Accounting Information System Reporters:

James A. Hall Rommel Bacay

7th Edition Sarah Jean Gargar

Chapter 7:
THE
CONVERSION
CYCLE
Learning Objectives:
After studying this chapter, students should able to:
 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 principle, operating features, and technologies that
characterize lean manufacturing.
 Understand the shortcoming 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.

2
The Traditional
Manufacturing
Environment
1
Conversion Cycle
• Transforms input resources, such as raw materials, labor, and overhead, into
finished products or services for sale.

Conversion Cycle Activities:

• Physical Activities
- the production system
• Information Activities
- the cost accounting system

4
ILLUSTRATION:

The Traditional Manufacturing Environment 5

Production Method
Depending on the type of product being manufactured, a company will
employ one of the following production method:
1. Continuous Processing
 Creates a homogeneous product through a continuous series of standard
procedures.
2. Make-to-order Processing
 Involves the fabrication of discrete products in accordance with customer
specification.

3. Batch Processing
 Produces discrete groups (batches) of product)
 Most common method of production and is used to manufacture products
such as:
• Automobiles
• Household Appliances
• Canned Goods
• Automotive tires
• Textbooks 6
Batch Processing System

Production System
- involves the planning, scheduling, and control of the
physical product through the manufacturing process.

Four Basic Processes

1. Plan and control production
2. Perform production operations
3. Maintain inventory control
4. Perform cost accounting

7
OVERVIEW:

Batch Production Process 8

Documents in the Batching System:
1. Production Schedule – the formal plan and authorization to
begin production.

9
Documents in the Batching System:
2. Bill of Materials (BOM) – specifies the types and quantities of raw materials and
subassemblies used in producing a single unit of finished product.

10
Documents in the Batching System:
3. Route Sheet – details the production path that a particular batch of product
follows during manufacturing

11
Documents in the Batching System:
4. Work Order – uses BOM and route sheet to specify materials and production for
each batch.

12
Documents in the Batching System:
5. Move ticket – records work done in each work center and authorize the
movement of the job or batch from one work center to next.

13
Documents in the Batching System:
6. Materials Requisition – authorizes the storekeeper to release materials to
individuals or work centers in the production process.

14
Production Planning and Control
• Materials and operations requirements
• Production scheduling

Materials and Operations Requirements

• Material Requirement – difference between what is
needed and what us available

• Operations Requirement – the assembly and/or

manufacturing activities to be applied to the
product

15
Production Scheduling
• Coordinates the production of multiple batches
• Influenced by time constraints, batch size, and other specifications

Work Center and Storekeeping

• Production operations begin when work
centers obtain raw materials from
storekeeping
• It ends with the completed product being
send to the finished goods warehouse
• Fulfill an important role in recording labor
time costs

16
Inventory Control
Three Main Activities:
1. Provides production planning and control
with status of finished goods and raw
materials.
2. Continually updates the raw material
inventory during production process
3. Upon completion of the production,
updates finished goods inventory

17
OVERVIEW:

Batch Production Process 18

Economic Order Quantity (EOQ)
• Commonly used inventory model
• Based on simplifying assumptions that may not reflect thee economic reality

Assumptions:
1. Demand is for the product constant and known with certainty
2. Ordering lead time are known and constant
3. All inventories in the order at the same time
4. Total cost per year of placing orders is a variable that decrease as the ordered
increase
5. Carrying Cost is a variable that increase as the quantity ordered increase
6. No quantity discount

Note: The objective of EOQ model is to reduce total inventory costs.

19
ILLUSTRATION
:

Economic Order Quantity 20

 Economic Order Quantity

Reorder Point (ROP)

formula
• to determine how
much to purchase

21
ILLUSTRATION
:

Inventory Usage 22
Cost Accounting Activities
• 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 record is 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 journal voucher to transfer balance FG inventory accounts and
forwards to the GL Department.

