The Conversion Cycle in a Traditional Manufacturing Environment • A company’s conversion cycle transforms (converts) input resources, such as raw materials, labor, and overhead, into finished products or services for sale. • Materials requirements planning (MRP) systems are used to determine how much raw materials are required to fulfill production orders. • The conversion cycle consists of both physical and information activities related to manufacturing products for sale • One of the following production methods is used: – Continuous processing creates a homogeneous product through a series of standard procedures. – Made-to-order processing involves fabrication of discrete products in accordance with customer specifications. – Batch processing produces batches of discrete products. Batch Processing System Documents in the Batch Processing System • The production schedule is the formal plan and authorization to begin production. • The bill of materials (BOM) is a document that specifies the types and quantities of the raw materials and subassemblies used in producing a single unit of finished product. • A route sheet is a document that shows the production path a particular batch of products follows during manufacturing. • The work order (or production order) is a document that draws from bills of materials and route sheets to specify the materials and production for each batch. • A move ticket is a document that records work done in each work center and authorizes the movement of the job or batch from one work center to the next. • A materials requisition is a document that authorizes the storekeeper to release materials to individuals or work centers in the production process. Batch Production Activities • Production planning and control: – Specifying materials and operations requirements. – Production scheduling. • Material and operations requirements: – Requirement is the difference between what is needed for the batch and what is available in the RM inventory. – Purchase requisitions created for additional RM needs. • Production scheduling: – Master schedule coordinates productions of different batches. – Produces work orders, move tickets, and material requisitions for each batch with copies of work orders sent to cost accounting. • Work centers and storekeeping: – Production begins when workers obtain raw materials. – When task completed move ticket authorizes batch to proceed to next work center with copy sent to production planning. – Finished products sent to FG warehouse and copy of work order sent to inventory control to update FG inventory records. – Work center supervisors send employee time cards and job tickets to payroll and cost accounting. • Inventory control: – Provides production planning and control with status reports on finished goods and raw materials inventory. – Continual updates of raw materials inventory. – Records completed production by updating FG inventory records. EOQ Inventory Model • Objective of inventory control is to minimize total inventory cost while ensuring adequate inventories to meet demand. – When and how much inventory should be purchased? • The economic order quantity (EOQ) model is an inventory model designed to reduce total inventory costs. The reorder point (ROP) is the lead time multiplied by daily demand. Safety stock is additional inventories added to the reorder point to avoid unanticipated stock-out conditions. Economic order quantity (EOQ) model based on assumptions that may not reflect economic reality: – Demand is constant and known with certainty. – Ordering lead time is known and constant. – All inventories in the order arrive at the same time. – Total yearly cost of placing orders decreases as order quantities increase. – Carrying costs increase as quantity of inventory orders increases. – No quantity discounts so purchase price is constant. Cost Accounting Activities • Record the financial effects of the physical events occurring in the production process. • Begins when the production planning and control department sends the work order to cost accounting. • 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. – Deviations from standards are recorded to produce variances. • Receipt of last move ticket signals completion of production and transfer for WIP to FG inventory. – WIP account is closed, journal vouchers are recorded and sent to the GL department for posting to the control accounts. Controls in the Traditional Environment • Transaction authorizations: – Production planning and control authorize the production activity via a formal work order. – Move tickets signed by supervisors authorize batch activities and product movement through work centers. – Materials requisitions and excess material requisitions authorize storekeeper to release materials to work centers. • Segregation of duties: – Separation of transaction authorization and processing. – Separation of record keeping from asset custody. • Inventory control records separate from storerooms and warehouses. • Cost accounting separate from production work centers. • GL separate from subsidiary accounting records. • Supervision: – Work center supervisors oversee RM usage to ensure all released materials are used in production and waste is minimized. – Employee time cards and job tickets are checked for accuracy. • Direct access to assets: – Limited access to sensitive areas. – Quantities in excess of standards require approval. • Indirect access to assets: – Control over critical