Addis Ababa University

College of Business and Economics

School of Commerce
Department of Accounting and Finance
Assignment on Accounting Information System
Title: Production Cycle

Prepared by: ID No. Sec

1. Bezawit Abrham BEE/1370/09 E4A1
2. Fisseha WoldeMichael BEE/3420/08 E4A1
3. Mekdes Tegegn BEE/2138/09 E4A1
4. Netsanet Yalew BEE/2397/09 E4A1
5. Menen Gebrearegawi BEE/2165/09 E4A1
6. Tebkew Mussie BEE/2666/09 E4A1

Submitted to: Instructor Wogayehu Woldeyesus

January, 2020
Addis Ababa, Ethiopia
 1. General overview of production cycle

The production cycle is a recurring set of business activities and related information processing
operations associated with the manufacture of products.

Customer order

Purchase requisitions

Sales Forecasts
Overhead
Expenditure cycle
Revenue cycle Production
cycle
Raw materials
Finished goods

Labor needs
Cost of goods
manufactured report Labor cost

Human resource
Management management/
General ledger and payroll cycle
reporting system

The above diagram shows how the production cycle is linked to the other subsystems in a
company’s information system. The revenue cycle information system provides the information
of customer orders and sales forecasts used to plan production and inventory levels. In return, the
production cycle information system sends the revenue cycle information about finished goods
that have been produced and are available for sale. Information about raw materials needs is sent
to the expenditure cycle information system in the form of purchase requisitions. In exchange,
the expenditure cycle system provides information about raw material acquisitions and also
about other expenditures included in manufacturing overhead. Information about labor needs is
sent to the human resource cycle, which in return provides data about labor costs and
availability. Finally, information about the cost of goods manufactured is sent to the general
ledger and reporting information system.

2. Business activity/process of production cycle

The four basic activities in the production cycle are:
1. Product design
2. Planning and scheduling
3. Production operations
4. Cost accounting
2.1. Product design
The objective of product design is to design a product that strikes the optimal balance of
meeting customer requirements for quality, durability, and functionality; and minimizing
production costs. Simulation software can improve the efficiency and effectiveness of product
design.
 Key documents and forms in product design:
 Bill of Materials: Lists the components that are required to build each product.
 Operations List: Lists the sequence of steps and the equipment and time required to
produce each product.
The accountant participates in product design, because 65-80% of product cost is determined at
this stage. The accountant can add value by designing an AIS that measures and collects the
needed data and by helping the design team use that data to improve profitability.

2.2. Planning and scheduling

The objective of the planning and scheduling activity is to develop a production plan that
is efficient enough to meet existing orders and anticipated short-term demand while minimizing
inventories of both raw materials and finished goods. There are two common approaches to
production planning:
 Manufacturing Resource Planning (MRP-II)-An extension of MRP inventory control
systems. Seeks to balance existing production capacity and raw materials needs to meet
forecasted sales demands. Often referred to as push manufacturing.
 Lean Manufacturing-An extension of just-in-time inventory systems. Seeks to minimize or
eliminate inventories of raw materials, work in process, and finished goods. Theoretically
produces only in response to customer orders, but in reality, there are short-run production
plans. Often referred to as pull manufacturing.
 Key documents and forms:
 Master production schedule-specifies how much of each product is to be produced
during each period and when.
 Production order-authorizes production of a specified quantity of a product.
 Materials requisition-authorizes movement of materials to the factory floor.
 Move ticket-documents transfer of parts and materials through the factory.
Role of the accountant is to ensure the AIS collects and reports costs in a manner consistent with
the company’s production planning techniques.