23
ILLUSTRATION
:

Cost Accounting Procedure 24

Controls in the Traditional Environment

Six General Classes of Internal Control Activities:

1. Transaction Authorization
 Work Order – reflects a legitimate need based on sales forecast and the
finished goods on hand.
 Move Tickets – signatures from each workstation authorize the
movement of the batch through the work centers.
 Material Requisitions – authorize the warehouse to release materials to
the work centers.

25
Six General Classes of Internal Control Activities: (continued)

2. 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 separate from work centers
 General ledger separate from other accounting functions
3. Supervision
 Work centers oversee the usage of RM in the production process
 Employee time cards and job tickets are checked for accuracy

26
Six General Classes of Internal Control Activities: (continued)
4. Access Control
 Direct access to assets
• Controlled access to storerooms, production work centers, and
finished goods warehouse
• Quantities in excess of standard amounts require approval
 Indirect access to assets
• Controlled use of materials requisitions, excess materials requisition,
and employee time card

5. Accounting Records
 Pre-numbered documents  Material requisition
 Work orders  WIP and FG files
 Move tickets

27
Six General Classes of Internal Control Activities: (continued)
6. Independent Verification

Verification steps in the conversion cycle are performed as follows:

1. Cost accounting reconciles material usage (material requisition)
and labor usage (Job ticket) with standards. (Variances are
investigated)
2. GL department verifies movement from WIP and FG by
reconciling journal vouchers from cost accounting and inventory
subsidiary ledgers from inventory journal.
3. Internal and external auditors periodically verify the raw materials
and FGs inventories through physical count.

28
 World-Class
Companies and Lean
Manufacturing
2
World Class Company
• Continuously pursue improvements in all aspects of their operations, including
manufacturing procedures.
“World-Class” define this modern era of business

Characteristics:
• Must maintain strategic agility and be able to turn on a dime
• Motivate and treat employees like appreciating assets
• Permeates the philosophy of customer satisfaction
• Profitably meets the needs of its customers
• Often adopt lean manufacturing model

30
Principles of Lean Manufacturing
Lean Manufacturing
• Method that focuses on minimizing the waste within a manufacturing
system while simultaneously maximizing the productivity.

Characterize Lean Manufacturing:

 Pull Processing - products are pulled from the consumer end
(demand), not pushed from the production end (supply)
 Perfect Processing - pull processing requires zero defects in raw
materials, 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 firms
31
Characterize Lean Manufacturing: (continued)
Three common problem as to why inventory reduction is important:
1. Inventories cost money
2. Inventories camouflage production problems
3. Willingness to maintain 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 immediately because this
production model allows no inventory reserves to draw upon.
 Team Attitude - Each employee must be vigilant of problems that threaten
the continuous flow operation of the production line.

32
Lean Manufacturing Model, achieve production flexibility
by means of:
• Changes in the physical organization
of production facilities
• Employment of automated
technologies
• Use of alternatives accounting models
• Use of advanced information system

33
 Techniques and
Technologies that Promote
Lean Manufacturing
3
Physical Reorganization of the Production Facilities
Traditional Factory Layout
• Tend to evolve in
piecemeal fashion over
years into snakelike
sequences of activities

35
Flexible Production System
• Organized into a
smooth stream of
activities

36
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
• Reorganized is based on flows through cells which shorten the
physical distance between activities – reduces setup and processing
time, handling costs, and inventories

37
Automation of the Manufacturing Process
Automation
• At the heart of the lean manufacturing philosophy

38
Automation of the Manufacturing Process

Traditional Manufacturing
• Consists of many different type of machine require a lot of setup time
• Machine and operators are organized in functional departments
• WIP follows a circuitous route through the different operations

Islands of Technology
• Stand-alone islands which employ computer numerical control (CNC)
machines that can perform multiple operations with less human
involvement.
Computer Numerical Controlled 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

39
Computer-Integrated Manufacturing
• Completely automated environment which employs automated storage
and retrieval system (AS/RS) and robotics

Automated Storage and Retrieval System

• Replaces traditional forklifts and their human operators with computer-
controlled conveyor system
• Reduces errors, improved inventory control and lower storage costs

Robotics
• Use special CNC machines that are useful in performing hazardous,
difficult, and monotonous tasks.

