 The Conversion Cycle

- Transforms input resources (RM, Labor, OH) into FG or services for sale
- Consist of 2 subsystems
o Physical activities the Production system
o Information activities the cost accounting system

 Production System
 Involves: Planning
Scheduling
Control
Of the physical product through the manufacturing process:
o determining raw materials requirements
o authorizing the release of raw materials into production
o authorizing work to be conducted in the production process
o directing the movement of work through the various stages of production

 Production Methods
1. Continuous Processing: Homogeneous products through continuous standard procedures
2. Batch Processing: discrete groups of products
3. Make-to-order Processing: fabrication of discrete products in accordance with customer specifications

 Traditional Batch production model

Consist of four basic processes:
a. Plan and control procedures
b. Perform production operations
c. Maintain inventory control
d. Perform cost accounting

A. Batch Production system

 Production Planning and Control
Materials and operations requirements
Production scheduling
 Materials and Operations Requirements
Materials requirement – the difference between what is needed and what is available in inventory
Operations requirements – the assembly and/or manufacturing activities to be applied to the product
 Production Scheduling
Coordinates the production of multiple batches
Influenced by time constraints, batch size, and other specifications
 Work Centers and Storekeeping
Production operations begin when work centers obtain raw materials from storekeeping.
It ends with the completed product being sent to the finished goods (FG) warehouse
 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

o demand is known and constant
o ordering lead time is known and constant
o total cost per year of placing orders decreases as the order quantities increase
o carrying costs of inventory increases as quantity of orders increases
o no quantity discounts

 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
 Route Sheet - details the production path a particular batch will take in the manufacturing process
o sequence of operations
o 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
 Cost Accounting System
 Records the financial effects of the events occurring in the production process
 Initiated by the work order
 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
 Receipt of last move ticket signals completion of the production process
 clerk removes the cost sheet from WIP file
 prepares a journal voucher to transfer balance to a finished goods inventory account and forwards to the
General Ledger department

 Internal Controls
 Summary of Internal Controls

 Transaction authorizations
o work orders – reflect a legitimate need based on sales forecast and the finished goods on hand
o move tickets – signatures from each work station authorize the movement of the batch through the
work centers
o materials requisitions – authorize the warehouse to release materials to the work centers
 Segregation of duties
o production planning and control department is separate from the work centers
o inventory control is separate from materials storeroom and finished goods warehouse
o cost accounting function accounts for WIP and should be separate from the work centers in the
production process
 Supervision
o work center supervisors oversee the usage of raw materials to ensure that all released materials are
used in production and waste is minimized
o employee time cards and job tickets are checked for accuracy
 Access control
o direct access to assets
controlled access to storerooms, production work centers, and finished goods warehouses
quantities in excess of standard amounts require approval
o indirect access to assets
controlled use of materials requisitions, excess materials requisitions, and employee time cards
 Accounting records
o pre-numbered documents
o work orders
o cost sheets
o move tickets
o job tickets
o material requisitions
o WIP and finished goods files
 Independent verification
o cost accounting reconciles material usage (material requisitions) and labor usage (job tickets) with
standards
-variances are investigated
o GL dept. verifies movement from WIP to FG by reconciling journal vouchers from cost accounting
and inventory subsidiary ledgers from inventory control
o internal and external auditors periodically verify the raw materials and FGs inventories through a
physical count

 Principles of Lean Manufacturing

 Pull Processing – products are pulled from the consumer end (demand), not pushed from the production end
(supply)
 Perfect Quality –pull processing requires zero defects in raw material, WIP, and FG inventories
 Waste Minimization – activities that do not add value or maximize the use of scarce resources are eliminated
 Inventory Reduction – hallmark of lean manufacturing
 o Inventories cost money
o Inventories can mask production problems
o Inventories can precipitate overproduction
 Production Flexibility – reduce setup time to a minimum, allowing for a greater diversity of products, without
sacrificing efficiency
 Established Supplier Relations – late deliveries, defective raw materials, or incorrect orders will shut down
production since there are inventory reserves
 Team Attitude – each employee must be vigilant of problems that threaten the continuous flow of the
production line

 Lean Manufacturing Model

 Achieve production flexibility by means of:
o Changes in the physical organization of production facilities
o Employment of automated technologies
CIM, AS/RS, robotics, CAD, and CAM
o Use of alternative accounting models
ABC and value stream accounting
o Use of advanced information systems
MRP, MRPII, ERP, and EDI

 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.
o This reduces setup and processing time, handling costs, and inventories.

