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Chera Emiru

Chera Emiru/AIS/2005/ s7 1
The Production Cycle

Chapter 7

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Learning Objectives
1. Describe the major business activities and
related data processing operations performed
in the production cycle.
2. Explain how a company’s cost accounting
system can help it achieve its manufacturing
3. Identify major threats in the production cycle,
and evaluate the adequacy of various control
procedures for dealing with those threats.
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Learning Objectives
4. Discuss the key decisions that must
be made in the production cycle, and
identify the information needed to
make those decisions.
5. Read and understand an REA data
model of the production cycle.
6. Develop an REA data model for the
production cycle.

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 LeRoy Williams, VP of manufacturing for
Alpha Omega Electronics (AOE), is
concerned about problems associated with
AOE’s cost accounting system.
 Elizabeth Venko, AOE’s controller, and Ann
Brandt, AOE’s vice president of information
systems, agreed to undertake a study of how
to modify the system.
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 This chapter is organized around the three
major functions of the AIS in the
production cycle.
1. The description of production cycle activities
and cost accounting
2. Introduction of major control objectives in the
production cycle
3. Showing how the AIS can store and organize
information needs

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Learning Objective 1
Describe the major business
activities and related data
processing operations
performed in the production

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Production Cycle Activities
 The production
The production cyclecycle is a recurring
is a recurring set ofset
of business
business activitiesactivities and data
and related related data
processing operations
operations associated
associated with
with the
the manufacturing
manufacturing of products.
of products.

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Production Cycle Activities
 Accurate and timely cost accounting
information is essential input to decisions
• Product mix
• Product pricing
• Resource allocation and planning
• Cost management

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Production Cycle Activities
 There are four basic activities in the
production cycle:
1. Product design
2. Planning and scheduling
3. Production operations
4. Cost accounting

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Product Design (Activity 1)
 The first step in the production cycle is
product design.
 The objective of this activity is to design a
product that meets customer requirements
for quality, durability, and functionality
while simultaneously minimizing
production costs.

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Product Design (Activity 1)
 Documents and procedures:
 The product design activity creates two
main documents:
1 Bill of materials
2 Operations list

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Product Design (Activity 1)
 How can accountants be involved in product
– by showing how various design trade-offs affect
production costs and thereby profitability
– by ensuring that the AIS is designed to collect
and provide information about the machine setup
and materials handling costs associated with
alternative product designs
– by providing data about repair and warranty costs
associated with existing products

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Planning and Scheduling
(Activity 2)
 The second step in the production cycle is
planning and scheduling.
 The objective of this step is a production
plan efficient enough to meet existing
orders and anticipate short-term demand
without creating excess finished goods

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Planning and Scheduling
(Activity 2)
 What are two common methods of
production planning?
1 Manufacturing resource planning (MRP-II)
2 Just-in-time (JIT) manufacturing systems
 MRP-II is an extension of materials resource
planning that seeks to match existing production
capacity and raw materials needs with forecasted
sales demands.
 The goal of JIT is to minimize inventories of raw
materials, work in process, and finished goods.

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Planning and Scheduling
(Activity 2)
 Documents, forms and procedures:
– 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.
– A materials requisition authorizes removal of
materials from the storeroom to the factory.
– Subsequent transfers of these materials are
documented on move tickets.

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Planning and Scheduling
(Activity 2)
 How can accountants be involved in
planning and scheduling?
– by ensuring that the AIS collects and
reports costs in a manner consistent with
the production planning techniques used
by the company
– by helping to choose whether MRP-II or
JIT is more appropriate

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Production Operations
(Activity 3)
 The third step in the production cycle is the actual
manufacture of products.
 The manner in which this activity is accomplished
varies greatly across companies.
 What is computer-integrated manufacturing
– It is the use of information technology in the production

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Production Operations
(Activity 3)
 Computer-Integrated Manufacturing (CIM) is the use of
various forms of IT in the production process, such as
robots and computer-controlled machinery, to reduce
production costs.
 Every firm needs to collect data about the following four
facets of its production operations:
1. Raw materials used
2. Labor-hours expended
3. Machine operations performed
4. Other manufacturing overhead costs incurred

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Learning Objective 2
Explain how a company’s cost
accounting system can help it
achieve its manufacturing goals

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Cost Accounting (Activity 4)
 The final step in the production cycle is cost
 What are the three principal objectives of
the cost accounting system?
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
3. To collect and process the information used to
calculate the inventory and cost of goods sold

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Cost Accounting (Activity 4)
 What are two types of cost accounting
1 Job-order costing
2 Process costing
– Job-order costing assigns costs to specific
production batches or to individual jobs.
– Process costing assigns costs to each process,
and then calculates the average cost for all
units produced.
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Cost Accounting (Activity 4)
 The choice of job-order or process costing
affects only the method used to assign costs
to products, not the method used for data
 Raw Materials:
– When production is initiated, the issuance of a
materials requisition triggers the journal entry.

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Cost Accounting (Activity 4)
 Assume that $15,000 of raw materials were
 What is the journal entry?
Work in Process 15,000
Raw Materials Inventory 15,000 To record
issuance of raw materials
 Assume that $1,000 of raw materials were
returned to inventory.
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Cost Accounting (Activity 4)
 What is the journal entry?
Raw Materials Inventory 1,000
Work in Process 1,000
To record return of raw materials to inventory
 Most raw materials are bar-coded.
 Inventory clerks use online terminals to
enter usage data for those items that are not
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Cost Accounting (Activity 4)
 Direct Labor:
 A job-time ticket is a paper document used
to collect data about labor activity.
 This document records the amount of time a
worker spent on each specific job task.
 Workers can enter this data using online
terminals at each factory workstation.