source documents, including the use of pre-numbered documents. • Accounting records: – Objective is to establish an audit trail for each transaction. • Independent verification: – Cost accounting reconciles material and labor usage with standards and investigates variances. – 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 and Lean Manufacturing • Over the past three decades’ rapid swings in consumer demands, shorter product life cycles, and global competition have radically changed the rules of the marketplace. • In an attempt to cope with these changes, manufacturers have begun to conduct business in a dramatically different way. • The term world-class defines this modern era of business. What is a World-Class Company? • World-class companies must maintain strategic agility and be able to turn on a dime. • World-class companies motivate and treat employees like appreciating assets. • A world-class company profitably meets the needs of its customers. • The philosophy of customer satisfaction permeates the world-class firm. Lean manufacturing improves efficiency and effectiveness in product design, supplier interaction, factory operations, employee management, and customer relations. Principles of Lean Manufacturing • Evolved from Toyota Production System (TPS) which is based on the just-in-time (JIT) production model is a philosophy that addresses manufacturing problems through process simplification. – Goal is improved efficiency and effectiveness in every area. • Pull processing involves pulling products from consumer end (demand) rather than pushing from production end (supply). It is the principle characterizing the lean manufacturing approach where products are pulled into production as capacity downstream becomes available. Products are pulled from the consumer end (demand). • Perfect quality (zero inventory defects) is required for pull processing success. • Waste minimization requires activities that do not add value or maximize the use of scarce resources be eliminated. – Involves financial, human, inventory and fixed assets. • Inventory reduction is the hallmark of lean manufacturing. – Inventories cost money, camouflage production problems and can precipitate overproduction. • Production flexibility strives to reduce setup time to a minimum, allowing for the production of a greater diversity of products quickly, without sacrificing efficiency. • Established supplier relations are mandatory as late deliveries, defective raw materials, or incorrect orders will shut down production due to lack of inventory reserves. • Team attitude requires each employee to be vigilant of problems that threaten the continuous flow of production line. Techniques and Technologies that Promote Lean Manufacturing Modern consumers want quality products, they want them quickly, and they want variety of choice. This demand profile imposes a fundamental conflict for traditional manufacturers, whose structured and inflexible orientation renders them ineffective in this environment. • • Manufacturing flexibility is the ability to physically organize and reorganize production facilities and the employment of automated technologies. Physical reorganization of production facilities: – Simplified facility arrangement shortens the physical distance between activities reduces setup and processing time, handling costs and inventories. – Traditional manufacturing facilities tend to evolve into snakelike sequences of activities. – The inefficiencies inherent in this layout add handling costs, conversion time, and even inventories to the manufacturing process. – The flexible production system is organized into a smooth-flowing stream of activities. – Computer-controlled machines, robots, and manual tasks that comprise the stream are grouped physically into factory units called cells. • • • • • • • • Automation of the manufacturing process: – By replacing labor with automation, firm can reduce waste, improve efficiency, increase quality and improve flexibility. – Traditional manufacturing consists of a range of different machines each controlled by a single operator. – Islands of technology is an environment where modern automation exists in the form of islands of computer numerical controlled machines that perform multiple operations with little human involvement or it stand alone within the traditional setting. Computer numerical controlled (CNC) machines can perform multiple operations with little human involvement. The computer contains programs for all parts being manufactured by the machine. Computer-integrated manufacturing (CIM) is a completely automated environment with the objective of eliminating non-value added activities. Automated storage and retrieval systems (AS/RS) are computer-controlled conveyor systems that carry materials to the shop floor and finished products to the warehouse. – Reduced errors, improved inventory control, lower storage costs. Robotics uses robots to perform specific actions over and over with a high degree of precision. – Also used in hazardous environment or for performing dangerous and accidentprone monotonous tasks. Computer-aided design (CAD) is used to design better products faster. – Increases productivity and accuracy and allows firms to be more responsive to market demand. – Shortens time between initial and final design. – Advanced systems design product and process simultaneously. Computer-aided manufacturing (CAM) is the use of computers to assist the manufacturing process. – Output