Hapter 12: © 2006 Prentice Hall Business Publishing Accounting Information Systems, 10/e Romney/Steinbart

C HAPTER 12
The Production Cycle
© 2006 Prentice Hall Business Publishing Accounting Information Systems, 10/e Romney/Steinbart 1 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?
INTRODUCTION
• The production cycle is a recurring set of

business activities and related data
processing operations associated with the
manufacture of products.
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.
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.
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.
INTRODUCTION
• We’ll be looking at how the three basic

AIS functions are carried out in the
production cycle, i.e.:
– How do we capture and process data?
– How do we store and organize the data for
decisions?
– How do we provide controls to safeguard
resources, including data?
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.
are:
– Product design
– Cost accounting
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.
PRODUCT DESIGN
• Key documents and forms in product

design:
– Bill of Materials: Lists the components that
are required to build each product, including
part numbers, descriptions,and quantity.
– Operations List: Lists the sequence of steps
required to produce each product, including
the equipment needed and the amount of time
required.
PRODUCT DESIGN
• Role of the accountant in product design:

– Participate in the design, because 65-80% of
product cost is determined at this stage.
– Add value by:
• Designing an AIS that measures and collects the
needed data.
• Information about current component usage.
• Information about machine set-up and materials-
handling costs.
• Data on repair and warranty costs to aid in future
modification and design.
PRODUCT DESIGN
• Role of the accountant in product design:

– Participate in the
• Compare design,
current because
component usage65-80% of
with projected
usage in alternate designs.
product cost is determined at this stage.
• Compare current set-up and handling costs to
– Add value by: costs in alternate designs.
projected
• Provide info on how design trade-offs affect total
• Designing an AIS that measures and collects the
production cost and profitability.
needed data
• Helping the design team use that data to
improve profitability
are:
– Product design
– Cost accounting
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
shorter-term demand while minimizing
inventories of both raw materials and
finished goods.
• There are two common approachs to

production planning:
– Manufacturing Resource Planning (MRP-II)
– Lean Manufacturing
• There are two common approaches to

• MRP-II is 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.
• There are two common approaches to

• Lean manufacturing is an extension of the

principles 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.
• Comparison of the two systems:

– Both plan production in advance.
– They differ in the length of the planning horizon.
• MRP-II develops plans for up to 12 months ahead.
• Lean manufacturing uses shorter planning horizons.
– Consequently:
• MRP-II is more appropriate for products with
predictable demand and a long life cycle.
• Lean manufacturing more appropriate for products with
unpredictable demand, short life cycles, and frequent
markdowns of excess inventory.
• Key documents and forms:

– Master production schedule
• Specifies how much of each product is to be produced during the
period and when.
• Uses information about customer orders, sales forecasts, and finished
goods inventory levels to determine production levels.
• Although plans can be modified, production plans must be frozen a
few weeks in advance to provide time to procure needed materials and
labor.
• Scheduling becomes significantly more complex as the number of
factories increases.
• Raw materials needs are determined by exploding the bill of materials
to determine amount needed for current production. These amounts
are compared to available levels to determine amounts to be
purchased.

– Production order
• Authorizes production of a specified quantity of a
product. It lists:
– Operations to be performed
– Quantity to be produced
– Location for delivery
• Also collects data about these activities

– Materials requisition
• Authorizes movement of the needed materials
from the storeroom to the factory floor.
• This document indicates:
– Production order number
– Date of issue
– Part numbers and quantities of raw materials
needed (based on data in bill of materials)

– Materials requisition
– Move ticket
• Documents the transfer of parts and materials
throughout the factory.
• How can information technology help?

