The Conversion Cycle

1
Chapter 7

• The Conversion Cycle

2
Objectives for Chapter 7

• Elements and procedures of a traditional
  production process
• Data flows and procedures in a traditional cost
  accounting system
• Accounting controls in a traditional environment
• Operating features, philosophies, and
  technologies of a world-class company
• Just-in-time systems and the implications of
  maintaining excessive inventories in the
  world-class environment
• Importance of quality in the world-class
  environment
• Shortcomings of traditional accounting methods in
  the world-class environment
• Characteristics of a world-class information
  system

3
The Continuum of Manufacturing Practices
4
A World Class Company

• is a company that has achieved high standards and
  has undergone fundamental changes from
  traditional forms of organization and management
• continuously pursues improvement in all aspects
  of its operations, including its manufacturing
  procedures
• is highly customer oriented

5
Achieving World-Class 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 improvement in
  operations and products
• encourage the adoption of value-added activities
  and processes within the organization and
  identify those that do not add value
• efficiently support multiple users with both
  financial and nonfinancial information

6
The Conversion Cycle

• The conversion cycle transforms input resources,
  raw materials, labor, and overhead into finished
  products or services for sale.
• The conversion cycle consists of two subsystems
• the production system
• the cost accounting system

7
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

8
Production Methods

• Continuous Processing creates a homogeneous
  product through a continuous series of standard
  procedures.
• Batch Processing produces discrete groups
  (batches) of products. Each item in the batch is
  similar.
• Make-to-Order Processing involves the fabrication
  of discrete products in accordance with customer
  specifications.

9
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

10
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 information from the BOM and
  route sheet to specify the exact materials and
  production processes for each batch

11
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

12
Production Planning and Control
Sales Forecast Inventory Status
Report Engineering Specifications BOM and
route sheets
Raw Materials Requirements (Purchase
Requisitions) Operations Requirements
Production Scheduling
work orders move tickets materials
requisitions open work orders
work centers
cost accounting
job tickets time cards completed move tickets
payroll
prod. plan. and control
13
Upon Completion of the Production Process
Finished Product and Closed Work Order
Finished Goods Warehouse
Closed Work Order
Inventory Control
status report of raw materials and finished
goods journal voucher
Prod. Plan. and Control
General Ledger
14
EOQ Inventory Model

• Objective minimize total inventory costs while
  ensuring that adequate inventories exist to meet
  current demand
• 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

15
EOQ Inventory Model
2DS H
Q
Where Q economic order quantity D
annual demand in units S fixed
cost of placing each order H
holding or carrying cost per unit per year
16
EOQ Inventory Model
Inventory Cycle
Daily Demand
EOQ
INVENTORY LEVEL
Reorder Point
Time (days)
Lead Time
17
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 new batch and files in WIP file
• The records are updated as materials and labor
  are used

18
Elements of the Cost Accounting System
Inventory Control materials requisitions
Work Centers job tickets completed move tickets
COST ACCOUNTANTS
Update WIP accounts DL DM Mfg. OH. Compute
Variances
STANDARDS
19
Cost Accounting 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

20
Summary of Internal Controls
21
Internal Controls

• Transaction authorizations
• work orders reflect a legitimate need based upon
  sales forecast and the finished goods on hand
• move tickets (with authorized signature from each
  work station) authorize the movement of the batch
  through the various work centers
• materials requisitions authorize the warehouse to
  release materials to the work centers

22
Internal Controls

• Segregation of duties
• production planning and control department is
  separate from the work centers
• inventory control 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

23
Internal Controls

• Supervision
• supervisors in the work centers oversee the usage
  of raw materials in the production process to
  ensure that all released materials are used in
  production and waste is minimized
• employee time cards and job tickets are checked
  for accuracy

24
Internal Controls

• Access control
• direct access to assets
• storerooms, production work centers, and finished
  goods warehouses
• quantities in excess of standard amounts should
  require approval
• indirect access to assets
• materials requisitions, excess materials
  requisitions, and employee time cards

25
Internal Controls

• Accounting records
• pre-numbered documents
• work orders
• cost sheets
• move tickets
• job tickets
• material requisitions
• WIP and FGs files

26
Internal Controls

• Independent verification
• cost accounting reconciles material usage
  (material requisitions) and labor usage (job
  tickets) with prescribed standards, and variances
  are investigated
• GL dept. verifies the total movement from WIP to
  FG by reconciling journal vouchers from cost
  accounting and inventory subsidiary ledger
  summaries from inventory control
• internal and external auditors periodically
  verify the raw materials and FGs inventories on
  hand through a physical count