2.3. Production operations

Production operations vary greatly across companies, depending on the type of product and
the degree of automation. The use of various forms of IT, such as robots and computer-
controlled machinery is called computer-integrated manufacturing (CIM). Accountants must
understand how the CIM affects the AIS.
In a lean manufacturing environment, a customer order triggers several actions. The system
first checks inventory on hand for sufficiency, then calculates labor needs and determines
whether overtime or temporary help will be needed. Based on the bill of materials, the system
determines what components need to be ordered and transmits necessary purchase orders via
EDI. The master production schedule is adjusted to include the new order.
Sharing information across cycles helps companies be more efficient by timing purchases to
meet the actual demand.
While the nature of production processes and the extent of CIM vary, all companies need
data on: raw materials used; labor hours expended; machine operations performed; and other
manufacturing overhead costs incurred.
2.4. Cost accounting
The objectives of cost accounting are:
(1) to provide information for planning, controlling, and evaluating the performance of
production operations;
(2) to provide accurate cost data about products for use in pricing and product mix decisions;
and
(3) to collect and process information used to calculate inventory and COGS values for the
financial statements.
 Types of cost accounting systems:
 Job order costing- assigns costs to a particular production batch or job.
 Process costing- assigns costs to each process or work center in the production cycle and
calculates the average cost for all units produced.
Accounting for Fixed Assets: The AIS must collect and process information about the
property, plant, and equipment used in the production cycle. These assets represent a significant
portion of total assets for many companies and need to be monitored as an investment. The
purchase of fixed assets follows the same processes as other purchases in the expenditure cycle
(order à receive à pay). But the amounts involved necessitate competitive bidding, involvement
of more people, differences in payment approaches (e.g., installments), more elaborate controls,
and formal approval for disposal.
Both job-order and process costing systems require that data be accumulated about raw
materials, direct labor, machinery and equipment usage, and manufacturing overhead. The
choice of method does not affect how data are collected but does affect how costs are assigned to
products.
i. Raw Material Usage Data-When production is initiated, the issuance of a materials
requisition triggers a debit (increase) to work in process and a credit (decrease) to raw
materials inventory. Work in process is credited and raw materials are debited for any
amounts returned to inventory. Bar-coding of raw materials or RFID tags can improve
efficiency.
ii. Direct Labor Costs-Historically, job time tickets were used to record the time a worker
spent on each job task. Currently, workers may enter the data on online terminals or use
coded ID badges swiped through a badge reader.
 iii. Machinery and Equipment Usage-Data about machinery and equipment are collected at
each production step, often with data about labor costs.
iv. Manufacturing Overhead Costs-Include costs that can’t be easily traced to jobs or
processes, such as utilities, depreciation, and supervisory salaries. Accountants help
control overhead by assessing how product mix changes will affect overhead costs.

3. Interaction of production cycle with the general ledger and reporting system

Information flows to the production cycle from other cycles.

 The revenue cycle provides information on customer orders and sales forecasts for use in
planning production and inventory levels.
 The expenditure cycle provides information about raw materials acquisitions and overhead costs.
 The human resources/payroll cycle provides information about labor costs and availability.
Information also flows from the expenditure cycle.
 The revenue cycle receives information from the production cycle about finished goods available
for sale.
 The expenditure cycle receives information about raw materials needs.
 The human resources/payroll cycle receives information about labor needs.
 The general ledger and reporting system receives information about cost of goods manufactured.
 Decisions that must be made in the production cycle include decisions on product mix, pricing,
resource allocation, cost management, and performance evaluation.
 4. Control objectives of the production cycle

In the production cycle, a well-designed AIS should provide adequate controls to ensure
that the following objectives are met:
(1) All transactions are properly authorized;
(2) All recorded transactions are valid;
(3) All valid and authorized transactions are recorded;
(4) All transactions are recorded accurately;
(5) Assets are safeguarded from loss or theft;
(6) Business activities are performed efficiently and effectively;
(7) The company is in compliance with all applicable laws and regulations; and
(8) All disclosures are full and fair.
 5. Threats and procedures of the production cycle

