Instructor Outline CHAPTER 12 THE PRODUCTION CYCLE

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Nov 27, 2013 (3 years and 9 months ago)

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Instructor Outline

CHAPTER 12

THE PRODUCTION CYCLE


As a result of your study of this chapter, you should learn to:


1.

Describe the major business activities and related information
processing operations performed in the production cycle.

2.

Explain how a compa
ny’s cost accounting system can help it achieve
its manufacturing goals.

3.

Identify major threats in the production cycle, and evaluate the
adequacy of various control procedures for dealing with those threats.

4.

Discuss the key decisions that must be made in
the production cycle,
and identify the information required to make those decisions.


Production Cycle


The
production cycle

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

Figure 12
-
1

on
page 463

shows how the production cycle is
linked to the other subsystems in a company’s AIS.


A company’s AIS plays a vital role in the production cycle. Accurate and
timely cost accounting information is essential input to decisions abou
t the
following:




Product mix (what to produce)



Product pricing



Resource allocation and planning (e.g., whether to make or buy a
product, relative profitability of different products).



Cost management (planning and controlling manufacturing costs,
evaluati
ng performance).


This chapter examines the three major functions of the AIS in the production
cycle:


1)

capturing and processing data about business activities,

2)

storing and organization the data to support decision making, and

3)

providing controls to ensure
the reliability of data and the
safeguarding of organizational resources.

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Production Cycle Activities


Figure 12
-
2

on
page 464
shows the four basic activities in the production
cycle:


1)

product design,

2)

planning and scheduling,

3)

production operations, and

4)

co
st accounting


Figure 12
-
2

also depicts the principal information flows between each of
those activities and the other AIS cycles.


One popular approach to improving manufacturing performance, called Six
Sigma, begins with careful measurement and analysis
of current processes in
order to find ways to improve them.


Product Design


The first step in the production cycle is product design (
circle 1.0

in
Figure 12
-
2
).

The
objective

of this activity is to design a product that
meets customer requirements in ter
ms of quality, durability and
functionality while simultaneously minimizing production costs.


FOCUS 12
-
1

on
page 465

explains how simulation software is
constantly improving the efficiency and effectiveness of product
design.

Product life
-
cycle management

(PLM)
software consists of
three key components:


1.

computer
-
aided design (CAD)

software to design
new products,

2.

digital manufacturing software

that simulates how
those products will be manufactured, and

3.

product data management software

that stores all
the
data associated with products.


Properly managing the use of complex software like PLM
systems, however, is neither cheap nor easy. For example,
Boeing, to have all its employees and business partners using
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the same CAD software; it cost them approximately

$120,000
plus training costs.



Key Documents and Forms


The product design activity creates two main documents:




Bill of materials

which specifies the part number,
description and quantity of each component used in a
finished product, and



An
operations l
ist
, which specifies the sequence of steps to
follow in making the product, which equipment to use and
how long each step should take.


Role of the Accountant


Accountants should participate in product design because 65% to 80%
of product costs are determi
ned at the product design stage.

Production costs can be reduced by
increasing the number of common
components used for a line of related products.

Accountants can add
value if they not only design the AIS to measure and collect the
relevant cost data, but

also, if they help the design team to use that
data proactively to improve profitability.


Planning and Scheduling


The second setup in the production cycle is planning and scheduling
(
circle 2.0

in
Figure 12
-
2

on
page 464
).



Planning Methods


Two common

methods of production planning are
management
resource planning

and
lean

manufacturing.


Manufacturing resource planning (MRP
-
II)

is an extension
of materials resource planning, covered in chapter
11 that

seeks
to balance existing production capacity and
raw materials needs
to meet forecasted sales demands.
MRP

systems are often
referred to as
push manufacturing
, because goods are
produced in expectation of customer demand.

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Lean manufacturing

extends the principles of
just
-
in
-
time

systems to the entire pro
duction process.

Lean manufacturing

is often referred to as
pull manufacturing
, because goods are
produced in response to customer demand.

However, in
practice, most lean manufacturing systems develop
short
-
run
production plans.


Both
MRP
-
II

and
lean manuf
acturing

systems plan
production in advance.

