Conversion Cycle

Conversion Cycle
This cycle transforms (converts)
input resources such as raw
materials, labor and overhead into
finished products or services that
will be available for sale.
 Manufacturing Environment
Production is usually triggered by the orders from the
revenue cycle and/or sales forecasts from marketing. These
inputs will be used to set a production plan and prepare the
production budget.
Cost data for raw materials (from expenditure cycle), labor
(from human resources cycle) and the manufacturing costs
associated with work-in-process and finished goods are sent to
the general ledger and financial reporting system.
Types of Supply Chain Strategy
1. Push Supply Chain Strategy – products are pushed
through the supply chain, from the production to the
retailer. Products are manufactured and kept as
inventory.
2. Pull Supply Chain Strategy – customers seek out the
product and orders for stock are directed by direct
consumer demand. This is usually done by
companies employing Just-in-Time system.
 Types of Production Method
1. Make-to-order Processing - fabrication of discrete products in
accordance with customer specifications. This is initiated by sales
order rather than depleted inventory levels.
2. Continuous Processing – creates homogenous product through a
continuous series of standard procedures. This approach attempts to
maintain finished goods inventory at levels needed to meet expected
sales demand.
3. Batch Processing – produces groups of products. Each item in the
group is similar and requires the same raw materials and operations.
 Types of Costing Systems
1. Job-order Costing – a system for assigning manufacturing
costs to a unique product.
2. Process Costing – a system of assigning manufacturing costs
to production in companies producing large quantities of
homogenous products.
3. Operations Costing – mixture of job order and process
costing. Initially uses different raw materials but is finished
using a common process.
 Marketing
System
Sales Forecast
Raw MaterialsExpenditure Cycle
Sales Order Conversion
Revenue Cycle and Human
Cycle Resources Cycle
Labor

Work-in-Process Finished Goods

General Ledger and
Financial Reporting
System
 Documents in Batch Processing System
Production Schedule – formal plan and authorization to begin
production. This describes the specific products to be made, the
quantities to be produced in each batch.
Bill of Materials – specifies the type of raw materials used in
producing a single unit of finished product. The requirements for an
entire batch are determined by multiplying the Bill of Materials per
unit by the number of items in the batch.
Route Sheet – shows the production path that a particular batch of
product follows during manufacturing.
 Documents in Batch Processing System
Work order – also called the production order, specifies the materials and
production processes for each batch.
Move Ticket – records work done in each production process and
authorizes the movement of the job or work from one process to the next
process.
Materials Requisition – authorizes the warehouse keeper to release
materials to individuals or work centers in the production process. This
only specifies the standard quantity for the product. Materials in excess of
standard will require a separate materials requisition. This is to have control
over excess material usage.
 Conversion Cycle Controls
1.Transaction Authorization
2.Segregation of Duties
3.Supervision
4.Access Control
5.Accounting Records
6.Independent Verification
 Transaction Authorization
Materials released from the warehouse should be
authorized by the warehouse keeper.
Move tickets must be signed by the supervisor to
authorize the movement of the materials and products in
the manufacturing process.
 Segregation of Duties
The Inventory control maintains the accounting records about the raw
materials and finished goods while the warehouse have custody of the
materials and finished products.
The cost accounting department maintains the records about the
work-in-process inventories and must be separate from the production
process work centers.
The general ledger should be separate from the inventory control and
cost accounting department and act as the independent verification of
the records.
 Access Control
Access to warehouses and production work
centers should be limited to authorized
personnel only. Installing security devices or
appointing security guards may help limit
the access to the assets.
 Accounting Records
The records for the materials should be
maintained by the inventory control through the
materials requisition and purchase orders. The
records for the labor should be maintained by the
Human Resource Department through the job
tickets and labor distribution summary.
 Independent Verification
1. Cost Accounting Department should reconcile the materials and
labor usage from the materials requisition and job tickets.
2. The General Ledger Department should also verify the
movement of the Work-in-process inventories to the Finished
Goods Inventories.
3. Internal and External auditors should conduct physical inventory
count of inventories on hand. This is to compare the actual
inventories with the inventory records and to make necessary
adjustments.
 Production Planning and Control
Materials and Operations Requirements – determining the
raw material requirements needed to produce the target
products based on the sales forecast.
Production Scheduling – the preparation of a master
schedule that will consider the time constraints, batch size
and specifications for the products. This will also show the
production process and flow through the various work
centers.
 Inventory Control
This provides production planning and control
with statue reports on finished goods and raw
materials.
This is done to minimize the total cost of
inventory but will also ensure that the current
demand of the products is met.
 Economic Order Quantity (EOQ)
This model reduces the total inventory
costs by minimizing the cost to order the
inventory and the cost to store the
inventory. The question, “How Many to
Order?” is answered by EOQ.
 Economic Order Quantity Assumptions
1.Demand for the product is known and constant.
2.The lead time (the time between the placing of
order to receiving the order) is constant.
3.All inventories ordered arrive at the same time.
4.There are no quantity discounts. The price of
inventory is constant.
 Economic Order Quantity Formula
2 𝑥 𝐴𝑛𝑛𝑢𝑎𝑙 𝐷𝑒𝑚𝑎𝑛𝑑 𝑥 𝑂𝑟𝑑𝑒𝑟𝑖𝑛𝑔 𝐶𝑜𝑠𝑡
𝐸𝑂𝑄 =
𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑈𝑛𝑖𝑡
Example: A company has an annual demand of 2,000 units and it costs P 6.25 to order. It costs
P0.40 to store the inventory. Using these, the EOQ is:

2 𝑥 2,000 𝑥 𝑃6.25
𝐸𝑂𝑄 = EOQ = 250 units
𝑃0.40
This means that to minimize the cost of inventory, 250 units should be placed every order of the
units.
 Economic Order Quantity Inventory Costs
Total Carrying Cost
𝐸𝑂𝑄
= x Carrying Cost per Unit
2

Total Ordering Cost

𝐴𝑛𝑛𝑢𝑎𝑙 𝐷𝑒𝑚𝑎𝑛𝑑
= x Ordering Cost
𝐸𝑂𝑄
*At EOQ level, total ordering cost and total carrying cost will be equal.
Re-order Point (ROP)
This shows the time that the entity
must place an order. The question
“When to Order?” is answered by
this.
 Re-order Point Formula
ROP = Lead Time x Daily Demand
Lead Time – the time between placing an order and the arrival of
the order.
Daily Demand – the average unit demanded (Total Demand/ Total
Working Days).
Example: The lead time is 8 days, and the average demand of the
product is 5 units. The ROP will be 40 units. This means that
when the inventory level is reduced to 40, it is time to place an
order. At the time of arrival of the units, the zero inventory will be
replenished.
Seatwork # 1
A firm has an annual demand of 10,000 units. The ordering cost is P 4
and carrying cost is P 0.50.

Create a table showing the total carrying cost and total ordering cost if
the units ordered is:
1. Equal to the EOQ
2. Below the EOQ (-10, -20, -30, -40, -50)
3. Above the EOQ (+10, +20, +30, +40, +50)