 Automating Manufacturing
 Traditional Approach to Automation
o Consists of many different types of machines which require a lot of setup time
o Machines and operators are organized in functional departments
o WIP follows a circuitous route through the different operations
 Islands of Technology
o Stand-alone islands which employ computer numerical controlled (CNC) machines that can perform
multiple operations with less human involvement
 Computer Numerical Controlled (CNC) Machines
o Reduce the complexity of the physical layout
o Arranged in groups and in cells to produce an entire part from start to finish
o Need less set-up time
 Computer Integrated Manufacturing (CIM)
o A completely automated environment which employs automated storage and retrieval systems
(AS/RS) and robotics
 Automated Storage and Retrieval Systems (AS/RS)
o Replaces traditional forklifts and their human operators with computer-controlled conveyor systems
o Reduce errors, improved inventory control, and lower storage costs
 Robotics
o Use special CNC machines that are useful in performing hazardous, difficult, and monotonous tasks
 Computer-Aided Design (CAD)
o Increases engineers’ productivity
o Improves accuracy
o Allows firms to be more responsive to market demands
o Interfaces with CAM and MRPII systems
 Computer Aided Manufacturing (CAM)
o Uses computers to control the physical manufacturing process
o Provides greater precision, speed, and control than human production processes

 Achieving World-Class Status

 The world-class firm needs new accounting methods and new information systems that:
o show what matters to its customers
o identify profitable products
o identify profitable customers
o identify opportunities for improving operations and products
o encourage the adoption of value-added activities and processes and identify those that do not add
value
o efficiently support multiple users with both financial and nonfinancial information
 What’s Wrong with Traditional Accounting Information
 Inaccurate cost allocations – automation changes the relationship between direct labor, direct materials, and
overhead cost
  Promotes non lean behavior – incentives to produce large batches and inventories, and conceal waste in
overhead allocations
 Time lag – data lag due to assumption that control can be applied after the fact to correct errors
 Financial orientation – dollars as the standard unit of measure

B. Activity Based Costing ABC

 is an information system that provides managers with information about activities and cost objects
 assumes that activities cause costs and that products (and other cost objects) create a demand for activities
 is different from traditional accounting system since ABC has multiple activity drivers, whereas traditional
accounting has only one, e.g. machine hours

 ABC pros and Cons

 Advantages
o More accurate costing of products/services, customers, and distribution channels
o Identifying the most and least profitable products and customers
o Accurately tracking costs of activities and processes
o Equipping managers with cost intelligence to drive continuous improvements
o Facilitating better marketing mix
o Identifying waste and non-value-added activities
 Disadvantages
o Too time-consuming and complicated to be practical
o Promotes complex bureaucracies in conflict with lean manufacturing philosophy

 Value Stream Accounting

 Value stream – all the steps in a process that are essential to producing a product
 Value streams cut across functions and departments
 Captures costs by value stream rather than by department or activity
o Simpler than ABC accounting
 Makes no distinction between direct and indirect costs
o Including labor costs

 Information System that Supports Lean Manufacturing

 Manufacturing Resources Planning (MRP)
o Ensures adequate raw materials for production process
o Maintains the lowest possible level of inventory on hand
o Produce production and purchasing schedules and other information needed to control production
 MRP II
o An extension of MRP
o More than inventory management and production scheduling – it is a system for coordinating the
activities of the entire firm
 Enterprise Resource Planning (ERP) Systems
o Huge commercial software packages that support the information needs of the entire organization, not
just the manufacturing functions
o Automates all business functions along with full financial and managerial reporting capability
 Electronic Data Interchange (EDI)
o External communications with its customers and suppliers via Internet or direct connection