– Improve the efficiency of material-handling
activities by using:
• Bar coding of materials to improve speed and
accuracy
• RFID tags can eliminate human intervention in the
scanning process
• Up to 40 times faster than using bar-code scanners.
• Not impeded by dirt.
• Not limited to reading only those items in line of sight.
• Much easier to locate needed products and broadcast their
location to forklift operators or other warehouse workers.
• Role of the accountant:

– Ensure the AIS collects and reports costs in a
manner consistent with the company’s
production planning techniques.
are:
– Product design
– Cost accounting
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).
– Can significantly reduce production costs.
• Accountants aren’t experts on CIM, but they
must understand how it affects the AIS.
– One effect is a shift from mass production to custom-
order manufacturing and the need to accumulate
costs accordingly.
• In a lean manufacturing environment, a

customer order triggers several actions:
– System first checks inventory on hand for sufficiency.
– Calculates labor needs and determines whether
overtime or temporary help will be needed.
– Based on bill of materials, determines what
components need to be ordered.
• Necessary purchase orders are sent 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
– Other manufacturing overhead costs incurred
are:
– Product design
– Cost accounting
COST ACCOUNTING
• The objectives of cost accounting are:

– To provide information for planning,
controlling, and evaluating the performance of
production operations;
– To provide accurate cost data about products
for use in pricing and product mix decisions;
and
– To collect and process information used to
calculate inventory and COGS values for the
financial statements.
COST ACCOUNTING

– To provide information for planning,
controlling, and evaluating the
performance of production operations;
• –To
Toaccomplish
provide the accurate cost data
first objective, the AISabout products
must collect real-time
data
for on
usethein
performance
pricing and of production
product activities so
mix decisions;
management can make timely decisions.
andtechnology can be especially helpful, e.g.:
• RFID
– To collect and
– Broadcasting process
repair information used to
needs proactively
– Helping in the location of particular items
calculate inventory and COGS values for the
financial statements.
COST ACCOUNTING
• To accomplish the 2nd and 3rd objectives, the AIS must collect
costs by various categories and assign them to specific
products and organizational units.
• –Requires
To provide
carefulinformation
coding of costfor planning,
data during collection because
controlling,
costs and evaluating
may be allocated the performance
in different ways of
for different reporting
purposes.
production operations;
– To provide accurate cost data about
products for use in pricing and product
mix decisions; and
– To collect and process information used to
calculate inventory and COGS values for
the financial statements.
COST ACCOUNTING
• Types of cost accounting systems:

– Job order costing
• Assigns costs to a specific production batch or job.
• Used when the product or service consists of discretely
identifiable items.
• Example: Houses
COST ACCOUNTING
• Types of cost accounting systems:

– Job order costing
– Process costing
• Assigns costs to each process or work center in the
production cycle
• Calculates the average cost for all units produced
• Used when similar goods or services are produced in
mass quantities and discrete units can’t be easily
identified
• Example: Paint
COST ACCOUNTING
• 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.
COST ACCOUNTING
• The following information should be

maintained about each fixed asset:
• ID number • Expected life

• Serial number • Expected salvage value
• Location • Depreciation method
• Cost • Accumulated depreciation
• Acquisition date • Improvements
• Vendor info • Maintenance performed
COST ACCOUNTING
• The purchase of fixed assets follows the same

processes as other purchases in the expenditure
cycle (order  receive  pay).
• But the amounts involved necessitate some
modification to the process:
– Competitive bidding
• Machinery and equipment purchases almost always
involve a formal request for competitive bids.
COST ACCOUNTING

– Number of people involved
• More people are likely to be involved in reviewing bids
for fixed assets.
COST ACCOUNTING

– Payment
• Purchases of fixed assets are often paid for in
installments, including interest.
COST ACCOUNTING

– Payment • The cost of fixed assets justifies more elaborate
– Controls controls to safeguard them, including:
– Maintenance of detailed records of each item.
– RFID tags to:
• Monitor location
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COST ACCOUNTING

