Rais11_ch12
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Transcript of Rais11_ch12
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C HAPTER 12
The Production Cycle
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INTRODUCTION
• Questions to be addressed in this chapter include:– What are the basic business activities and data
processing operations that are performed in the production cycle?
– What decisions need to be made in the production cycle, and what information is needed to make these decisions?
– How can the company’s cost accounting system help in achieving the entity’s objectives?
– What are the major threats in the production cycle and the controls that can mitigate those threats?
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INTRODUCTION
• The production cycle is a recurring set of
business activities and related data
processing operations associated with the
manufacture of products.
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INTRODUCTION
• Information flows to the production cycle from other cycles, e.g.:
– 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.
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INTRODUCTION
• 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.
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INTRODUCTION
• Decisions that must be made in the production cycle include:
– What mix of products should be produced?
– How should products be priced?
– How should resources be allocated?
– How should costs be managed and performance evaluated?
• These decisions require cost data well beyond that required for external financial statements.
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INTRODUCTION
• We’ll be looking at how the three basic AIS
functions are carried out in the production
cycle, i.e.:
– How do we capture and process data?
– How do we store and organize the data for
decisions?
– How do we provide controls to safeguard
resources, including data?
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PRODUCTION CYCLE ACTIVITIES
• The four basic activities in the production cycle are:– Product design
– Planning and scheduling
– Production operations
– Cost accounting
• Accountants are primarily involved in the fourth activity (cost accounting) but must understand the other processes well enough to design an AIS that provides needed information and supports these activities.
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PRODUCTION CYCLE ACTIVITIES
• The four basic activities in the production cycle are:– Product design
– Planning and scheduling
– Production operations
– Cost accounting
• Accountants are primarily involved in the fourth activity (cost accounting) but must understand the other processes well enough to design an AIS that provides needed information and supports these activities.
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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.
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PRODUCT DESIGN
• Key documents and forms in product
design:
– Bill of Materials: Lists the components that
are required to build each product, including
part numbers, descriptions,and quantity.
– Operations List: Lists the sequence of steps
required to produce each product, including
the equipment needed and the amount of time
required.
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PRODUCT DESIGN
• Role of the accountant in product design:
– Participate in the design, because 65−80% of
product cost is determined at this stage.
– Add value by:
• Designing an AIS that measures and collects the
needed data.
• Information about current component usage.
• Information about machine set-up and materials-
handling costs.
• Data on repair and warranty costs to aid in future
modification and design.
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PRODUCT DESIGN
• Role of the accountant in product design:
– Participate in the design, because 65−80% of
product cost is determined at this stage.
– Add value by:
• Designing an AIS that measures and collects the
needed data.
• Helping the design team use that data to
improve profitability.
• Compare current component usage with projected
usage in alternate designs.
• Compare current set-up and handling costs to
projected costs in alternate designs.
• Provide info on how design trade-offs affect total
production cost and profitability.
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PRODUCTION CYCLE ACTIVITIES
• The four basic activities in the production cycle are:– Product design
– Planning and scheduling
– Production operations
– Cost accounting
• Accountants are primarily involved in the fourth activity (cost accounting) but must understand the other processes well enough to design an AIS that provides needed information and supports these activities.
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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
shorter-term demand while minimizing
inventories of both raw materials and
finished goods.
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PLANNING AND SCHEDULING
• There are two common approaches to
production planning:
– Manufacturing Resource Planning (MRP-II)
– Lean Manufacturing
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PLANNING AND SCHEDULING
• There are two common approaches to
production planning:
– Manufacturing Resource Planning (MRP-II)
– Lean Manufacturing
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PLANNING AND SCHEDULING
• MRP-II is 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.
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PLANNING AND SCHEDULING
• There are two common approaches to
production planning:
– Manufacturing Resource Planning (MRP-II)
– Lean Manufacturing
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PLANNING AND SCHEDULING
• Lean manufacturing is an extension of the principles 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.