MRP
-
II

systems may develop
production plans for up to 12 months in advance.

Lean
manufacturing

systems use much shorter planning horizons.


Key Documents and Forms


The
master production schedule (MPS)

specifies

how much of each
product is to be produced during the planning period and when that
production should occur (Refer to
Figure 12
-
3

on
page 467
)
.

The
MPS

is used to develop a detailed timetable that specifies daily
production and to determine if raw materia
ls need to be purchased. To
do this, it is necessary to “explode” the bill of materials to meet the
production goals as listed in the MPS (see
Table 12
-
1

on
page 468
).
This figure shows that the planning and scheduling activity produces
three other documen
ts:


1)

A
production order

which authorizes the manufacture of a
specified quantity of a particular product.

A sample of the
production order is provided in
Figure 12
-
4

on
page 469
.


2)

A
materials requisition

authorizes the removal of the
necessary quantity of
raw materials from the storeroom to the
factory location where they will be used. A sample of the
materials requisition is provided in
Figure 12
-
5

on
page 469
.


3)

Subsequent transfers of raw materials throughout the factor are
documented on
move tickets
, whi
ch identify the parts being
transferred, the location to which they are transferred and the
time of transfer. A sample of the move ticket is provided in
Figure 12
-
6

on
page 470
.


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Bar
-
coding improve
s

the speed and accuracy of recording
information about mat
erial movements b
y

eliminating the need to
manually enter data.


More recently, radio
-
frequency identification (RFID) tags further
improve efficiency by eliminating the need for any human
intervention in the scanning process. This makes
the
RFID scanner
up

to 40 times faster than bar
-
code scanners.

Surveys estimate that
as much as 10% to 20% of handling materials in the warehouse is
spent on looking for the right product. RFID technology can
eliminate this cost. RFID tags have a scanner the broadcast a sign
al
to locate the desired product.


Role of the Accountant


The accountant must ensure that the AIS collects and reports costs
in a manner consistent with the production planning techniques of
the company.


Lean manufacturing

emphasizes working in teams and

seeks to
maximize the efficiency and
synergy

of all teams involved in
making a particular product.


Production Operations


The third step in the production cycle is the actual manufacture of
products (
circle 3.0

in
Figure 12
-
2

on
page 464
)
.

Using various

forms of IT in the production process, such as robots and computer
-
controlled machinery, is referred to as
computer
-
integrated
manufacturing (CIM)
.

Accountants are not required to be experts on
every facet of CIM, but they must understand how it affects t
he AIS.


In order to minimize inventory carrying costs, the AIS must maintain
accurate perpetual inventory records. This requires integrating
information about customer orders (from the revenue cycle) with
information about purchases from suppliers (from t
he expenditure
cycle), along with information about labor available (from the
HR/payroll cycle).

Figure 12
-
7

on
page 471

shows the Enterprise
Resource Planning systems providing such integration.


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Every firm requires cost accounting data about the followi
ng four
facets of its production operations:


1)

raw materials used

2)

labor hours expended

3)

machine operations performed, and

4)

other manufacturing overhead costs incurred


Cost Accounting


The final step in the production cycle is cost accounting (
circle 4.0

in
F
igure 12
-
2

on
page 464
)
.
The three principal objectives of the cost
accounting system 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
pr
icing and product mix decisions; and

(3)

to collect and process the information used to calculate the
inventory and cost of goods sold values that appear in the
company’s financial statements.


FOCUS 12.2

on
page 472

explains how RFID can be
especially
helpful

in accomplishing the first object
ive
.

Effective management of
production activities requires real
-
time information about the status of
machinery and equipment.

RFID capabilities embedded in new
production machinery enable devices to continuously transmit
information about their condition.

Schneider Electric’s Square D
-
brand circuit breakers alert operators when a breaker’s performance
indicates that it is approaching the time when it will fail.

Built
-
in
Internet capabilities mean that the device can automa
tically send e
-
mail requests to the manufacturer or maintenance provider to schedule
service.

RFID tags can also save manufacturers money should there
be a need to recall products.