– Payment
– Controls • It’s critical to formally approve and
– Disposal accurately record the sale or disposal
of fixed assets.
COST ACCOUNTING
• A typical AIS would look something like

the following:
– Product design
• Engineering specifications result in new records
for both the bill of materials and the operations
list file.
• To create these lists, engineering accesses both
files to view designs of similar products.
• They also access the general ledger and
inventory files for info about alternate designs.
COST ACCOUNTING

the following:
– Product design
– Production planning
• The sales department enters sales forecasts and
customer special order information.
• Production planning uses that information and
data on current inventory levels to develop a
master production schedule.
• New records are added to the production order
file to authorize the production of goods.
COST ACCOUNTING

the following:
– Product design
– Cost accounting
• New records are added to the work-in-process
file to accumulate cost data.
COST ACCOUNTING

the following:
– Product design
– Cost accounting
• The list of operations to be performed is displayed at
workstations.
• Instructions are also sent to the CIM interface to guide
operation of machinery and robots.
• Materials requisitions are sent to inventory stores to authorize
release of raw materials
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COST ACCOUNTING
• Such a system can be used for a job-order or

process costing system.
• Both require that data be accumulated about:
– Raw materials
– Direct labor
– Machinery and equipment usage
– Manufacturing overhead
• The choice of method:
– Does not affect how data are collected
– Does affect how costs are assigned to products
COST ACCOUNTING
• 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.
– Many raw materials are bar coded so that usage data
is collected by scanning.
– RFID tags improve the efficiency of tracking material
usage.
– Usage may be entered online for materials such as
liquids that are not conducive to tagging.
COST ACCOUNTING
• 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.
• Use coded ID badges which are run through a
badge reader at the beginning and end of each
job.
COST ACCOUNTING
• Machinery and Equipment Usage:

– Machinery costs make up an ever-increasing
proportion of production costs.
– Data about machinery and equipment are collected at
each production step, often with data about labor
costs.
– Until recently, data was collected by wiring the factory
so all equipment was linked to the computer system.
• Limits the ability to rearrange the shop floor.
– 3-D simulations can be used to assess the impact of
altering floor layout.
COST ACCOUNTING
• Manufacturing Overhead Costs:

– Includes costs that can’t be easily traced to
jobs or processes, such as utilities,
depreciation, supervisory salaries.
– Most of these costs are collected in the
expenditure cycle.
– An exception is supervisory salaries, which
are collected in the HRM/payroll cycle.
COST ACCOUNTING
– Accountants help control overhead by

assessing how product mix changes will affect
overhead costs.
– They should also identify the factors that drive
the changes in these costs.
• This information can be used to realign processes
and layout.
– Accurate and complete information about
production cycle activities are required to
perform these analyses.
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:
– All transactions are properly authorized
– All recorded transactions are valid
– All valid and authorized transactions are recorded
– All transactions are recorded accurately
– Assets are safeguarded from loss or theft
– Business activities are performed efficiently and effectively
– The company is in compliance with all applicable laws and
regulations
– All disclosures are full and fair
• There are several actions a company can take
with respect to any cycle to reduce threats of
errors or irregularities. These include:
– Using simple, easy-to-complete documents with
clear instructions (enhances accuracy and
reliability).
– Using appropriate application controls, such as
validity checks and field checks (enhances
accuracy and reliability).
– Providing space on forms to record who completed
and who reviewed the form (encourages proper
authorizations and accountability).
– Pre-numbering documents (encourages recording
of valid and only valid transactions).
– Restricting access to blank documents (reduces
risk of unauthorized transaction).
– Using RFID tags when feasible to improve data
entry accuracy.
• In the following sections, we’ll discuss the

threats that may arise in the four major steps
of the production cycle, as well as general
threats, EDI-related threats, and threats
related to purchases of services.
THREATS IN PRODUCT DESIGN
• The major threats in the product design

process is:
– THREAT 1: Poor Product Design
• You can click on the threat above to get more
information on:
– The types of problems posed by each threat
– The controls that can mitigate the threat
THREATS IN PRODUCT DESIGN
• THREAT NO. 1—POOR PRODUCT DESIGN