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PLANNING AND SCHEDULING
• Comparison of the two systems:
– Both plan production in advance.
– They differ in the length of the planning horizon.
• MRP-II develops plans for up to 12 months ahead.
• Lean manufacturing uses shorter planning horizons.
– Consequently:
• MRP-II is more appropriate for products with
predictable demand and a long life cycle.
• Lean manufacturing more appropriate for products with
unpredictable demand, short life cycles, and frequent
markdowns of excess inventory.
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PLANNING AND SCHEDULING
• Key documents and forms:
– Master production schedule• Specifies how much of each product is to be produced during the
period and when.
• Uses information about customer orders, sales forecasts, and finished
goods inventory levels to determine production levels.
• Although plans can be modified, production plans must be frozen a
few weeks in advance to provide time to procure needed materials and
labor.
• Scheduling becomes significantly more complex as the number of
factories increases.
• Raw materials needs are determined by exploding the bill of materials
to determine amount needed for current production. These amounts
are compared to available levels to determine amounts to be
purchased.
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PLANNING AND SCHEDULING
• Key documents and forms:
– Master production schedule
– Production order
• Authorizes production of a specified quantity of a
product. It lists:
– Operations to be performed
– Quantity to be produced
– Location for delivery
• Also collects data about these activities,
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PLANNING AND SCHEDULING
• Key documents and forms:
– Master production schedule
– Production order
– Materials requisition
• Authorizes movement of the needed materials
from the storeroom to the factory floor.
• This document indicates:
– Production order number
– Date of issue
– Part numbers and quantities of raw materials
needed (based on data in bill of materials)
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PLANNING AND SCHEDULING
• Key documents and forms:
– Master production schedule
– Production order
– Materials requisition
– Move ticket
• Documents the transfer of parts and materials
throughout the factory.
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PLANNING AND SCHEDULING
• How can information technology help?
– Improve the efficiency of material-handling
activities by using:
• Bar coding of materials to improve speed and
accuracy,
• RFID tags can eliminate human intervention in the
scanning process,
• Up to 40 times faster than using bar-code scanners.
• Not impeded by dirt.
• Not limited to reading only those items in line of sight.
• Much easier to locate needed products and broadcast their
location to forklift operators or other warehouse workers.
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PLANNING AND SCHEDULING
• Role of the accountant:
– Ensure the AIS collects and reports costs in a
manner consistent with the company’s
production planning techniques.
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PRODUCTION CYCLE ACTIVITIES
• The four basic activities in the production cycle are:– Product design
– Planning and scheduling
– Production operations
– Cost accounting
• Accountants are primarily involved in the fourth activity (cost accounting) but must understand the other processes well enough to design an AIS that provides needed information and supports these activities.
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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).– Can significantly reduce production costs.
• Accountants aren’t experts on CIM, but they must understand how it affects the AIS.– One effect is a shift from mass production to custom-
order manufacturing and the need to accumulate costs accordingly.
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PRODUCTION OPERATIONS
• In a lean manufacturing environment, a
customer order triggers several actions:
– System first checks inventory on hand for sufficiency.
– Calculates labor needs and determines whether
overtime or temporary help will be needed.
– Based on bill of materials, determines what
components need to be ordered.
• Necessary purchase orders are sent via EDI.
– The master production schedule is adjusted to include
the new order.
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PRODUCTION OPERATIONS
• Sharing information across cycles helps
companies be more efficient by timing
purchases to meet the actual demand.
• Although 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
– Other manufacturing overhead costs incurred
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PRODUCTION CYCLE ACTIVITIES
• The four basic activities in the production cycle are:– Product design
– Planning and scheduling
– Production operations
– Cost accounting
• Accountants are primarily involved in the fourth activity (cost accounting) but must understand the other processes well enough to design an AIS that provides needed information and supports these activities.
