industries.

For many years, ERP systems were expensive and

complex, limiting their use to large companies, with
dominant vendors like SAP, JD Edwards, and
Peoplesoft. However, in recent years, the market
has expanded as smaller vendors have entered,
offering more affordable and easier-to-implement
ERP systems targeted at small and mid-sized
businesses.