of the CAD system is fed to the CAM system. – Benefits include improved process productivity, cost and time estimates, process monitoring and quality, and decreased setup and labor costs. Value Stream Mapping – Essential activities add value; nonessential activities do not and should be eliminated. – A company’s value stream includes all the steps in the process that are essential to producing a product. – A value stream map (VSM) is a graphical representation of the business process to identify process aspects that are wasteful and should be eliminated. Works best in focused, high-volume processes which benefit from reducing repetitive processes by even small amounts of time. Less effective in low-volume processes in which employees frequently switch between multiple tasks. Accounting in a Lean Manufacturing Environment • Lean companies require new accounting methods and new information that: 1. Shows what matters to their customers (such as quality and service). 2. Identifies profitable products. 3. Identifies profitable customers. 4. Identifies opportunities for improvement in operations and products. 5. Encourages the adoption of value-added activities and processes within the organization and identifies those that do not add value. 6. Efficiently supports multiple users with both financial and nonfinancial information. What’s Wrong with Traditional Accounting Information? • Inaccurate cost allocations occur because overhead is assumed to be directly related to direct labor. – Automation changes the relationship between direct labor, direct materials, and overhead costs which becomes more significant. – Using standard costs leads to distortions in a lean environment. • Promotes non-lean behavior due to incentives to produce large inventories and conceal waste in overhead allocations. • • Time lags as standard cost data are historic in nature. – After-the-fact info is too late to be useful in a lean environment. Financial orientation is not always suitable for evaluations pertaining to functionality and improvements. Activity Based Costing (ABC) • Method that allocates costs to facilitate planning and control by assigning costs to activities and cost objects. – Activities describe work performed in a firm. – Cost objects are the reasons for performing activities. • Assumes that activities cause costs and that products (and other cost objects) create a demand for activities. • First step is to determine the cost of an activity and an appropriate activity driver is a factor that measures the activity consumption by the cost object. – ABC uses multiple activity drivers, whereas traditional accounting has only one, e.g. machine or labor hours. Advantages and Disadvantages of ABC • Advantages: – More accurate costing of products/services, customers, and distribution channels. – Identifying the most and least profitable products and customers. – Accurately tracking costs of activities and processes. – Equipping managers 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 of process simplification and waste elimination. Value Stream Accounting • Captures costs by value stream rather than by department or activity making it simpler than ABC accounting. • Value streams cut across functional and departmental lines and includes nonmanufacturing costs. • Essential aspect is defining the product family (share common processes from the point of placing the order to shipping the finished goods to the customer). • Makes no distinction between direct and indirect costs. – Raw materials based on purchases and all employee labor costs of employees in the value stream are included. • Typically, only allocated cost is a charge for the facility – Overhead costs which cannot be controlled are not allocated. Information Systems that Support Lean Manufacturing • Materials Requirement Planning (MRP) is an automated production planning and control system used to support inventory management. It is systems used to plan inventory requirements in response to production work orders. Its operational objectives are to: – 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 Resource Planning (MRP II) is an extension of MRP that has evolved beyond inventory management. It integrates product manufacturing, product engineering, sales order processing, customer billing, human resources, and related accounting functions, thus, incorporates techniques to execute the production plan, provide feedback, and control the process. – – • Coordinates a wide range of manufacturing activities. Benefits include improved customer service and cash flow, reduced inventory, increase productivity, help in achieving long-term goals and managing change and production flexibility. Benefits of the MRP II: Improved customer service Reduced inventory investment Increased productivity Improved cash flow Assistance in achieving long-term strategic goals Help in managing change (e.g., new product development or specialized product development for customers or by vendors) Flexibility in the production process Enterprise Resource Planning (ERP) Systems are software suites that integrate the entire organization into one system connected to a single common database. It is a system assembled of prefabricated software components. – An electronic data interchange (EDI) communication link allows firm to interact with customers and suppliers via Internet or direct connection. It is an intercompany exchange of computer-process able business information in standard format.