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COST ACCOUNTING
• The objectives of cost accounting are:
– To provide information for planning,
controlling, and evaluating the performance of
production operations;
– To provide accurate cost data about products
for use in pricing and product mix decisions;
and
– To collect and process information used to
calculate inventory and COGS values for the
financial statements.
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COST ACCOUNTING
• The objectives of cost accounting are:
– To provide information for planning,
controlling, and evaluating the
performance of production operations;
– To provide accurate cost data about products
for use in pricing and product mix decisions;
and
– To collect and process information used to
calculate inventory and COGS values for the
financial statements.
• To accomplish the first objective, the AIS must collect real-time
data on the performance of production activities so
management can make timely decisions.
• RFID technology can be especially helpful, e.g.:
– Broadcasting repair needs proactively.
– Helping in the location of particular items.
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COST ACCOUNTING
• The objectives of cost accounting are:
– To provide information for planning,
controlling, and evaluating the performance of
production operations;
– To provide accurate cost data about
products for use in pricing and product
mix decisions; and
– To collect and process information used to
calculate inventory and COGS values for
the financial statements.
• To accomplish the second and third objectives, the AIS must
collect costs by various categories and assign them to specific
products and organizational units.
• Requires careful coding of cost data during collection because
costs may be allocated in different ways for different reporting
purposes.
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COST ACCOUNTING
• Types of cost accounting systems:
– Job order costing
• Assigns costs to a specific production batch or job.
• Used when the product or service consists of discretely
identifiable items.
• Example: Houses.
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COST ACCOUNTING
• Types of cost accounting systems:
– Job order costing
– Process costing• Assigns costs to each process or work center in the
production cycle.
• Calculates the average cost for all units produced.
• Used when similar goods or services are produced in
mass quantities and discrete units can’t be easily
identified.
• Example: Paint.
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COST ACCOUNTING
• 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.
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COST ACCOUNTING
• The following information should be
maintained about each fixed asset:
• ID number
• Serial number
• Location
• Cost
• Acquisition date
• Vendor info
• Expected life
• Expected salvage value
• Depreciation method
• Accumulated depreciation
• Improvements
• Maintenance performed
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COST ACCOUNTING
• The purchase of fixed assets follows the same
processes as other purchases in the expenditure
cycle (order receive pay).
• But the amounts involved necessitate some
modification to the process:
– Competitive bidding
• Machinery and equipment purchases almost always
involve a formal request for competitive bids.
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COST ACCOUNTING
• The purchase of fixed assets follows the same
processes as other purchases in the expenditure
cycle (order receive pay).
• But the amounts involved necessitate some
modification to the process:
– Competitive bidding
– Number of people involved
• More people are likely to be involved in reviewing bids
for fixed assets.
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COST ACCOUNTING
• The purchase of fixed assets follows the same
processes as other purchases in the expenditure
cycle (order receive pay).
• But the amounts involved necessitate some
modification to the process:
– Competitive bidding
– Number of people involved
– Payment
• Purchases of fixed assets are often paid for in
installments, including interest.
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COST ACCOUNTING
• The purchase of fixed assets follows the same
processes as other purchases in the expenditure
cycle (order receive pay).
• But the amounts involved necessitate some
modification to the process:
– Competitive bidding
– Number of people involved
– Payment
– Controls
• The cost of fixed assets justifies more elaborate
controls to safeguard them, including:
– Maintenance of detailed records of each item.
– RFID tags to:
• Monitor location
• Facilitate preventive maintenance
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COST ACCOUNTING
• The purchase of fixed assets follows the same
processes as other purchases in the expenditure
cycle (order receive pay).
• But the amounts involved necessitate some
modification to the process:
– Competitive bidding
– Number of people involved
– Payment
– Controls
– Disposal
• It’s critical to formally approve and
accurately record the sale or disposal
of fixed assets.
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COST ACCOUNTING
• A typical AIS would look something like
the following:
– Product design
• Engineering specifications result in new records
for both the bill of materials and the operations
list file.
