Chapter 6

The Conversion Cycle

1
 Objectives for Chapter 7
 Elements and procedures of 2a traditional production
process
 Data flows and procedures in a traditional cost accounting
system
 Accounting controls in a traditional environment
 Principles, operating features, and technologies of lean
manufacturing
 Shortcomings of traditional accounting methods in the
world-class environment
 Key features of activity based costing and value stream
accounting
 Information systems of lean manufacturing and world-
class companies
 3
The Conversion Cycle
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
Conversion Cycle in Relation to Other Cycles

Marketing
System

Sales
Forecast

Purchase Requisitions
Revenue Cycle Sales Orders
Conversion Expenditure
Cycle Cycle
Labor Usage

Work
Finished
In
Goods
Process

General Ledger
and Financial
Reporting
System

4
 5
Production System
Involves the planning, scheduling, and control of
the physical product through the manufacturing
process
 determining raw materials requirements
 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
 Production6 Methods
Continuous Processing creates a homogeneous
product through a continuous series of standard
procedures.
Batch Processing produces discrete groups
(batches) of products.
Make-to-Order Processing involves the
fabrication of discrete products in accordance with
customer specifications.
 7

Overview: Traditional Batch Production

Model…

consists of four basic processes:

 plan and control production
 perform production operations

 maintain inventory control

 perform cost accounting

 8
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
 9
Batch Production System
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 .
 10
Batch Production System
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
 11
EOQ Inventory Model
 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
 EOQ Inventory Model
INVENTORY LEVEL

Inventory Cycle Daily Demand

EOQ

Reorder
Point

Lead Time Time (days)

12
 13
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
14
 15
Information: Documents in the Batch
Production System
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
16
 17
Information: Documents in the Batch
Production System
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
 Production Planning and Control
Sales Forecast Raw Materials Requirements
Inventory Status Report (Purchase Requisitions)

Engineering Specifications
BOM and Route Sheets Operations Requirements

Production Scheduling
Work Orders
Move Tickets
Materials Requisitions
Open Work Orders
Work Centers
Job Tickets Cost Accounting
Time Cards Payroll
Completed Move Tickets Prod. Plan. and Control
18
Upon Completion of the Production Process…
Finished Product Finished Goods Warehouse
and Closed Work Order

Closed Work Order

Inventory Control
Status Report of Raw Materials
and Finished Goods Prod. Plan. and Control

Journal Voucher General Ledger

19
 Cost Accounting
20 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
Elements of the Cost Accounting System

Inventory Control Work Centers

materials requisitions job tickets
completed move tickets

COST ACCOUNTANTS
Update WIP accounts
STANDARDS DL
DM
Mfg. OH.
Compute Variances

21
 Cost Accounting
22
System
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
Summary of Internal
23
Controls
 Internal24Controls
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
 Internal 25Controls
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
 Internal 26Controls
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
 Internal27Controls
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
 28
Internal Controls
Accounting records
 pre-numbered documents
 work orders
 cost sheets

 move tickets

 job tickets

 material requisitions

 WIP and finished goods files

 Internal29Controls
Independent verification
 cost accounting reconciles material usage (material
requisitions) and labor usage (job tickets) with standards
 variances are investigated

 GL dept. verifies movement from WIP to FG by

reconciling journal vouchers from cost accounting and
inventory subsidiary ledgers from inventory control
 internal and external auditors periodically verify the raw
materials and FGs inventories through a physical count
 30

World-Class Companies…
continuously pursue improvements in all
aspects of their operations, including
manufacturing procedures
are highly customer oriented
have undergone fundamental changes
from the traditional production model
often adopt a lean manufacturing model
 Principles of Lean
31
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
 Inventories cost money
 Inventories can mask production problems
 Inventories can precipitate overproduction
 Principles of Lean Manufacturing
32

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
 33
Lean Manufacturing Model
Achieve production flexibility by means of:
 Changes in the physical organization of
production facilities
 Employment of automated technologies
 CIM, AS/RS, robotics, CAD, and CAM
 Use of alternative accounting models
 ABC and value stream accounting
 Use of advanced information systems
 MRP, MRPII, ERP, and EDI
 Physical Reorganization
34
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.
 Progression of Automation
35
in the
Manufacturing Process

Traditional Islands of Computer

Technology Integrated
Manufacturing

Progression of Automation toward World-Class Status

 36
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
 WIP follows a circuitous route through the
different operations
 37
Automating Manufacturing
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
 38
Automating Manufacturing
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
 Reduce errors, improved inventory control, and
lower storage costs
Computer-Integrated Manufacturing (CIM)
39
System
 40
Automating Manufacturing
Robotics
 Usespecial CNC machines that are useful in
performing hazardous, difficult, and monotonous
tasks
Computer-Aided Design (CAD)
 Increases engineers’ productivity
 Improves accuracy
 Allows firms to be more responsive to market
demands
 Interfaces with CAM and MRPII systems
 41
Automating Manufacturing

Computer Aided Manufacturing

(CAM)
 Uses computers to control the physical
manufacturing process
 Provides greater precision, speed, and
control than human production processes
 Achieving World-Class
42
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
 What’s Wrong with43Traditional Accounting
Information?
 Inaccurate cost allocations – automation changes the
relationship between direct labor, direct materials, and
overhead cost
 Promotes nonlean 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
 Activity Based Costing
44
(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
45
 ABC – Pros
46
and Cons
 Advantages
 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 with cost intelligence to drive continuous
improvements
 Facilitating better marketing mix
 Identifying waste and non-value-added activities
 Disadvantages
 Too time-consuming and complicated to be practical
 Promotes complex bureaucracies in conflict with lean
manufacturing philosophy
 Value Stream Accounting
47

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
 Simpler than ABC accounting
Makes no distinction between direct and indirect
costs
 Including labor costs
 Cost Assignment to Value Stream
Sales Product Warehousing Manufacturing Shipping
Planning

Production Production Cell

Materials Labor Machines

Value Stream Product Family A

Marketing and Product Support Facilities Rent &

Design Labor Distribution Expenses
Selling Expenses Maintenance

Value Stream Product Family B

Production Production Cell

Materials Labor Machines
48
 49
Information Systems that Support Lean
Manufacturing
Manufacturing Resources Planning (MRP)
 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
MRP II
 An extension of MRP
 More than inventory management and production
scheduling – it is a system for coordinating the
activities of the entire firm
50
 51
Information Systems that Support Lean
Manufacturing
Enterprise Resource Planning (ERP)
Systems
 Huge commercial software packages that support the
information needs of the entire organization, not just the
manufacturing functions
 Automates all business functions along with full financial
and managerial reporting capability
Electronic Data Interchange (EDI)
 External communications with its customers and suppliers
via Internet or direct connection