Chapter 7

The Conversion
Cycle

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Learning Objectives
• Understand the basic elements and procedures encompassing a
traditional production process.
• Understand the data flows and procedures in a traditional cost
accounting system.
• Be familiar with the accounting controls found in a traditional
environment.
• Understand the principles, operating features, and technologies that
characterize lean manufacturing.
• Understand the shortcomings of traditional accounting methods in a
world-class environment.
• Be familiar with the key features of activity-based costing and value
stream accounting.
• Be familiar with the information systems commonly associated with
lean manufacturing and world-class companies.
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 The 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.
• Materialsrequirements 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.

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Conversion Cycle in Relation to Other Cycles

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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.
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 DFD of Batch Production Process

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 Production Schedule

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 Bill of Materials

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 Route Sheet

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 Work Order

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 Move Ticket

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 Materials Requisition, Excess Materials
Requisition, and Materials Return Ticket

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BATCH PROCESSING SYSTEM (continued)
• Batch Production Activities
• PRODUCTION PLANNING AND CONTROL
• MATERIALS AND OPERATIONS REQUIREMENTS
• PRODUCTION SCHEDULING
• WORK CENTERS AND STOREKEEPING
• INVENTORY CONTROL: 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.
• Cost Accounting Activities

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 Batch Production Process

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 Batch Production Process (continued)

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The Relationship of Total Inventory Cost and
Order Quantity

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 Inventory Usage

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 The Use of Safety Stock to Prevent
Stock-Outs

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 Cost Accounting Procedures

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CONTROLS IN THE TRADITIONAL
ENVIRONMENT
• Transaction Authorization

• Segregation of Duties
• Supervision

• Access Control
• DIRECT ACCESS TO ASSETS
• INDIRECT ACCESS TO ASSETS
• Accounting Records
• Independent Verification

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 Summary of IT Application Controls

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 Summary of Conversion Cycle Physical
Controls

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 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.

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WHAT IS A WORLD-CLASS COMPANY?
• World-class companies must maintain strategic agility and
be able to turn on a dime.
• World-classcompanies motivate and treat employees like
appreciating assets.
• A world-class company profitably meets the needs of its
customers.
• Thephilosophy 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.
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PRINCIPLES OF LEAN MANUFACTURING

• TheToyota Production System (TPS) is a lean

manufacturing system based on the just-in-time
production model.
• The just-in-time (JIT) production model is a philosophy
that addresses manufacturing problems through process
simplification.
• Pull Processing
• Pull processing 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

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PRINCIPLES OF LEAN MANUFACTURING
(continued)

• Waste Minimization
• Inventory Reduction
• Production Flexibility
• Established Supplier Relations
• Team Attitude

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 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.

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PHYSICAL REORGANIZATION OF THE
PRODUCTION FACILITIES
• Traditional
manufacturing facilities tend to evolve into
snakelike sequences of activities.
• Theinefficiencies 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.

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 The Traditional Factory Layout

James A. Hall, Accounting Information Systems, 10th Edition. © 2019 Cengage. All Rights Reserved.
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 Flexible Production System

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AUTOMATION OF THE MANUFACTURING
PROCESS
• Traditional Manufacturing
• Islands of Technology
• The term islands of technology describes an environment
where modern automation exists in the form of islands that
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.

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AUTOMATION OF THE MANUFACTURING
PROCESS (continued)
• Computer-Integrated Manufacturing
• Computer-integrated manufacturing (CIM) is a completely
automated environment.
• Automated storage and retrieval systems (AS/RS) are
computer-controlled conveyor systems that carry raw materials
from stores to the shop floor and finished products to the
warehouse.
• ROBOTICS
• Computer-aided design (CAD) is the use of computers to
design products to be manufactured.
• Computer-aided manufacturing (CAM) is the use of
computers in factory automation.

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AUTOMATION OF THE MANUFACTURING
PROCESS (continued)
• Value Stream Mapping
• 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 aspects that are wasteful and
should be removed.

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 The Automation Continuum

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Computer-Integrated Manufacturing System

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 Value Stream Map

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 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.

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WHAT’S WRONG WITH TRADITIONAL
ACCOUNTING INFORMATION?
• Inaccurate Cost Allocations
• Promotes Nonlean Behavior
• Time Lag
• Financial Orientation

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Changes in Cost Structure between Different
Manufacturing Environments

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ACTIVITY-BASED COSTING
• Activity-based costing (ABC) is an accounting
technique that provides managers with information about
activities and cost objects.
• Anactivity driver is a factor that measures the activity
consumption by the cost object.
• Advantages of ABC
• Disadvantages of ABC

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 Allocation of Overhead Costs to Products
under ABC

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VALUE STREAM ACCOUNTING
• Valuestream accounting is an accounting technique that
captures cost data according to value stream rather than
by department.
• Product families share common processes from the
point of placing the order to shipping the finished goods to
the customer.

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 Cost Assignment to Value Stream

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 Grouping Products by Families

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Information Systems That Support Lean
Manufacturing
• Materialsrequirements planning (MRP) are systems
used to plan inventory requirements in response to
production work orders.
• Manufacturing resources planning (MRP II) is a system
that incorporates techniques to execute the production
plan, provide feedback, and control the process.
• Enterprise
resource planning (ERP) is a system
assembled of prefabricated software components.

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MATERIALS REQUIREMENT PLANNING
• MRPis an automated production planning and control
system used to support inventory management. Its
operational objectives are to:
• Ensure that adequate raw materials are available to the
production process.
• Maintain the lowest possible level of inventory on hand.
• Produce production and purchasing schedules and other
information needed to control production.

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 Overview of MRP System

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MANUFACTURING RESOURCE PLANNING

• MRP II is an extension of MRP that has evolved beyond the

confines of inventory management.
• MRP II integrates product manufacturing, product
engineering, sales order processing, customer billing, human
resources, and related accounting functions.
• 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
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The Integration of Manufacturing and Financial
Systems within the MRP II Environment

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ENTERPRISE RESOURCE PLANNING
SYSTEMS
• Electronic data interchange (EDI) is an intercompany
exchange of computer-processable business information
in standard format.

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