• To create these lists, engineering accesses both
files to view designs of similar products.
• They also access the general ledger and
inventory files for info about alternate designs.
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COST ACCOUNTING
• A typical AIS would look something like
the following:
– Product design
– Production planning• The sales department enters sales forecasts and
customer special order information.
• Production planning uses that information and
data on current inventory levels to develop a
master production schedule.
• New records are added to the production order
file to authorize the production of goods.
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COST ACCOUNTING
• A typical AIS would look something like
the following:
– Product design
– Production planning
– Cost accounting
• New records are added to the work-in-process
file to accumulate cost data.
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COST ACCOUNTING
• A typical AIS would look something like
the following:
– Product design
– Production planning
– Cost accounting
– Production operations
• The list of operations to be performed is displayed at
workstations.
• Instructions are also sent to the CIM interface to guide
operation of machinery and robots.
• Materials requisitions are sent to inventory stores to authorize
release of raw materials to production.
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COST ACCOUNTING
• Such a system can be used for a job-order or
process costing system.
• Both require that data be accumulated about:
– Raw materials
– Direct labor
– Machinery and equipment usage
– Manufacturing overhead
• The choice of method:
– Does not affect how data are collected
– Does affect how costs are assigned to products
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COST ACCOUNTING
• 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.
– Many raw materials are bar coded so that usage data is collected by scanning.
– RFID tags improve the efficiency of tracking material usage.
– Usage may be entered online for materials such as liquids that are not conducive to tagging.
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COST ACCOUNTING
• 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.
• Use coded ID badges, which are run through a
badge reader at the beginning and end of each
job.
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COST ACCOUNTING
• Machinery and equipment usage:
– Machinery costs make up an ever-increasing
proportion of production costs.
– Data about machinery and equipment are collected at
each production step, often with data about labor
costs.
– Until recently, data was collected by wiring the factory
so all equipment was linked to the computer system.
• Limits the ability to rearrange the shop floor.
– 3-D simulations can be used to assess the impact of
altering floor layout.
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COST ACCOUNTING
• Manufacturing overhead costs:
– Includes costs that can’t be easily traced to
jobs or processes, such as utilities,
depreciation, supervisory salaries.
– Most of these costs are collected in the
expenditure cycle.
– An exception is supervisory salaries, which
are collected in the HRM/payroll cycle.
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COST ACCOUNTING
– Accountants help control overhead by
assessing how product mix changes will affect
overhead costs.
– They should also identify the factors that drive
the changes in these costs.
• This information can be used to realign processes
and layout.
– Accurate and complete information about
production cycle activities are required to
perform these analyses.
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CONTROL: OBJECTIVES, THREATS,
AND PROCEDURES
• In the production cycle (or any cycle), a well-designed
AIS should provide adequate controls to ensure that the
following objectives are met:
– All transactions are properly authorized.
– All recorded transactions are valid.
– All valid and authorized transactions are recorded.
– All transactions are recorded accurately.
– Assets are safeguarded from loss or theft.
– Business activities are performed efficiently and effectively.
– The company is in compliance with all applicable laws and
regulations.
– All disclosures are full and fair.
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CONTROL: OBJECTIVES, THREATS,
AND PROCEDURES
• There are several actions a company can take with respect to any cycle to reduce threats of errors or irregularities. These include:
– Using simple, easy-to-complete documents with clear instructions (enhances accuracy and reliability).
– Using appropriate application controls, such as validity checks and field checks (enhances accuracy and reliability).
– Providing space on forms to record who completed and who reviewed the form (encourages proper authorizations and accountability).
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CONTROL: OBJECTIVES, THREATS,
AND PROCEDURES
– Pre-numbering documents (encourages recording of valid and only valid transactions).
– Restricting access to blank documents (reduces risk of unauthorized transaction).
– Using RFID tags when feasible to improve data entry accuracy.