 Threats
• Unauthorized transaction
• Theft or destruction of inventories and fixed assets
• Recording and posting errors
• Loss of data
• Inefficiencies and quality control problems
 Exposures
• Overproduction and excess inventories
• Obsolescence
• Underproduction, stock outs, and lost sales
• Excess investment in fixed assets
• Loss of assets
• Overstated inventory records ineffective scheduling and planning
• Decision errors
• Increased expenses and taxes on fixed assets that are incorrectly valued
• Ineffective decision making
• Loss of customer goodwill and future sales
 Control objectives
• Control procedures?
• Accurate sales forecasts and inventory
• Records
• Authorization of production
• Restricted access to production planning
• Program and to blank production order
• Documents
• Review and approval of capital asset
• Expenditures documentation of all internal movements of
• Inventory
• Proper segregation of duties
• Source data automation
• Online data entry edit controls
• Backup and disaster recovery procedures
• Regular performance reports
• Cost of quality control measurement
6. Criticism and solutions of the production cycle

Two major criticisms have been directed at traditional cost accounting systems:

(1) overhead costs are inappropriately allocated to products; and

Potential solutions
• Activity-Based Costing (ABC) is utilized to address some of these criticisms. There are
three significant differences between ABC and traditional approaches.
  Tracing of overhead costs-ABC directly traces a larger proportion of overhead costs
to products. This tracing is made possible by advances in IT.
 Number of cost pools-ABC uses more cost pools to accumulate overhead costs,
distinguishing between batch-related, product-related, and company-wide overhead.
 Identification of cost drivers
(2) reports do not accurately reflect effects of factory automation.
Potential solutions
• Integrated production cycle data model
7. Measure of production effectiveness

Throughput represents the number of good units produced in a given period of time. It consists
of three factors, each of which can be separately controlled, as shown in the following formula

Throughput = (Total units produced / Processing time) x (Processing time / Total time)
x (Good units / Total units)

Productive capacity, the first term in the formula, shows the maximum number of units
that can be produced using current technology. Productive capacity can be increased by
improving labor or machine efficiency, by rearranging the factory-floor layout to expedite the
movement of materials, or by simplifying product design specifications. Productive processing
time, the second term in the formula, indicates the percentage of total production time used to
manufacture the product. Productive processing time can be improved by improving
maintenance to reduce machine downtime or by more efficient scheduling of material and supply
deliveries to reduce wait time. Yield, the third term in the formula, represents the percentage of
good (non-defective) units produced. Using better-quality raw materials or improving worker
skills can improve yield.

8. Quality control measures

The objective of quality control is to minimize the sum of these four costs. Information
about quality costs can help companies determine
the effects of actions taken to improve yield and identify areas for further improvement.
Quality control costs can be divided into four areas:
1. Prevention costs are associated with changes to production processes designed to reduce
the product defect rate.
2. Inspection costs are associated with testing to ensure that products meet quality standards.
3. Internal failure costs are associated with reworking, or scrapping, products identified as
being defective prior to sale.
4. External failure costs result when defective products are sold to customers. They include
such costs as product liability claims, warranty and repair expenses, loss of customer satisfaction,
and damage to the company’s reputation.
The ultimate objective of quality control is to “get it right the first time” by manufacturing
products that meet customer specifications. This often requires trade-offs among the four
quality cost categories. For example, increasing prevention costs can lower inspection costs as
well as internal and external failure costs. Indeed, many companies have found that increased
spending to prevent defects reduces total manufacturing costs. In addition, improved quality
control can also help companies become “greener.”

9. Final summary of the paper

The production cycle consists of four basic activities: product design, production planning and
scheduling, production operations, and cost accounting. Companies are continually investing in
IT to improve the efficiency of the first three activities. However, for a business to reap the full
benefit of these changes, corresponding modifications must also be made to the cost accounting
system. In addition, accountants need to modify financial reports and develop new measures that
more accurately reflect and measure manufacturing performance.
Reference

Marshll B.Romney, Paul J.Steinbart 2012: Accounting Information System, 12 th edition, prentice Hall,
Inc.