ACCO20153 - ACCOUNTING INFORMATION SYSTEM

by: James Hall

CHAPTER 7

THE CONVERSION CYCLE

OBJECTIVES:

● Elements and procedures of a 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 system of lean manufacturing and world class companies.

The Conversion Cycle

● Transforms input resources, raw materials, labor, and overhead into finished products or services for
sale.
● Consist of 2 subsystems:
▪ Physical Activities – the production system.
▪ Information Activities – the cost accounting system

● Central role is the conversion cycle and interacts with other cycles.

Production 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.

Production System

● Involves the planning, scheduling, and control of the physical product through the manufacturing
process.
▪ Determining raw materials requirement
▪ 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.

Overview: Traditional Batch Production Model…

● Consists of four basic processes:

▪ Plan and control production
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▪ Perform production operations

▪ Maintain inventory control
▪ Perform cost accounting

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.
▪ 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
● Move Ticket – records work done in each work center and authorizes the movement of the batch.
● Material Requisition – authorizes warehouses to release raw materials for use in the production
process.

Batch Production Activities

● Production Planning and Control

▪ Materials and operations requirements
▪ Production scheduling
● Materials and Operations Requirements
▪ Materials requirements – 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 for
production demand.
▪ Provides production planning and control with status of finished goods and raw materials
inventory.
▪ Continually updates the raw materials inventory during the production process.
▪ Upon completion of production, updates finished goods inventory.

EOQ Inventory Model

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ACCO20153 - ACCOUNTING INFORMATION SYSTEM
by: James Hall

● Very simple to 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.

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

● Receipts 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 finished goods inventory account and
forwards to the general ledger department.

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 workstation authorize the movement of the batch through
the work centers
▪ Materials requisitions – authorize the warehouse to release materials to the work centers.
● 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.
● Supervision
▪ Work center supervisors oversee the usage of raw materials are used in production and waste
is minimized
▪ Employee time cards and job tickets are checked for accuracy.
● Access Control
▪ Direct Access to Assets
o Controlled access to storerooms, production work centers, and finished goods
warehouses
o Quantities in excess of standard amounts required approval.
▪ Indirect Access to Asset
o Controlled use of materials requisitions, excess materials requisitions and employee time
cards
● Accounting Records
▪ Pre-numbered documents
▪ Work orders
▪ Cost sheets
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▪ Move tickets
▪ Job tickets material requisitions
▪ WIP and finished goods files
● Independent Verification
▪ Cost accounting reconciles material usage (material requisition) and labor usage (job tickets)
with standards
o 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.

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 Manufacturing

● Pull Processing – products are pulled from the customer end (demand), not pushed from the
production end (supply)
● Perfect Quality – 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
▪ Inventories cost money
▪ Inventories can mask production problems
▪ 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 Attitudes –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:

▪ Changes in the physical organization of production facilities
▪ Employment of automated technologies
o CIM, AS/RS, robotics, CAD, and CAM
▪ Use of alternatives accounting models
o ABC and value stream accounting
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▪ Use of advance information systems

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

Automatic Manufacturing

● Traditional Approach to Automation

▪ Consists of many different types of machines which require a lot of set up 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.
● 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.
● 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.

● Robotics
▪ Use special CNC machines that are useful in performing hazardous, difficult, and monotonous
tasks.
● Computer-Aided Design (CAD)
▪ Increase engineer’s productivity
▪ Improves accuracy
▪ Allows firms to be more responsive to market demands
▪ Interfaces with CAM and MRP II systems
● Computer-Aided Manufacturing (CAM)
▪ Uses computers to control the physical manufacturing process.
▪ Provides greater precision, speed, and control that human production processes.

Achieving World Class Status

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ACCO20153 - ACCOUNTING INFORMATION SYSTEM
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● 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
▪ Efficiency 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-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 standards unit of measure

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 the traditional accounting system since ABC has multiple activity drivers, whereas
traditional accounting has only one e.g. machine hours.

ABC – Pros and Cons

● Advantages:
▪ More accurate costing of products/services, customers, and distribution channels
▪ Identify the most and least profitable products and customers
▪ Accurately tracking costs of activities and process
▪ 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

● Value Stream – all the steps in the 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
● Makes no distinction between direct and indirect costs.
▪ Including labor costs
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ACCO20153 - ACCOUNTING INFORMATION SYSTEM
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Information System 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.
● Manufacturing Resources Planning II
▪ An extension of MRP
▪ More than inventory management and production scheduling – it is the system for coordinating
the activities of the entire firm.

● Enterprise Resources Planning (ERP) Systems

▪ Huge commercial software packages that support the information needs of the entire
organization, not just the manufacturing functions.
▪ Automates all the business functions along with full financial and managerial report capability.
● Electronic Data Interchange (EDI)
▪ External communications with its customer and suppliers via internet or direct connection.

Review Questions:

1. Define the conversion cycle.

2. What activities are involved in the batch processing system?

3. Distinguish between continuous, batch, and made-to-order processing.

4. What documents trigger and support batch processing systems?

5. What are the primary determinants for both materials and operations requirements?

6. What are the objectives of inventory control in the production process?

7. What document triggers the beginning of the cost accounting process for a given production run?

8. What documents are needed for cost accounting clerks to update the work-in-process accounts with
standard charges?

9. What types of management reports are prepared by the cost accounting system?

10. What document signals the completion of the production process?

11. What functions should be separated to segregate record keeping from asset custody?

12. Give an example for each of the following control activities in the conversion cycle: transaction
authorization, segregation of duties, and access.

13. Distinguish between computer-aided design and computer-aided manufacturing.

14. What is meant by the statement, ‘‘Inventories camouflage production problems and can cause
overproduction’’? What is wrong with overproduction if you already own the raw material?
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15. What are the primary goals of lean manufacturing?

16. Distinguish between activities and cost objects in activity-based costing.

17. Differentiate between essential and nonessential activities.

18. What is meant by the term islands of technology?

19. Define computer-integrated manufacturing.

20. Define the term value stream.

CHAPTER 7 - THE CONVERSION CYCLE