Conversion Cycle

MGMT 549

Conversion Cycle

Last Revised: 10/10/22 06:00

http://www.mgt.unm.edu/

Conversion Cycle Overview The conversion cycle transforms raw materials, labor, and overhead items into finished goods or services for sale.

Two primary subsystems:Production system (a physical system)Cost accounting system (an information system)

A physical production system examplehttp://www.youtube.com/watch?v=UxLzPhm4_Rs

http://www.youtube.com/watch?v=UxLzPhm4_Rs

http://www.youtube.com/watch?v=UxLzPhm4_Rs

Conversion Cycle Interaction With Other Transaction Cycles

Hall, Accounting Information Systems 6e (978-0-324-56089-3), Figure 7-1, Copyright © 2008 Cengage Learning

Revenue Cycle ExpenditureCycle

Purchase Requisitions

Marketing System

ConversionCycle

SalesForecast

Sales Orders

Labor Usage

General Ledgerand Financial ReportingSystem

WorkInProcess

FinishedGoods

Conversion & Logistics Overview

Planning Processes Planning processes determine:

What goods and services will be producedHow they’ll be producedWhen they’ll be producedResource requirements (including money)

MarketingDetermines product/service demand and characteristics

Usually works hand-in-hand with R&D to develop new products and refine existing ones

Primary planning output is a sales forecast, which estimates what goods (with what characteristics) can be sold, when, and for how much money

Planning Processes - Continued Research & development activities

Design, develop, and evaluate product/service prototypes (in conjunction with marketing)

Perform preliminary evaluation of engineering, cost, and production feasibility

Define initial product/service specifications Engineering activities

Finalize product/service specificationsDesign/develop automated and manual production processes

Determine material, equipment, and skill requirements

Generate a bill of materials and route sheet (a.k.a. operations list) for each product/service

Planning Processes - Continued Capital budgeting and finance

Work with engineering to determine/refine estimates of production costs and capital requirements

Provide capital to acquire/maintain plant and equipment

Provide working capital to support ongoing operations Raw materials Human resources Other production/logistics expenses

SchedulingMatch anticipated or actual product/service demand to productive capacity

Maximize productive use of production assets/capacityMaintain the production schedule and generate production orders

Resource Management Processes Maintenance and control

Acquire, install, and configure plant and equipmentMaintain and upgrade plant and equipment

Human resourcesHire/train employeesMatch employee skills to production skill requirements

Inventory controlPurchase needed raw materials and supplies to maintain optimal inventory quantities (using EOQ, JIT, …)

Receive, inspect, and store raw materialsDispatch raw materials to production processesMonitor/manage movement of work in processWarehouse and ship finished goods

Production Processes Production activities

Direct the movement of work in progress through the various stages of production (overlaps inventory control process)

Implement production processes (bake, forge, machine, paint, assemble, …)

Monitor/enhance production efficiency and output quality

Production methods/modes: Continuous processing - creates a homogeneous product through a continuous series of standard procedures – for example, oil refining or assembly of iPads

Batch processing - produces discrete groups (batches) of products – for example, a commercial bakery or microchip fab

Make-to-Order processing – fabricates or assembles discrete products (or small batches) in accordance with customer specifications – for example, Dell computer responding to an online customer configuration order

Questions Which of the three production methods described on the previous slide are used by a typical automobile manufacturing plant? Which are used by an out-sourcing pharmaceutical manufacturer?

How would the production overview described thus far differ in a service industry such as a public accounting firm or a call center?

Flow of Production Documents


Production Flowchart


Batch Production Documents Sales Forecast - Expected demand (quantity, characteristics, and timing) for the finished goods

Production Schedule - Production plan and authorization to produce

Finished goods “recipe” (ingredient list and instructions):Bill of Materials (BOM) - Specifies the types and quantities of the raw materials and subassemblies used to produce a single finished good or batch of finished goods

Route Sheet – Describes the production path a particular product/batch will take and the operations applied at each stage

Sequence of operations Physical specifics of each operation Time allotted to each operation

Batch Production Document Samples

Hall, Accounting Information Systems 6e (978-0-324-56089-3), Figures 7-4/5, Copyright © 2008 Cengage Learning

Batch Production Documents - Continued

Work Order Starts as a combination of the BOM and route sheet

Adds actual production statistics including units produced and consumption of time and materials

May compute variances and track scrap/defects Move Ticket - Summarizes work completed in a work center and authorizes the movement of the batch to the next work center

Materials Requisition - Authorizes the inventory warehouse to release raw materials for use in the production process

Batch Production Document Samples

Hall, Accounting Information Systems 6e (978-0-324-56089-3), Figures 7-6/7/8, Copyright © 2008 Cengage Learning

Exercise Imagine that you run a large business that sells thousands of cases per month of 10 “New Mexican” salsa products made out of the same basic ingredients. Your basic production processes are adding ingredients, mixing, cooking, bottling, labeling, and packing.