40
ILLUSTRATION
:

Computer-Integrated Manufacturing 41
Computer-Aided Design (CAD)
• Increases engineer’s productivity
• Improves accuracy
• Allows firm to be more responsive market demands

Computer-Aided Manufacturing
• Uses computers to control the physical manufacturing process
• Provides grater precision, speed, and control than human production
processes

42
Value Stream Mapping
• The activities that constitute a firm's production process are either
essential or they are not.
 Essentials activities add value
 Non-essential activities do not and should be eliminated
• Includes all the steps in the process that are essential to producing a
product
• Graphically represent their business processes to identify aspects of it
that are wasteful and should be remove
• Identifies all of the actions required to complete processing on a product
(batch or single item)

43
ILLUSTRATION
:

Value Stream Mapping 44

Accounting in a Lean
Manufacturing
Environment
4
The world-class firm needs new accounting methods and new information
systems that:
• Shows what matters to its customers
• Identifies profitable products
• Identifies profitable customers
• Identifies opportunities for improving operations and products
• Encourage the adoption of value-added activities and processes and
identify those that do not add value
• Efficiently supports multiple users with both financial and non-financial
information
46
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
error
Financial Orientation
• Dollars as the standard unit of measure

47
Activity-Based Costing (ABC)
• A method of allocating costs to products and services to facilitate better
planning and control
• It accomplishes this by assigning cost to activities based on their use of
resources and assigning cost to objects based on their use of activities

Activities – describe the work performed in a firm

Cost Objects – the reasons for performing activities

48
ILLUSTRATION
:

Activity Based Costing 49

Advantages of ABC
• More accurate costing of products/services, customers, and distribution
channels
• Identifying the most and least profitable products and customers
• Accurately tracking costs of activities and processes
• Equipping managers cost intelligence to drive continuous improvements
• Facilitating better marketing mix
• Identifying waste and non-value-added activities

Disadvantages of ABC
• Too time-consuming and complicated for practical applications
• Promotes complex bureaucracies in conflict with lean manufacturing
philosophy

50
Value Stream Accounting
Value Stream
• all the steps in a process that are essential to producing a product
• Cut across functions and department
• Captures costs by value stream rather than by department
• Makes no distinction between direct and indirect

An essential aspect in implementing value stream accounting is defining the

product family.

Product Family share common processes from point of placing the order to
shipping the FG to the customer

51
ILLUSTRATION
:

Value Stream Accounting 52

Information System that
Support Lean
Manufacturing
5
Manufacturing Requirement Planning (MRP)
• Automated production planning and control system used to
support inventory management

MRP optional objectives:

• Ensures adequate raw materials for production process
• Maintain the lowest possible level of inventory on hand
• Produce production and purchasing schedules and other
information needed to control production

54
ILLUSTRATION
:

Manufacturing Requirement Planning 55

Manufacturing Resources Planning (MRP II)
• An extension of MRP
• More than inventory management and production scheduling –
its is system for coordination the activities of the entire firm

Benefit from highly integrated MRP II system:

• Improved customer service
• Reduced inventory investment
• Increased productivity
• Improved cash flow
• Assistance in achieving long-term strategic goals
• Help in managing change
• Flexibility in the production process
56
ILLUSTRATION
:

Manufacturing Resources Planning II 57

Enterprise Resources Planning (ERP) System
• Integrates departments and functions across company into one
system of integrated applications that is connected to a single
common database
• Composed of function-specific modules that reflect industry
best practices

Electronic Data interchange (EDI)

• External communications with its customers and suppliers
via internet or direct connection

58
 END OF
DISCUSSION

59