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Type of Accounting System


Most companies use either
job
-
order

or
pro
cess costing

to assign
production costs.

Job
-
order costing

assigns costs to specific
production batches, or jobs, and is used when the product or service
being sold consists of discretely identifiable items.


Process costing

assigns costs to each process,
or work center, in the
production cycle, then calculates the average cost for all units
produced.


Accounting for Fixed Assets


The AIS must also collect and process information about the property,
plant and equipment used in the production cycle.

At a min
imum,
every organization should maintain the following information about
each fixed asset:




identifying number,



serial number,



location,



cost date of acquisition, vendor name and address,



expected life,



expected salvage value,



depreciation method,



accumu
lated depreciation to date,



improvements, and



maintenance services performed


Orders for machinery and equipment almost always involve a formal
request for competitive bids by potential suppliers.

In addition,
acquisitions of fixed assets often are paid fo
r in installments,
including interest.


RFID tags provide an efficient method for monitoring the location of
machinery and equipment.


Finally, because manufacturing machinery and equipment is often
replaced before it is completely worn out, it is importan
t to formally
approve and accurately record its sale or disposal.

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Information Processing Procedures


Figure 12
-
8

on
page 474

depicts a typical online AIS for the production
cycle.

The system shown in
Figure 12
-
8

could be used to implement either a
job
-
orde
r or process costing system.

Both
systems

require accumulating data
about four basic kinds of costs: 1) raw materials, 2) direct labor, 3)
machinery and equipment, and 4) manufacturing overhead.


Raw Materials Usage Data

When production is initiated, the i
ssuance of materials requisition triggers a
debit to work
-
in
-
process for the raw materials sent to production, and a
credit when raw materials are not used and returned to inventory.


RFID tags improve the efficiency of tracking materials usage.


Direct La
bor Costs


As shown in
Figure 12
-
8
, worker enters the data on time spent on each
specific job task using online terminals at each factory workstation.


Machinery and Equipment Usage


Companies implement
computer
-
integrated

(
CIM
)

to automate the
production
process.


Data for machinery and equipment used at a
workstation and the duration of such use was collected by wiring the factory
so that each piece of equipment was linked to the computer.

The wired
connections are now being replaced with wireless technol
ogy. This enables
the use of 3
-
D simulation software
to evaluate the effects of modifying shop
-
floor layout and workflow to easily and quickly implement beneficial
changes.


Manufacturing Overhead Costs


Manufacturing costs that cannot be directly related
to the production of a
specific product is referred to as
manufacturing overhead
. Examples
include factory costs of water, power, and other utilities; miscellaneous
supplies; rent, insurance and property taxes.


Accountants can play a key role in controlli
ng overhead costs by carefully
assessing how changes in product mix affect total manufacturing overhead.

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Control Objectives, Threats and Procedures


A second function of a well
-
designed AIS is to provide adequate controls to
meet the following production
cycle objectives:


1.

All production activities and fixed asset acquisitions are properly
authorized

2.

Work
-
in
-
process inventories and fixed assets are safeguarded

3.

All valid, authorized production cycle transactions are recorded

4.

All production cycle transaction
s are recorded accurately

5.

Accurate records are maintained and protected from loss

6.

Production cycle activities are performed efficiently and effectively


Wherever feasible, use of RFID tags or bar codes can further improve data
entry accuracy.


Table 12
-
2

o
n
page 476

lists the major threats and exposures in the
production cycle and the additional control procedures, besides adequate
documents and records.


Product Design


Threat 1
:
Poor Product Design


Poor product design drives up costs in several ways to i
nclude using too
many unique components and poorly designed products.


Product design can be improved with accurate data about the relationship
between components and finished goods.


Planning and Scheduling


Threat 2
:
Over
-

or Underproduction


Two related

threats in the planning and scheduling process are
overproduction

and
underproduction
.


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Overproduction

can result in a supply of goods in excess of short
-
run
demands; thereby creating potential cash flow problems. There is also a risk
of carrying inventor
y items that become obsolete.


Underproduction

can result in lost sales and dissatisfied customers.