• In the following sections, we’ll discuss the threats that may arise in the four major steps of the production cycle, as well as general threats, EDI-related threats, and threats related to purchases of services.
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THREATS IN PRODUCT DESIGN
• The major threats in the product design
process is:
– THREAT 1: Poor product design
• You can click on the threat above to get more
information on:
– The types of problems posed by each threat.
– The controls that can mitigate the threat.
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THREATS IN PLANNING AND
SCHEDULING
• Threats in the planning and scheduling
process include:
– THREAT 2: Over- or under-production
– THREAT 3: Suboptimal investment in fixed
assets
• You can click on any of the threats above to get
more information on:
– The types of problems posed by each threat
– The controls that can mitigate the threats.
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THREATS IN PRODUCTION
OPERATIONS
• Threats in the production operations
process include:
– THREAT 4: Theft of inventories and fixed
assets
– THREAT 5: Disruption of operations
• You can click on any of the threats above to get
more information on:
– The types of problems posed by each threat.
– The controls that can mitigate the threats.
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THREATS IN COST ACCOUNTING
• Threats in the cost accounting process
include:
– THREAT 6: Inaccurate recording and
processing of production activity data
• You can click on the threat above to get more
information on:
– The types of problems posed by the threat.
– The controls that can mitigate the threat.
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GENERAL THREATS
• Two general objectives pertain to activities
in every cycle:
– Accurate data should be available when needed.
– Activities should be performed efficiently and
effectively.
• Threats in the process of ordering goods
include:
– THREAT 7: Loss, alteration, or unauthorized
disclosure of data
– THREAT 8: Poor performance
• You can click on any of the threats below to get
more information on:
– The types of problems posed by each threat.
– The controls that can mitigate the threats.
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PRODUCTION CYCLE INFORMATION
NEEDS
• In a manufacturing environment, the focus
must be on total quality management.
Managers need info on:
– Defect rates
– Breakdown frequency
– Percent of finished goods needing rework
– Percent of defects discovered by customers
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PRODUCTION CYCLE INFORMATION
NEEDS
• In traditional systems, this type of data
was not well linked with financial data, and
cost accounting systems were separate
from production operations information
systems.
• However, both financial and operating
information are needed to manage and
evaluate these activities.
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PRODUCTION CYCLE INFORMATION
NEEDS
• Two major criticisms have been directed at
traditional cost accounting systems:
– Overhead costs are inappropriately allocated
to products.
– Reports do not accurately reflect effects of
factory automation.
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PRODUCTION CYCLE INFORMATION
NEEDS
• Two major criticisms have been directed at
traditional cost accounting systems:
– Overhead costs are inappropriately
allocated to products.
– Reports do not accurately reflect effects of
factory automation.
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CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Traditional cost accounting systems use
volume-driven bases such as direct labor
hours or machine hours to apply
overhead.
• However, overhead does not vary with
production volume.
• EXAMPLE: Purchasing costs vary with the
number of purchase orders processed.
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CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Allocating overhead based on output
volume:
– Overstates the costs of products
manufactured in large quantities.
– Understates the costs of products
manufactured in small batches.
• Also, allocating overhead based on direct
labor input can distort costs.
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CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Example of two products:
– Product one uses:
• $5 of materials
• 1 hour of labor
• 5 minutes of machine time
– Product two uses:
• $5 of materials
• 1 hour of labor
• 42 hours of machine time on very expensive
equipment
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CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Example of two products:
– Product one uses:
• $5 of materials
• 1 hour of labor
• 5 minutes of machine time
– Product two uses:
• $5 of materials
• 1 hour of labor
• 42 hours of machine time on very expensive
equipment
Under a traditional
cost accounting
system, both
products will
appear to have the
same cost.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 88 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Solution to criticism 1: Activity Based
Costing (ABC)
– ABC can refine and improve cost allocations
under either job-order or process costing
systems.
• ABC traces costs to the activities that create them
and allocates them accordingly.