Which batch production documents would you employ?

List some sample content of one of the production documents.

Internal Control Issues Authorization

Production initiated in response to valid production or sales orders

Release of raw materials in response to valid materials requisition

Authorization of moves from one production station to another via routing slip (often not implemented)

Segregation of dutiesProduction authorization comes from outside production

Inventory release authorization comes from outside inventory/stores

Physical asset custody (inventory, WIP, finished goods, and equipment separated from related record-keeping

Internal Control Issues - Continued

Records/documentsAll production and inventory documents:

Authenticity Access controls Archiving

Separate accounting records updated from authorization and other documents:

Inventory subsidiary ledgers (raw materials and finished goods)

Fixed assets subsidiary ledger

Internal Control Issues - Continued

Independent verification and reconciliation:Physical inventory counts compared to subsidiary ledgers

Physical inventory, condition, and assumptions compared to fixed asset subsidiary leger

Finished goods subsidiary ledger to production source documents (production/sales order, materials requisition, routing slip, time sheets, …)

Payroll source and output documents to labor-related production documents

Subsidiary ledgers to general ledger

Cost Accounting System Goals Record the financial effects of production events

Enable identification and correction of production process problems or inefficiencies

Support decisions about acquisition, reallocation, and disposal of production resources

Support profitability analysis for specific products and detemine allocation of production resources to maximize profitability

Don’t “get in the way” of production and decision-making processes!

Approaches to Cost Accounting Standard-costing

Practices and principles developed over many decades

Showing its age – better suited to production methods and organizations of the past, not present or future

Activity-based costingA modern replacement to standard-costing

Addresses some cost accounting shortcomings The “cure” may be worse than the disease

Value stream accountingA far-reaching but rather nebulous concept that’s difficult to apply in the real world

Standard-Cost Accounting Principles

Costs are categorized as:Direct costs – Costs easily traceable to a single product or batch (e.g., the raw materials and labor time required to assemble one laptop computer)

Indirect costs – Sometimes called overhead costs (imprecise) - costs that are difficult to accurately assign to specific products or batches (e.g., heating costs of a building that houses multiple production processes)

Work-in-process “accumulates” direct and indirect costs as it moves through production processesVisualize a car moving down the assembly line with attached and full-costed copies of all materials requisitions and work orders from previous stations

Standard-Cost Accounting PrinciplesContinued

Accumulated costs are compared to standard costs (predetermined benchmarks)

Cost variance (difference between accumulated and standard cost for a product) indicate:Need to revise standards (e.g., to reflect changes in raw material cost or production efficiency), AND/OR

Need to bring an “out-of-control” production process into standards compliance (e.g., a machine needs maintenance/replacement or a poorly-performing employee needs additional training or to be terminated)

Elements of a Standard-Cost Accounting System

Inventory Controlmaterials requisitions

Work Centersjob ticketscompleted move tickets

STANDARDS

COST ACCOUNTINGUpdate WIP accounts direct labor direct materials manufacturing overheadCompute Variances

Standard-Cost Accounting Procedures


What’s Wrong With Standard-Cost Accounting

Time warp – It was designed for a world with higher variable and lower fixed costs (i.e., labor-intensive production processes)

Inaccurate cost allocations – Automation changes the relationship between direct labor, direct materials, and overhead cost

Promotes “fat” 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 – Money as the standard/only unit of measure

Activity-Based Costing Activity-based costing is a cost accounting paradigm centered around activities and cost objects instead of products, standard costs, and cost allocations to products:Activity – Unit of work or a work process such as preparing a document, operating a production machine, or packing a product for shipment

Cost object - Any product, service, customer, contract, project, process, or other work unit for which a separate cost measurement is desired

Activity driver - The best single quantitative measure of the frequency and intensity of the demands placed on an activity by cost objects or other activities - used to allocate activity costs to cost objects or to other activities

Cost Allocation Under ABC


Quick Exercise Which activities in the previous slide wouldn’t be directly accounted for in a standard-cost system?