More accurate production planning can prevent over
-

and underproduction.
Improvement requires accurate and current sales forecasts from the revenue
cycle s
ystems, and data about inventory stocks from the expenditure cycle.


Proper approval and authorization of production orders is another control to
prevent overproduction of specific items.


Threat 3
:
Suboptimal Investment in Fixed Assets


Overinvesting

in f
ixed assets can create excess costs and
underinvestment

can impair productivity. Both problems reduce profitability.


Proper authorization of fixed
-
asset transactions is important.


Holding managers accountable for their department’s return on the fixed
as
sets provides additional incentive to control such expenditures.


Due to the size of fixed
-
asset purchases, companies should invite several
competing suppliers to provide bids. A document called a
request for
proposal (RFP),

which specifies the desired pro
perties of the asset, is sent
to each vendor.


Production Operations


Threat 4
:
Theft of Inventories and Fixed Assets


To reduce the risk of inventory loss, physical access to inventories should be
restricted and all internal movements of inventory should
be documented.


Proper segregation of duties is important to safeguard inventory.
Maintaining physical custody of the raw materials and finished goods
inventories is the responsibility of the
inventory stores department
.
Department of
factory supervisors

h
ave
primary responsibility

for work
-
in
-
process inventories.

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Internal controls are also needed to safeguard fixed assets. Managers should
be assigned responsibility and accountability for fixed assets under their
control.


Finally, inventories and fixed as
sets are also subject to loss due to fire or
other disasters. Therefore, adequate insurance covered should be maintained
to cover such losses and provide for the replacement costs of these assets.


Threat 5
:
Disruption of Operations


The high level of auto
mation in production cycle activities means that
disasters that disrupt the functioning of information systems can also disrupt
manufacturing activities.


Backup power sources and uninterruptible power supply devices are
required to ensure that critical eq
uipment and machinery is not damaged
during a power loss. This will ensure that the production process can
continue on schedule.


Not only due companies need to have a disaster plan, but companies need to
check on their suppliers plan and come up with alte
rnate sources for critical
components.


General Threats


Threat 7
:
Loss, Alteration or Unauthorized Disclosure of Data


Loss or alteration of production data hinders the monitoring of inventory and
fixed assets and makes it difficult to ensure that manufac
turing activities are
being performed efficiently and effectively.


Inventory and work
-
in
-
process records must be protected from both
intentional and accidental losses or damages.


Regular back
-
up of all dat
a

files is important.

Access controls are also
ne
cessary
to protect production data because of the potential losses of
production trade secrets.

Unauthorized access also increases the risk of
damage to important data files.

Passwords and user IDs can limit access to
sensitive files.

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It is important to en
force proper access controls and segregation of duties
which requires to controller or CFO to review and suggest appropriate
configuration of user rights in integrated AIS packages and ERP systems.


Access and processing integrity controls are also needed
to ensure the
confidentiality and accuracy of production cycle data transmissions between
different factories.


Threat 8
:
Poor Performance


Inefficiencies in production operations result in increased expenses. Thus,
manufacturing activities must be closely

monitored and prompt action taken
to correct any deviations from standards.


Production Cycle Information Needs


A third function of the AIS is to provide information useful for decision
making.

The focus must be on total quality management.

Many companie
s
have maintained the cost accounting and production operations information
system separately.

Both costs and operational data should be integrated into
one system.


The traditional cost systems have been criticized for not providing adequate
information t
o manage production operations.


There are two major criticisms:


1)

overhead costs are inappropriately allocated to products, and

2)

reports do not accurately reflect the effect of factory
automation


Criticism 1
:
Inappropriate Allocation of Overhead Costs


Tr
aditional cost systems use volume
-
driven bases, such as direct labor or
machine hours to apply overhead to products.

As a result, the costs of
products manufactured are overstated.

In addition, allocating overhead based
on direct labor input can distort co
sts across products.




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Solution to Criticism 1
:
Activity Based Costing


Activity Based Costing

refines a costing system by identifying individual
activities as the fundamental cost objects. An
activity

is an event, task, or
unit of work with a specified p
urpose such as designing products, setting up
machines, operating machines and distributing products.