• ABC aims to link costs to corporate strategy.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 89 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
– Corporate strategy results in decisions about
what goods and services to produce.
• These activities incur costs.
• So corporate strategy determines costs.
– By measuring the costs of the basic activities,
ABC provides information to management for
evaluating the consequences of their decisions.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 90 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• ABC vs. traditional cost systems:
– There are three significant differences between
ABC and traditional approaches.
• Tracing of overhead costs
• Number of cost pools
• Identification of cost drivers
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 91 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• ABC vs. traditional cost systems:
– There are three significant differences between
ABC and traditional cost accounting approaches.
• Tracing of overhead costs
• Number of cost pools
• Identification of cost drivers
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 92 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• ABC directly traces a larger proportion of
overhead costs to products.
• This tracing is made possible by advances
in IT.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 93 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• ABC vs. traditional cost systems:
– There are three significant differences between
ABC and traditional cost accounting approaches.
• Tracing of overhead costs
• Number of cost pools
• Identification of cost drivers
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 94 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• ABC uses a greater number of cost pools
to accumulate indirect costs
(manufacturing overhead).
• Most systems lump all overhead together,
but ABC distinguishes three categories:
- Batch-related overhead
• EXAMPLES: Setup, inspection, and material
handling costs.
• Accumulated for a batch and allocated to the
products in that batch.
• Consequently, costs per product will be less
when products are made in larger quantities.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 95 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• ABC uses a greater number of cost pools
to accumulate indirect costs
(manufacturing overhead).
• Most systems lump all overhead together,
but ABC distinguishes three categories:
- Batch-related overhead
- Product-related overhead
• Examples: R&D, environmental regulations, and
purchasing costs.
• These costs are related to the diversity of the
company’s product line.
• ABC attempts to link these costs to the products
that generate them.
• For example, purchasing costs might be
allocated to products based on the number of
purchase orders generated for each product.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 96 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• ABC uses a greater number of cost pools
to accumulate indirect costs
(manufacturing overhead).
• Most systems lump all overhead together,
but ABC distinguishes three categories:
- Batch-related overhead
- Product-related overhead
- Company-wide overhead
• EXAMPLE: Rent or depreciation.
• These costs are applied to all products
and allocated according to departmental
or plant rates.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 97 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• ABC vs. traditional cost systems:
– There are three significant differences between
ABC and traditional cost accounting approaches.
• Tracing of overhead costs
• Number of cost pools
• Identification of cost drivers
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 98 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Benefits of ABC systems
– ABC systems are more costly and complex.
– But proponents argue two important benefits:
• More accurate cost data result in better product
mix and pricing decisions.
• More detailed cost data improve management’s
ability to control and manage total costs.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 99 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Benefits of ABC systems
– ABC systems are more costly and complex.
– But proponents argue two important benefits:
• More accurate cost data result in better
product mix and pricing decisions
• More detailed cost data improve management’s
ability to control and manage total costs.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 100 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Better decisions
– ABC avoids problems of applying too much or
too little overhead to products and
consequently results in better price decisions.
– ABC uses the data collected to improve
product design.
– ABC provides management with the
information about the costs associated with
specific activities, resulting in better analysis
and decisions.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 101 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Benefits of ABC systems
– ABC systems are more costly and complex.
– But proponents argue two important benefits:
• More accurate cost data result in better product
mix and pricing decisions.
• More detailed cost data improve management’s
ability to control and manage total costs.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 102 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Improved cost management
– ABC measures the results of managerial
actions on overall profitability.
– ABC measures both the amount spent to
acquire resources and the amount spent to
consume them.
– ABC measures unused capacity:
• Cost of activity capability = Cost of activity used +
Cost of unused capacity
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 103 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• EXAMPLE: A publishing company has five employees who operate printing presses.
• The employees each have annual salaries of $25,000 for a total salary cost of $125,000.
• Each employee should be able to print about 10,000 books per year.