Activity-Based Costing – AIS Issues

Activity-based costing encourages cost examination at a more detailed level than standard costing: Dozens to thousands of activities Many cost objects

Tracing/allocating costs based on this many activities and objects would be impossibly complex and error-prone with paper and pencil

Automated information systems can deal with the complexity of data collection, storage, and processing

Automated information systems can only do so much to make the resulting information tractable/usable to/by human decision-makers

Activity-based costing can be successfully applied if decision-making can be automated in addition to data collection, storage, and processing

Value Stream Mapping Value streams (a.k.a. value chains) are process maps that decompose production and related activities into processes that add specific value to a product

Value stream accounting attempts to measure costs associated with value stream elements and match them to related product value attributes, for exampleAre you spending $100 to add $20 worth of value in an “optional feature” of your product.

Value Stream Mapping Pros and Cons

VSM is best applied to repetitive high-volume production processes with linear relationships among production steps and among product components VSM helps to identify bottlenecks and inefficiencies VSM focuses attention on areas where eliminating or redesigning processes will yield maximal benefit

VSM works poorly when product configuration can vary significantly and when value in a “selling price” sense is difficult to trace to specific production activities – for example, What are the value stream elements of a production facility that produces both economy and luxury vehicles?

What are the value stream elements that generate improved vehicle reliability?

VSM is more relevant to high-level planning and management control than to day-to-day production and related transaction processing and financial records

Lean Manufacturing Lean manufacturing – a set of manufacturing principles and techniques that attempt to minimize resource inputs, increase flexibility, and shorten production time – often with significant application of computer and information technology

Key principles and techniquesDemand-driven (pull processing) production

Continuously measure demand (convert from batch to make-to-order production where possible)

Schedule production to meet measured demand quickly and precisely

Zero defects Design production processes to eliminate defects in final products

Detect WIP defects as early as possible Employ production processes that guarantee few or zero defects (e.g., 6Σ)

Lean Manufacturing Principles and Techniques - Continued

Minimize use/waste of time, materials, and other resources To some extent, a natural consequence of previous two principles:

Don’t produce what isn’t known to be sellable Don’t waste anything to produce the product

Choose production methods and technology that maximize production speed and efficiency

Just-in-time inventory Minimize stocking of raw materials and other production inputs

Make suppliers your partners: Integrate information systems to coordinate their production with your scheduling and ordering

Co-locate production facilities to minimize transport time and cost

Reduce or eliminate set-up time – choose production processes than can be reconfigured for new products or models as quickly as possible

Exercise Consider a manufacturing company, e.g.,Intel, Johnson & Johnson, General Mills, GM, Dell

Describe specific examples of as many lean manufacturing principles and techniques as possible

Computer- and Software-Related Production Terminology

Computer-aided design (CAD) – computer modeling of products or production processes – used to:Speed design/developmentImprove qualityDigitally integrate R&D with engineeringCreate automated inputs to CAM

Computer-aided manufacturing (CAM) – use of computers/software in to implement/control manufacturing – e.g.,Program robotic assembly based on CAD part and product models

Automated movement of materials and WIPAutomated process monitoring and control

More Computer- and Software-Related Production Terminology

Materials resource plan (MRP) – short-term automated purchasing, scheduling, and inventory control

MRP-2 – adds medium- and long-term Enterprise resource planning (ERP) – Integrated application software suite with “modules” for functional areas (e.g., MS Dynamics and SAP)

Computer integrated manufacturing (CIM) Textbook: CAD plus CAM plus ERPGeneric: Synonym for CAM

Just-in time production – integrated sales order capture with CAM, MRP, and JIT purchasing and inventory control

Conversion-Related Financial Statement Frauds

Conversion-related risk areas for financial statement fraud include: Allocation of fixed costs Capital vs. operating costs Valuation of inventory

Fixed costs issues: Most manufacturing firms have high fixed costs Fixed costs are allocated to WIP and finished goods inventory via formulas based on estimates:

Fixed costs not yet allocated are an expense (income statement item

Fixed costs already allocated are either an asset (WIP or FG inventory) or a cost matched to a revenue stream (COGS)

Since financial statement ratios are common analysis tool used by analysts and investors, management can manipulate the ratios (choose which ones to “improve” at the expense of others) by manipulating fixed cost allocation estimates and production timing

Classification Issues Costs can be shifted from the income statement to the balance sheet by incorrectly classifying operating expenses as capital expenses – e.g.,Classify an expensive repair as a capital improvement

Replace an obsolete machine with positive book value but don’t dispose of the old one and keep it “on the books”

Inventory valuations can be manipulated by mislabeling and other means, e.g.,Counting rework not yet completed as finished goodsLabeling a shipping carton of 3G phones as 4G phones