The Conversion Cycle

Chapter 7: The Conversion Cycle

• Elements and procedures of a traditional production process are covered
• Review data flows and procedures in a traditional cost accounting system
• Examines accounting controls in a traditional environment
• Discusses the principles, operating features, and technologies of lean manufacturing
• Explores the shortcomings of traditional accounting methods in the world-class environment
• Focuses on key features of activity-based costing and value stream accounting
• Overviw information systems of lean manufacturing and world-class companies

The Conversion Cycle Explained

• Transforms raw materials, labor, and overhead into finished goods or services
• Consists of the physical activities (production system) and information activities (cost accounting system)

Production System Overview

• Involves planning, scheduling, and controlling the physical product
• Key activities include determining raw material needs, authorizing material release, authorizing production work, and directing work through production stages

Types of Production Methods

• Continuous Processing: Creates a uniform product through standardized procedures
• Batch Processing: Produces goods in discrete groups
• Make-to-Order Processing: Creates products to meet specific customer requirements

Traditional Batch Production Model

• Involves planning and controlling production, performing operations, controlling inventory, and performing cost accounting

Batch Production System - Production Planning and Control

• Involves managing materials and operations requirements through production scheduling
• Materials Requirement: The difference between what is needed and available in inventory
• Operations Requirements: The assembly and manufacturing activities for the product

Batch Production System - Production Scheduling

• Coordinates multiple batches while considering time, batch size, and specifications

Batch Production System - Work Centers and Storekeeping

• Production begins when work centers get materials from storekeeping
• Ends when the product is sent to the finished goods warehouse

Batch Production System - Inventory Control Objective

• Minimize total inventory cost and ensure adequate inventories for production demand
• Production planning and control with finished goods and raw materials inventory status provided
• Raw material inventory updated during production; finished goods inventory updated upon completion

EOQ Inventory Model Assumptions

• Demand and ordering lead time are known and constant
• Total ordering cost decreases as order quantities increase
• Carrying costs increase with order quantity and there are no quantity discounts

Batch Production System Documents

• Sales Forecast: Expected demand for finished goods.
• Production Schedule: Plan and authorization to produce
• Bill of Materials (BOM): Lists types and quantities of materials for a single finished unit

Batch Production System - Route Sheet

• Details the path of a specific batch in manufacturing including the operation sequence, and time allotted per station
• Work Order: Uses the BOM and route sheet to specify materials and processes for each batch

Batch Production System - Move Ticket

• Records the work done in each work center and authorizes batch movement

Batch Production System - Materials Requisition

• Authorizes the inventory warehouse to release raw materials for production

Internal Controls - Transaction Authorizations

• Work orders: Ensure legitimate production needs, based on sales forecasts and inventory levels
• Move tickets: Signatures at each workstation authorize batch movement
• Materials requisitions: Authorize the release of materials for the work centers

Internal Controls - Segregation of Duties

• Separate: Production planning and control from work centers
• Separate: Inventory control from material storeroom and finished goods warehouse
• Separate: Cost accounting for work in progress from the production process

Internal Controls - Supervision

• Supervisors: Oversee raw material use to minimize waste and ensure production use
• Employee Time Cards and Job Tickets: Checked for accurac

Internal Controls - Access Control

• Direct Access: Controlled access to storerooms, work centers, and finished goods warehouses; requires approval for excess quantities
• Indirect Access: Controlled use of materials and access requisitions

Internal Controls - Accounting Records

• Pre-numbered: Documents, work orders, cost sheets, move tickets, job tickets, and material requisitions logged in WIP, and finished goods files

Internal Controls - Independent Verification

• Cost Accounting: Reconciles material/labor usage with standards; investigates variances
• General Ledger Department: Verifies WIP to FG movement by reconciling vouchers
• Internal/External Auditors: Periodically verify inventories through physical counts

World-Class Companies - Characteristics

• Continuously improve all aspects of operations
• Customer-oriented with changes from traditional models
• They often adopt a lean manufacturing model

Lean Manufacturing Principles

• Pull Processing: Driven by consumer demand, not production-end supply
• Perfect Quality: Requires zero defects in inventories
• Waste Minimization: Activities not adding value are eliminated
• Inventory Reduction: Critical, inventories cost money, mask problems and overproduction arises

Lean Manufacturing - Flexibility

• Production flexibility: Minimal setup time allows diverse products without efficiency loss
• Supplier relations: Reliable suppliers are vital to prevent production shutdown
• Team Attitude: Vigilance in protecting continuous production flow, from all employees

Lean Manufacturing Model Flexibility

• Changes: Physical organization of production, automated technologies like CIM, alternative accounting models, and advanced information systems

Reorganization of Production Facilities

• Corrects inefficiencies from traditional layouts to reduce handling costs, conversion time, and excess inventories

Automating Manufacturing - Traditional Approach

• Includes different machines needing setup time, with machines and operators in departments, and inefficient WIP routing

Automating Manufacturing - Islands of Technology

• Employs computer numerical controlled (CNC) machines for multiple operations

Automating Manufacturing - CNC Machines

• CNC Machines: Reduce layout complexity, arranged in cells for complete part production
• Need less setup time

Automating Manufacturing - Computer Integrated Manufacturing(CIM)

• Automated Environment: Storage, retrieval systems (AS/RS), and robotics are employed

Automating Manufacturing - Automated Storage and Retrieval Systems(AS/RS)

• Replaces traditional forklifts with computer-controlled systems which improves inventory control while reducing errors and storage costs

Automating Manufacturing - Robotics

• Use: Special computer numerical controlled (CNC) machines for hazardous, difficult monotonous tasks

Automating Manufacturing - Computer Aided Design (CAD)

• Increases engineers' productivity, improves accuracy, and allows firms responsiveness to market demands plus interfaces with CAM and MRPII systems

Automating Manufacturing - Computer Aided Manufacturing(CAM)

• Uses computers to control physical processes, providing greater precision, speed, and control than human processes

World-Class Status - Accounting Needs

• New accounting methods + information systems needed
• Firms require to show what matters to customers, identify profitable products, customers, and opportunities
• Encourage value-added activities, minimize waste, and efficiently support all information users

Traditional Accounting - Inaccuracies

• Inaccurate - Cost allocations are inaccurate
• Nonlean - Promotes nonlean behaviors
• Time-lag - Suffer from time-lag, financial centric

Activity Based Costing (ABC)

• Provides information about activities and cost objects and assumes activities drive costs
• Differs from traditional accounting and has multiple activity drivers

ABC - Advantages vs. Disadvantages

• Advantages: Accurate product/customer costing, better tracking and intelligence, facilitates marketing, and identifies waste
• Disadvantages: Time-consuming, complex, and may promote bureaucracy conflicting with lean manufacturing

Value Stream Accounting

• Employs all steps to produce a product plus cuts across functions and departments
• Captures costs by its value stream
• Simpler than ABC accounting and makes no distinction between direct and indirect costs, including labor costs

Manufacturing Resources Planning (MRP)

• Ensures material adequacy, maintains minimal inventory and is used to produce production and purchasing schedules

Manufacturing Resources Planning (MRP II)

• Coordinates the entire firm's activities

Enterprise Resource Planning (ERP) Systems

• Huge commercial software packages that support the information needs of the entire organization
• Automates business functions with reporting capability

Electronic Data Interchange (EDI)

• Facilitates external communications and internet connectivity with customers and suppliers