• The total capacity, therefore is 50,000 books.
• The salary cost per book would be $125,000 / 50,000 books = $2.50 per book.
• During the most recent year, the presses produced 47,000 books.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 104 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• EXAMPLE: A publishing company has five employees who operate printing presses.
• The employees each have annual salaries of $25,000 for a total salary cost of $125,000.
• Each employee should be able to print about 10,000 books per year.
• The total capacity, therefore is 50,000 books.
• The salary cost per book would be $125,000 / 50,000 books = $2.50 per book.
• During the most recent year, the presses produced 47,000 books.
• The cost of the activity capability is the total
book capacity for the year of 50,000 books times
the salary cost per book of $2.50.
• 50,000 books x $2.50 = $125,000.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 105 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• EXAMPLE: A publishing company has five employees who operate printing presses.
• The employees each have annual salaries of $25,000 for a total salary cost of $125,000.
• Each employee should be able to print about 10,000 books per year.
• The total capacity, therefore is 50,000 books.
• The salary cost per book would be $125,000 / 50,000 books = $2.50 per book.
• During the most recent year, the presses produced 47,000 books.
• The cost of the activity used is the number of
books actually produced times the salary cost
per book of $2.50.
• 47,000 books x $2.50 = $117,500.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 106 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• EXAMPLE: A publishing company has five employees who operate printing presses.
• The employees each have annual salaries of $25,000 for a total salary cost of $125,000.
• Each employee should be able to print about 10,000 books per year.
• The total capacity, therefore is 50,000 books.
• The salary cost per book would be $125,000 / 50,000 books = $2.50 per book.
• During the most recent year, the presses produced 47,000 books.
• The unused capacity is the difference between
the activity capability ($125,000) and the cost of
the activity used ($117,500).
• $125,000 - $117,500 = $7,500 unused capacity.
• Alternately, unused capacity can be calculated
as the cost per book of $2.50 times the difference
between the books that could be produced and
the books that were actually produced.
• $2.50 x (50,000 possible books – 47,000 actual
books) = $7,500 unused capacity.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 107 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Management may be able to improve
profitability by:
- Applying the unused capacity to other
revenue-generating activities; or
- Eliminating the unused capacity.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 108 of 122
PRODUCTION CYCLE INFORMATION
NEEDS
• Two major criticisms have been directed at
traditional cost accounting systems:
– Overhead costs are inappropriately allocated
to products.
– Reports do not accurately reflect effects of
factory automation.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 109 of 122
CRITICISM 2: REPORTS DO NOT ACCURATELY
REFLECT EFFECTS OF AUTOMATION
• When an organization transitions from a traditional production system to a lean manufacturing system, inventory levels are depleted. Consequently, almost all production costs of the year are expensed that year.
• Although the effect is temporary, managers will be concerned if their performance evaluations are based on the company’s reported financial statements.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 110 of 122
CRITICISM 2: REPORTS DO NOT ACCURATELY
REFLECT EFFECTS OF AUTOMATION
• Solution to criticism two: Better reports
and measures
– Produce reports based on lean accounting
principles.
• Report for each product all costs incurred to
design, produce, sell, deliver, process customer
payments, and provide post-sale support for that
product.
• Separate overhead costs from COGS.
• Identify changes in inventory levels as a
separate expense item.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 111 of 122
CRITICISM 2: REPORTS DO NOT ACCURATELY
REFLECT EFFECTS OF AUTOMATION
• Solution to criticism two: Better reports
and measures
– Produce reports based on lean accounting
principles.
– Develop resources to focus on issues
important to production cycle managers.
• Examples:
– Useable output produced per time period.
– Monitoring of product quality.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 112 of 122
THROUGHPUT: A MEASURE OF
PRODUCTION EFFECTIVENESS
• Throughput = Productive Capacity x
Productive Processing Time x Yield
– Productive Capacity = Total Units
Produced / Processing Time
• Can be improved by:
– Improving machine or labor efficiency.
