CHAPTER 12

THE PRODUCTION CYCLE

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?
• The production cycle is a recurring set of business activities and related data processing
operations associated with the manufacture of products.
• Information flows to the production cycle from other cycles. 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.
• 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.
• Decisions that must be made in the production cycle include decisions on product mix, pricing,
resource allocation, cost management, and performance evaluation.

PRODUCTION CYCLE ACTIVITIES

• The four basic activities in the production cycle are: (1) product design; (2) planning and
scheduling; (3) production operations; and (4) 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.

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.
• Key documents and forms in product design:
– Bill of Materials: Lists the components that are required to build each product.
– Operations List: Lists the sequence of steps and the equipment and time required to
produce each product.
• The accountant participates in product design, because 65-80% of product cost is determined at
this stage. The accountant can add value by designing AIS that measures and collects the needed
data and by helping the design team use that data to improve profitability.

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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 short-term demand while minimizing
inventories of both raw materials and finished goods. There are two common approaches to
production planning:
– Manufacturing Resource Planning (MRP-II)--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.
– Lean Manufacturing--An extension 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.
• Key documents and forms:
– Master production schedule—specifies how much of each product is to be produced
during each period and when.
– Production order—authorizes production of a specified quantity of a product.
– Materials requisition—authorizes movement of materials to the factory floor.
– Move ticket—documents transfer of parts and materials through the factory.
• Role of the accountant is to ensure the AIS collects and reports costs in a manner consistent with
the company’s production planning techniques.

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). Accountants must understand
how the CIM affects the AIS.
• In a lean manufacturing environment, a customer order triggers several actions. The system first
checks inventory on hand for sufficiency, then calculates labor needs and determines whether
overtime or temporary help will be needed. Based on the bill of materials, the system determines
what components need to be ordered and transmits necessary purchase orders via EDI. The
master production schedule is adjusted to include the new order.
• Sharing information across cycles helps companies be more efficient by timing purchases to meet
the actual demand.
• While 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; and other
manufacturing overhead costs incurred.

COST ACCOUNTING

• The objectives of cost accounting 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 pricing and product mix decisions; and (3) to collect and process information
used to calculate inventory and COGS values for the financial statements.
• Types of cost accounting systems:
– Job order costing—assigns costs to a particular production batch or job.
– Process costing--assigns costs to each process or work center in the production cycle and
calculates the average cost for all units produced.

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 • 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. The purchase of fixed
assets follows the same processes as other purchases in the expenditure cycle (order à
receive à pay). But the amounts involved necessitate competitive bidding, involvement
of more people, differences in payment approaches (e.g., installments), more elaborate
controls, and formal approval for disposal.
• Both job-order and process costing systems require that data be accumulated about raw materials,
direct labor, machinery and equipment usage, and manufacturing overhead. The choice of
method does not affect how data are collected but does affect how costs are assigned to products.
• 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.
Bar-coding of raw materials or RFID tags can improve efficiency.
• 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 or use coded ID badges
swiped through a badge reader.
• Machinery and Equipment Usage--Data about machinery and equipment are collected at each
production step, often with data about labor costs.
• Manufacturing Overhead Costs--Include costs that can’t be easily traced to jobs or processes,
such as utilities, depreciation, and supervisory salaries. Accountants help control overhead by
assessing how product mix changes will affect overhead costs.

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: (1) all transactions are properly authorized; (2) all
recorded transactions are valid; (3) all valid and authorized transactions are recorded; (4) all
transactions are recorded accurately; (5) assets are safeguarded from loss or theft; (6) business
activities are performed efficiently and effectively; (7) the company is in compliance with all
applicable laws and regulations; and (8) all disclosures are full and fair.

THREATS IN PRODUCT DESIGN

• Threat No. 1—Poor Design
– Controls: Accurate data about components; analysis of warranty and repair costs.

THREATS IN PLANNING AND SCHEDULING

• Threat No. 2—Over- or Under-Production
– Controls: Accurate sales forecasts and inventory data; investment in production planning;
collection of production performance data; proper authorization of production orders;
restricted access to production scheduling programs; validity checks on production
orders.
• Threat No. 3—Sup-optimal Investment in Fixed Assets
– Controls: Proper authorization of fixed asset transactions; competitive bidding.

