C HAPTER 12 The Production Cycle © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart of 122 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? © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart of 122 INTRODUCTION • The production cycle is a recurring set of business activities and related data processing operations associated with the manufacture of products © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart of 122 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 © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart of 122 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 © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart of 122 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 © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart of 122 INTRODUCTION • We’ll be looking at how the three basic AIS functions are carried out in the production cycle, i.e.: – How we capture and process data? – How we store and organize the data for decisions? – How we provide controls to safeguard resources, including data? © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart of 122 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 © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart of 122 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 © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart of 122 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 © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 10 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 not accurately reflect effects of factory automation © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 108 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 109 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 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 – 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 111 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 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 – 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 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 – 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 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 • EXAMPLE: Manster Co produced 1,000 bottles of Zithmowash in a 10-hour period During this period there was a total of hour of machine downtime and waiting time for materials One hundred of the bottles were defective – PRODUCTIVE CAPACITY = 1,000 bottles / productive hours = 111.11 bottles / hour – PRODUCTIVE PROCESSING TIME = 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 115 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 116 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 117 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 118 of 122 QUALITY CONTROL • Information about quality control – Quality control costs can be divided into four categories: • • • • • Costs when defective products are sold to Prevention costs customers, e.g., warranty and repair costs, Inspection costs costs, costs of customer product liability dissatisfaction, and damage to reputation Internal failure costs External failure costs © 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 have found that the most • Some companies importantcosts management decision involves Inspection switching from the traditional "management by Internal failure costs exception" philosophy to a "continuous External failure costs improvement" viewpoint Continuous focuses on comparing – The improvement objective of quality control actual is to performance to the of ideal (i.e., perfection) minimize the sum these four costs © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 120 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 121 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 © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 122 of 122 ... Publishing Accounting Information Systems, 11/e Romney/ Steinbart of 122 INTRODUCTION • Information flows to the production cycle from other cycles, e.g.: – The revenue cycle provides information. .. Business Publishing Accounting Information Systems, 11/e Romney/ Steinbart of 122 INTRODUCTION • Information also flows from the expenditure cycle: – The revenue cycle receives information from the... modification and design © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/ Steinbart 12 of 122 PRODUCT DESIGN • Role of the accountant in product design: • Compare