MGT 549
Conversion Cycle
Last Revised: 3/15/2016 1:33 AM
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)
Conversion Cycle Interaction With Other
Transaction Cycles
Marketing
System
Sales
Forecast
Purchase Requisitions
Revenue Cycle
Sales Orders
Conversion
Cycle
Expenditure
Cycle
Labor Usage
Work
In
Process
Finished
Goods
General Ledger
and Financial
Reporting System
Hall, Accounting Information Systems 6e (978-0-324-56089-3), Figure 7-1, Copyright © 2008 Cengage Learning
Production System Overview

Activities
 Determine raw materials requirements
 Authorize the release of raw materials into production
 Authorize work to be conducted in the production process
 Direct the movement of work through the various stages of
production

Production Methods
 Continuous processing - creates a homogeneous product
through a continuous series of standard procedures – for
example, oil refining
 Batch processing - produces discrete groups (batches) of
products – for example, a commercial bakery
 Make-to-Order processing - Fabrication of discrete products in
accordance with customer specifications – for example, Dell
computer responding to an online customer configuration order
Batch Production Process DFD
Hall, Accounting Information Systems 6e (978-0-324-56089-3), Figure 7-2, Copyright © 2008 Cengage Learning
Batch Production Processes

Production planning and control
 Determine materials requirement – the difference between
what is needed and what is available in inventory
 Determine operations requirements – the assembly and/or
manufacturing activities to be applied to the product
 Schedule production



Coordinates the production of multiple batches
Influenced by time constraints, batch size, and other specifications
Production operations
 Begins when work centers obtain raw materials from
storekeeping.
 Ends with the completed product being sent to the finished
goods (FG) warehouse
Batch Production Processes - Continued

Inventory control
Objective: Minimize total inventory cost while ensuring
that adequate inventories exist of production demand,
possible supporting models/methods include:


EOQ
Just-in-time
Provides production planning and control with status of
finished goods and raw materials inventory
Continually updates the raw material inventory during
production process
Upon completion of production, updates finished goods
inventory
Batch Production Documents
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
 Route Sheet - Details the production path a particular
batch will take in the manufacturing process

 Sequence of operations
 Time allotted at each station

Think of the BOM and route sheet as a cooking recipe
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 - 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
among work centers

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, bottling,
labeling, and packing

Which batch production documents would you
employ?

List some sample content of one of the production
documents.
Production Flowchart
Hall, Accounting Information Systems 6e (978-0-324-56089-3), Figure 7-9, Copyright © 2008 Cengage Learning
Sales Forecast
Raw Materials Requirements
Inventory Status Report
Engineering Specifications
BOM and Route Sheets
(Purchase Requisitions)
Operations Requirements
Production Scheduling
Work Orders
Move Tickets
Materials Requisitions
Open Work Orders
Work Centers
Job Tickets
Time Cards
Completed Move Tickets
Cost Accounting
Payroll
Prod. Plan. and Control
Completion of Production
Finished Product
and Closed Work Order
Finished Goods Warehouse
Closed Work Order
Inventory Control
Status Report of Raw Materials
Prod. Plan. and Control
and Finished Goods
Journal Voucher
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

Determine profitability of specific products and
support allocation of production resources to
maximize profitability

Don’t “get in the way” of production and decisionmaking 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 costing
A modern replacement to standard-costing

Value stream accounting
A 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 processes
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), 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 Control
Work Centers
materials requisitions
job tickets
completed move tickets
COST ACCOUNTING
STANDARDS
Update WIP accounts
direct labor
direct materials
manufacturing overhead
Compute Variances
Standard-Cost Accounting Procedures
Hall, Accounting Information Systems 6e (978-0-324-56089-3), Figure 7-13, Copyright © 2008 Cengage Learning
Conversion Cycle Controls
Hall, Accounting Information Systems 6e (978-0-324-56089-3), Table 7-1 , Copyright © 2008 Cengage Learning
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 techniques

 Demand-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

Just-in-time inventory
 Minimize stocking of raw materials and other production inputs
 Make suppliers 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 local manufacturing company, e.g.,
Intel, GE, Honeywell, Eclipse, and Johnson & Johnson

Describe specific examples of as many lean
manufacturing principles and techniques as
possible
What’s Wrong With Standard-Cost
Accounting
Time warp – It was designed for a world with high
variable and low fixed costs (e.g., 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 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
Activity-Based Costing – AIS Issues

Activity-based costing encourages examination of costs at
a high detail level:
 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 mapping
processes 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
example
Are 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 identifies 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?
Value Stream Mapping – AIS Issues

Costs are:
Accumulated per value stream
Accumulated per period rather than per product
Distinctions between production and non-production
costs are irrelevant
Problems of allocation don’t disappear, though they
become less relevant when looking at value streams for
product families instead of cost allocations to individual
product units or batches
Value streams are more relevant to high-level planning
and management control than to day-to-day production
and related transaction processing and financial records