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THREATS IN PRODUCTION OPERATIONS

• Threat No. 4—Theft of Inventory and Fixed Assets

– Controls: Restricted physical access; documentation of internal inventory movement;
properly authorized material requisitions; RFID tags and bar codes; segregation of duties;
logical and physical access controls; independent count of inventory; ID and recording of
fixed assets; management accountability; physical security; authorization of disposal;
fixed asset reports; adequate insurance.
• Threat No. 5—Disruption of Operations
– Controls: Backup power sources; suppliers with disaster preparedness;

THREATS IN COST ACCOUNTING

• Threat No. 6—Inaccurate Recording and Processing of Production Activity Data
– Controls: Automate data recording with bar codes, RFID, and badge readers; online
terminals for data entry; logical access controls; input validation routines; periodic
physical counts of inventory; inspections and counts of fixed assets.

GENERAL THREATS

• Threat No. 7—Loss, Alteration, or Unauthorized Disclosure of Data

– Controls: File backups; external and internal file labels; logical access controls;
adjustment to default ERP settings; encryption; and message acknowledgment
techniques.
• Threat No. 8—Poor Performance
– Controls: Performance reports.

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, and percent
of defects discovered by customers.
• Two major criticisms have been directed at traditional cost accounting systems: (1) overhead
costs are inappropriately allocated to products; and (2) reports do not accurately reflect effects of
factory automation.
• Activity-Based Costing (ABC) is utilized to address some of these criticisms. There are three
significant differences between ABC and traditional approaches.
– Tracing of overhead costs--ABC directly traces a larger proportion of overhead costs to
products. This tracing is made possible by advances in IT.
– Number of cost pools—ABC uses more cost pools to accumulate overhead costs,
distinguishing between batch-related, product-related, and company-wide overhead.
– Identification of cost drivers

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

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QUALITY CONTROL
• Quality control costs can be divided into prevention, inspection, internal failure, and external
failure costs. The objective of quality control is to minimize the sum of these four costs.

SUMMARY OF MATERIAL COVERED

• Basic business activities and data processing operations that are performed in the production
cycle, including: (1) product design; (2) production planning and scheduling; (3) production
operations; and (4) cost accounting.
• How IT can improve the efficiency and effectiveness of these processes.

TEACHING TIPS
• The production cycle is probably the most difficult cycle for students with little or no prior work
experience.
• Much of the terminology is new or forgotten. If you help them master the terminology early, it
becomes less of an impediment as they work on understanding the more important concepts,
which are the processes.

CHAPTER 12 CROSSWORD PUZZLE

1 2 3

4 5 6

10

11

12

www.CrosswordWeaver.com

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Across
1 Specifies how much of each product is to be produced during each period and when (3 words).
8 Lists the components that are required to build each product (3 words).
9 A costing method that assigns costs to each process or work center in the production cycle and
calculates the average cost for all units produced.
11 Authorizes movement of materials to the factory floor (2 words).
12 Authorizes production of a specified quantity of a product (2 words).

Down
2 A costing method that traces more overhead costs to products, uses more cost pools, and
identifies cost drivers.
3 Lists the sequence of steps and the equipment and time required to produce each product (2
words).
4 Documents transfer of parts and materials through the factory (2 words).
5 Use of various forms of IT, such as robots and computer-controlled machinery, in manufacturing.
6 Another term for manufacturing resource planning.
7 A costing method that assigns costs to a particular production batch or job (2 words).
10 Also referred to as pull manufacturing, seeks to minimize or eliminate inventories of raw
materials, work in process, and finished goods

CHAPTER 12 CROSSWORD SOLUTION

M A S T E R P R O D U C T I O N S C H E D U L E
B P
C E
M C R P
O J I A U
V B I L L O F M A T E R I A L S
E B I H
T O P R O C E S S
I R N L
C D S E
K E L A
M A T E R I A L S R E Q U I S I T I O N
T S
P R O D U C T I O N O R D E R

6 Chapter 12: Production Cycle