27
Trends in Competitive Advantage
28
The World-Class Environment and Manufacturing
Flexibility

• Customers
• want quality products
• want them quickly
• want variety
• Achieving manufacturing flexibility incorporates
  four operational characteristics
• physical reorganization of the production
  facilities
• automation of the manufacturing process
• reduction of inventories
• high product quality

29
Physical Reorganization of the Production
Facilities

• The inefficiencies inherent in the layout of
  traditional plants add handling costs,
  conversion, time, and excess inventories to the
  manufacturing process.
• Employees tend to feel ownership over their
  stations, which is contrary to a team concept.
• The reorganization is based on flows through
  cells which shorten the physical distance between
  the activities, thus reducing setup and
  processing time, handling costs, and inventories
  in the flow.

30
Progression of Automation in the Manufacturing
Process
Process Simplification (JIT)
Islands of Technology
Computer Integrated Manufacturing
Traditional
Progression of Automation toward World-Class
Status
31
Automation of the Manufacturing Process

• Traditional
• 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
• Islands of Technology
• stand alone islands which employ computer
  numerical controlled (CNC) machines that can
  perform multiple operations with less human
  involvement
• less set up time needed

32
Automating Manufacturing
33
Automating Manufacturing

• Process Simplification
• reduces the complexity of the physical layout
• groups of CNC machines are arranged in cells to
  produce an entire part from start to finish
• no human involvement in a cell
• Computer Integrated Manufacturing (CIM)
• a completely automated environment which employs
  automated storage and retrieval systems (AS/RS)
  and robotics

34
Automating Manufacturing

• Robotics
• use special 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

35
Automating Manufacturing

• Computer Aided Manufacturing (CAM)
• uses computers to control the physical
  manufacturing process
• provides greater precision, speed, and control
  than human production processes
• Manufacturing Resources Planning (MRP II)
• an extension of materials requirements planning
  (MRP)
• more than inventory management--it is a system
  for coordinating the activities of the entire
  firm

36
Automating 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

37
Accounting and MRP
38
The Evils of Inventories

• Inventories cost money and
• represent an investment
• need to be insured and stored
• can become obsolete over time
• Inventories camouflage production problems.
• Willingness to maintain inventories can
  precipitate overproduction.

39
How can inventories be reduced?

• Just-in time (JIT) manufacturing is a model that
  fosters inventories reduction and even
  elimination. It is based on the following
  assumptions
• zero defects
• zero setup time
• small lot sizes
• zero inventories
• zero lead times and reliable vendors
• team attitude

40
Product Quality

• is important because poor quality is expensive to
  the firm via scrap, reworking, scheduling delays,
  extra inventories to compensate for defective
  parts, warranty claims, and service
• is a basis on which world-class manufacturers
  compete
• can be improved though control point methods such
  as statistical process control

41
Whats Wrong with Traditional Cost Accounting
Information?

• Inaccurate cost allocations
• Time lag in reporting
• Financial orientation
• Emphasis on standard costs

42
Activity Based Costing (ABC)

• is an information system that provides managers
  with information about activities and cost
  objects
• assumes that activities cause costs and 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

43
Allocation of Costs Using ABC
44
Activity Management

• Managers must understand which activities should
  be performed and how best to perform them.
• Managers should deploy resources to activities
  that yield maximum benefits.
• Managers should seek to improve those factories
  most important to their customers.

45
Activity Management Tasks

• Evaluating manufacturing activities
• Identifying nonessential activities
• Identifying cost drivers
• Comparing activities to benchmarks
• Establishing links
  between key activities

46
The World-Class Information System

• is the integration of all the systems functional
  and technological components
• basic accounting applications
• ABC
• materials requirements planning
• capacity planning
• inventory control
• bill-of-materials
• master productions schedule
• forecasting
• order entry
• computer-aided design
• computer-aided manufacturing
• EDI communications links

47
Need for New Performance Measures in the
Information Pyramid
48
Control Issues in the WCIS

• Paperless environment - no traditional audit
  trail
• Automatic transactions - need assurance that
• the system places orders only when inventory is
  needed
• inventory orders are placed only with approved
  vendors
• the quantity of items ordered is correct for the
  needs of the organization
• programmed procedures matching electronic
  controls data before initiating payment perform
  correctly
• Networking considerations