– Improving factory layout.
– Simplifying product design specifications.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 113 of 122
THROUGHPUT: A MEASURE OF
PRODUCTION EFFECTIVENESS
• Throughput = Productive Capacity x
Productive Processing Time x Yield
– Productive Capacity = Total Units Produced /
Processing Time
– Productive Processing Time = Processing
Time / Total Time
• The opposite of downtime.
• Can be improved by:
– Better maintenance to reduce machine downtime.
– Better scheduling of deliveries to reduce wait time.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 114 of 122
THROUGHPUT: A MEASURE OF
PRODUCTION EFFECTIVENESS
• Throughput = Productive Capacity x
Productive Processing Time x Yield
– Productive Capacity = Total Units Produced /
Processing Time
– Productive Processing Time = Processing
Time / Total Time
– Yield = Good Units / Total Units
• Can be improved by:
– Using better raw materials.
– Improving worker skills.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 115 of 122
THROUGHPUT: A MEASURE OF
PRODUCTION EFFECTIVENESS
• Throughput = Productive Capacity x Productive
Processing Time x Yield
– Productive Capacity = Total Units Produced / Processing Time
– Productive Processing Time = Processing Time / Total Time
– Yield = Good Units / Total Units
• EXAMPLE: Manster Co. produced 1,000 bottles of Zithmowash
in a 10-hour period. During this period there was a total of 1
hour of machine downtime and waiting time for materials. One
hundred of the bottles were defective.
– PRODUCTIVE CAPACITY = 1,000 bottles / 9 productive hours =
111.11 bottles / hour.
– PRODUCTIVE PROCESSING TIME = 9 productive hours / 10 total
hours = .90.
– YIELD = 900 good units / 1,000 total units = .90
– THROUGHPUT = 111.11 x .90 x .90 = 90
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 116 of 122
QUALITY CONTROL
• Information about quality control
–Quality control costs can be divided
into four categories:
• Prevention costs
• Costs incurred to reduce product defect rates.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 117 of 122
QUALITY CONTROL
• Information about quality control
–Quality control costs can be divided
into four categories:
• Prevention costs
• Inspection costs
• Costs incurred to ensure products meet quality
standards.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 118 of 122
QUALITY CONTROL
• Information about quality control
–Quality control costs can be divided
into four categories:
• Prevention costs
• Inspection costs
• Internal failure costs
• Costs of rework and scrap when products are
identified as defective prior to sale.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 119 of 122
QUALITY CONTROL
• Information about quality control
–Quality control costs can be divided
into four categories:
• Prevention costs
• Inspection costs
• Internal failure costs
• External failure costs
• Costs when defective products are sold to
customers, e.g., warranty and repair costs,
product liability costs, costs of customer
dissatisfaction, and damage to reputation.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 120 of 122
QUALITY CONTROL
• Information about quality control
–Quality control costs can be divided into four categories:
• Prevention costs
• Inspection costs
• Internal failure costs
• External failure costs
– The objective of quality control is to minimize the sum of these four costs.
• Some companies have found that the most
important management decision involves
switching from the traditional "management by
exception" philosophy to a "continuous
improvement" viewpoint. Continuous
improvement focuses on comparing actual
performance to the ideal (i.e., perfection).
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 121 of 122
SUMMARY
• You’ve learned about the basic business
activities and data processing operations that
are performed in the production cycle, including:
– Product design
– Production planning and scheduling
– Production operations
– Cost accounting
• You’ve learned how IT can improve the
efficiency and effectiveness of these processes.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 122 of 122
SUMMARY
• You’ve learned about decisions that need to be
made in the production cycle and the information
required to make these decisions.
• You’ve also learned about the major threats that
present themselves in the production cycle and
the controls that can mitigate those threats.
• Finally, you’ve learned how the company’s cost
accounting system can help in achieving the
entity’s objectives.