Activity Based Costing versus Traditional Cost Systems


Following are three significant differences between ABC and traditional
approaches to product cos
ting:


1.

ABC systems attempt to directly trace a larger proportion of
overhead costs to products. Advances in IT make this feasible.

2.

ABC systems use a greater number of cost pools to accumulate
indirect costs (manufacturing overhead). Whereas most
traditiona
l cost systems lump all overhead costs together.

ABC systems distinguish three separate categories of overhead:




Batch
-
related overhead
. Examples include setup costs,
inspections and materials handling.





Product
-
related overhead
. These
costs

are related i
n the
diversity of the company’s product line. Examples include
research and development,
expediting,

shipping and
receiving, environmental regulations and purchasing.




Company
-
wide overhead
. This category includes such
costs as rent or property taxes. The
se
costs

apply to all
products.


3.

ABC systems attempt to rationalize the allocation of overhead to
products by identifying
cost drivers
.


A
cost driver

is anything that has a cause and effect
relationship on costs. For example, the number of purchase
orders

processed is one cost driver of purchasing department
costs.



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Benefits of ABC Systems


ABC systems cost more to run than traditional cost system because they
require the collection or more production
-
related data and in greater detail.
They are also more

complex.

More accurate cost data result in better product
mix and pricing decisions, and more detailed cost data to improve
management’s ability to control and mange total costs.


Better Decisions
.
Traditional cost systems tend to apply too much overhead
t
o

some products and too little to others. This lead
s

to two types of
problems:


1st.

Companies may accept sales contracts for some products at
prices below their true cost of production. Sales increase, but
profits decline.


2nd.

Companies may overprice other produ
cts.


ABC systems avoid these problems.

ABC also uses data to improve product
design.

Finally, ABC data improve managerial decision making by
providing information about the costs associated with specific activities,
instead of classifying those costs by f
inancial statement category.


Table 12
-
3

on
page 483

shows an example of this rearrangement of data
that can improve managerial analysis by focusing attention on key processes.

The ABC analysis shows which
activities

(
training, testing,
and
maintenance

and

system analysis) are running over budget and which are
not.


Improved Cost Management
.
Another advantage of ABC is that it clearly
measures the results of managerial actions on overall profitability.

ABC
systems measure both the amount spent to acquire r
esources and the
consumption of those resources. This distinction is reflected in the following
formula:


Cost of activity capability = Cost of activity used + Cost of unused
capacity.


To illustrate, consider the receiving function at a manufacturing firm

such as
AOE.

Assume the following:

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The salary expense for the receiving department is $100,000



Receiving employees can handle 500 shipments



The cost per shipment is $200



Assume that 400 shipments are actually received


The cost of the receiving activity i
s $80,000 ($200 X 400 shipments)
.
The remaining $20,000 ($100,000
-

$80,000) in salary expense
represents the cost of unused capacity.


Criticism 2
:
Misleading Reports


The modern approaches to production differ significantly from traditional
mass producti
on.

One major difference is a marked reduction in finished
goods inventory levels, because production is scheduled based on customer
demand instead of projections based on prior years.

Although, the
traditional approach is more beneficial in the long
-
run,

it often creates a
short
-
term decline in profitability.

The reason being is that the traditional
approach treats inventory as an asset. Thus
,

the cost of production inventory
is

not recognized until the products are sold.


Solution to Criticism 2
:
Better
Reports and Measures


CPAs have now added supplemented the traditional financial statements
with reports based on lean accounting. One suggested change involves
assigning costs to product lines instead of departments.

In addition to this
change, accountant
s should also develop new measures that are designed to
focus on issues important to production cycle managers.


Throughput
:
A Measure of Production Effectiveness


Throughput

represents the number of good units produced in a given period
of time. It consis
ts of three factors 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 tha
t can be produced using current technology.


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Productive processing time
, the second term in the formula indicates the
percentage of total production time use to manufacture the product.


Yield
, the third term in the formula, represents the percentage of go
od units
produced.


Information About Quality Control


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
custom
ers. 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.”


Some companies ha
ve found that the most important management decision
involves switching from the traditional “management by exception”
philosophy to a “continuous improvement” viewpoint.


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