Chapter 7

The Conversion Cycle

Principles of Accounting Information

Systems, Asia Edition
James A. Hall

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 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

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 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
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 Production System

 Involves the planning, scheduling, and control

of the physical product through the
manufacturing process

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 Production Methods

 Batch Processing

 Make-to-Order Processing

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 Overview: Traditional Batch
Production Model…
 consists of four basic processes:
 plan and control production
 perform production operations
 maintain inventory control
 perform cost accounting

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 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

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 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 .

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 Batch Production System
 Inventory Control
 Objective: minimize total inventory cost while
ensuring that adequate inventories exist of
production demand

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 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

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 EOQ Inventory Model
INVENTORY LEVEL

Inventory Cycle Daily Demand

EOQ

Reorder
Point

Lead Time Time (days)

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 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
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©2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
 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
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©2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
 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

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 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
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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

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 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

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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

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 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
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 Summary of Internal Controls

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 Internal Controls
 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
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 Internal Controls
 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

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 Internal Controls

 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

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 Internal Controls
 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
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 Internal Controls
 Accounting records
 pre-numbered documents
 work orders
 cost sheets
 move tickets
 job tickets
 material requisitions
 WIP and finished goods files

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 Internal Controls
 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
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 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

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 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
 Inventories cost money
 Inventories can mask production problems
 Inventories can precipitate overproduction
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 Principles of Lean Manufacturing
 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
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