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Cost Accounting (Activity 4)
 Machinery and Equipment:
As companies implement CIM to automate
the production process, an even larger
proportion of product cost relate to the
machinery and equipment used to make the

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Cost Accounting (Activity 4)
 Manufacturing Overhead:
 What is manufacturing overhead?
– all manufacturing costs that are not
economically feasible to trace directly to
specific jobs or processes

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Cost Accounting (Activity 4)
 Accounting for Fixed Assets:
 The AIS also needs to collect and process
information about investment in the
property, plant, and equipment used in the
production cycle.
 Fixed assets should be bar-coded.

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Cost Accounting (Activity 4)
What minimum information should
organizations keep about their fixed
– identification number – expected salvage value
– serial number – depreciation method
– location – depreciation charges to
– cost date
– date of acquisition – improvements
– vendor name and – maintenance services
address performed
– expected life

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Learning Objective 3
Identify major threats in the
production cycle, and evaluate
the adequacy of various control
procedures for dealing with

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Control: Objectives,
Threats, and Procedures
 The second function of a well-designed AIS is to
provide adequate controls to ensure that the
following objectives are met:
1. All production and fixed asset acquisitions are
properly authorized.
2. Work-in-process inventories and fixed assets are
3. All valid, authorized production cycle transactions are

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Control: Objectives,
Threats, and Procedures
4. All production cycle transactions are
recorded accurately.
5. Accurate records are maintained and
protected from loss.
6. Production cycle activities are performed
efficiently and effectively.

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Control: Objectives,
Threats, and Procedures
 What are some threats?
– unauthorized transaction
– theft or destruction of inventories and fixed
– recording and posting errors
– loss of data
– inefficiencies and quality control problems

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Control: Objectives,
Threats, and Procedures
 What are some control procedures?
– accurate sales forecasts and inventory records
– authorization of production
– restricted access to production planning
program and to blank production order
– review and approval of capital asset

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Control: Objectives,
Threats, and Procedures
– documentation of all internal movements of
– 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
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Learning Objective 4

Discuss the key decisions that

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

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Information Needs
and Procedures
 The third function of the AIS is to provide
information useful for decision making.
 In the production cycle, cost information is
needed by internal and external users.
 Traditionally, most cost accounting systems
have been designed primarily to meet
financial reporting requirements.

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Information Needs
and Procedures
 What are two major criticisms of
traditional cost accounting systems?
1. Inappropriate allocation of overhead costs
2. Inaccurate performance measures

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Information Needs
and Procedures
What is a potential solution to the first
 Activity-Based Costing (ABC):
– ABC attempts to trace costs to the activities that
create them and only subsequently allocates
those costs to products or departments.

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Information Needs
and Procedures
 ABC systems distinguish three separate
categories of overhead.
1. Batch-related overhead
2. Product-related overhead
3. Company-wide overhead
 The bases used to allocate manufacturing
overhead are the cost drivers.
 What is a cost driver?
– anything that has a cause-and-effect relationship on
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Information Needs
and Procedures
 What are some benefits of ABC?
– better decisions
– improved cost management
 More accurate cost data results in better
product mix and pricing decisions.
 More detailed cost data improves
management’s ability to control and manage
total costs.

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Information Needs
and Procedures
 What is the potential solution to the second
– Integrated production cycle data model

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Learning Objective 5

Read and understand a data

model (REA diagram) of the
production cycle.

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Production Cycle Data Model
 To maximize its usefulness for cost management
and decision making, production cycle data must
be collected at the lowest possible level of
 The following diagram presents relationships
between the work in process (resource entity) and
raw materials, labor, and machine operations
(event entities) used to produce a batch of goods.

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Production Cycle Data Model
Partial REA Diagram of the Production Cycle

Raw materials (1, 1) (1, N)

Work in
(1, N) process
(1, 1)
Job operations (1, N)

(1, 1)
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Learning Objective 6

Develop an REA data model

for the production cycle.

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Production Cycle
Customer orders Purchase Requisitions
Sales Overhead
Revenue forecast Production Expenditure
cycle cycle cycle

Finished goods Raw materials

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Production Cycle
Cost of goods
manufactured Labor needs
Reports costs

General ledger Human resource

and Management
reporting system payroll cycle

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Production Cycle
Bill of materials
Product Planning and
Operations list
design scheduling

WIP Orders,
Costs tickets and
Finished goods
Cost Production
accounting Tickets and requisitions operations
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Production Cycle
Data Model
 What are the relationships among work in
process and the three event entities?
– all are one-to-many
 What do they reflect?
– Each production run may involve a number of
raw materials issuances, labor operations, and
machine operations.
– Each of those activities, however, is linked to a
specific production run.
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Production Cycle
Data Model
Partial REA Diagram of the Production Cycle

(1, 1)
(1, N)

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Production Cycle
Data Model
 What is the relationship between the two
agent entities?
– many-to-one
 What does it reflect?
– Each employee is assigned to a specific
– Each supervisor is responsible for many
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Case Conclusion
 What did Elizabeth Venko decide?
– Implement activity-based costing
– Change the reports produced
 She decided that two major changes were
needed in the reports produced by the AIS:
1 Quality control costs will be reported.
2 Nonfinancial as well as financial measures will
be included in the performance reports.

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End of Chapter 7

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