– Why is this a problem?
• Higher materials purchasing and carrying costs
• Costs for inefficient production
• Higher repair and warranty costs
– Controls:
• Accurate data about the relationship between
components and finished goods.
• Analysis of warranty and repair costs to identify
primary causes of product failure to be used in re-
designing product.
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Threat Menu Next Threat
THREATS IN PLANNING AND
SCHEDULING
• Threats in the planning and scheduling
process include:
– THREAT 2: Over- or Under-Production
– THREAT 3: Suboptimal Investment in Fixed As
• You can click on any of the threats above to get

more information on:
– The controls that can mitigate the threats.
SCHEDULING
• THREAT NO. 2—OVER- OR UNDER-
PRODUCTION
• Over-production may result in:
– Excess goods for short-run demand and potential cash
flow problems
– Obsolete inventory
• Under-production may result in:
– Lost sales
– Customer dissatisfaction
SCHEDULING
– Controls:
• More accurate production planning, including accurate
and current:
– Sales forecasts
– Inventory data
• Investments in production planning
• Regular collection of data on production
performance to adjust production schedule
• Proper authorization of production orders
• Restriction of access to production scheduling
program
• Validity checks on production orders
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SCHEDULING
• THREAT NO. 3—SUBOPTIMAL
INVESTMENT IN FIXED ASSETS
• Over-investment causes excess costs
• Under-investment impairs productivity
– Controls:
• Proper authorization of fixed asset transactions:
– Larger purchases should be reviewed by a senior
executive or executive committee.
– Smaller purchases (<$10,000) can be handled with
departmental budgets, with managers being held
responsible for department return.
SCHEDULING
– Competitive bids should be sought via requests for
proposals (RFPs)
» The capital investment committee should review and
select the winning bid.
– Once a supplier is selected, acquisition may be handled
through the expenditure cycle process.
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THREATS IN PRODUCTION
OPERATIONS
• Threats in the production operations
process include:
– THREAT 4: Theft of Inventories and Fixed Ass
– THREAT 5: Disruption of Operations
• You can click on any of the threats above to get

OPERATIONS
• THREAT NO. 4—THEFT OF INVENTORIES
AND FIXED ASSETS
• Loss of assets
• Mis-stated financial data
• Potential underproduction of inventory
– Controls:
• Physical access to inventory should be restricted.
• All internal movement of inventory should be
documented.
OPERATIONS
• Materials requisitions should be used to authorize
release of raw materials.
– Should be signed by both inventory control clerk and
production employee to establish accountability.
• Requests in excess of the bill of materials should
be documented and have supervisory
authorization.
• RFID tags and bar codes can be used to track
inventory through production.
OPERATIONS
• Proper segregation of duties should be enforced:
– Inventory stores has custody of raw materials and
finished goods.
– Factory supervisors are responsible for work in process.
– Authorization of production orders, materials requisitions,
and move tickets, should be done by production planners
or the information system.
• Logical and physical access controls should be
enforced for production records.
• An independent party should count inventory and
investigate discrepancies.
• Fixed assets must be identified and recorded.
OPERATIONS
• Managers should be held accountable for assets
under their control.
• Fixed assets should be physically secured.
• Disposal of assets should be authorized and
documented.
• Periodic reports of fixed asset transactions should
be reviewed by the controller.
• Adequate insurance should be maintained.
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OPERATIONS
• THREAT NO. 5—DISRUPTION OF
OPERATIONS
• Disasters can disrupt functioning and destroy
assets
– Controls:
• Backup power sources, such as generators and
uninterruptible power supplies
• Investigate disaster preparedness of key suppliers
and identify alternative sources for critical
components
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THREATS IN COST ACCOUNTING
• Threats in the cost accounting process

include:
– THREAT 6: Inaccurate Recording and Process
• You can click on the threat above to get more

information on:
– The types of problems posed by the threat
– The controls that can mitigate the threat
• THREAT 6--INACCURATE RECORDING

AND PROCESSING OF PRODUCTION
ACTIVITY DATA
• Diminishes effectiveness of production scheduling
• Undermines management’s ability to monitor and
control operations
– Controls:
• Automate data collection with RFID technology,
bar code scanners, and badge readers to ensure
accurate data entry.
• Use online terminals for data entry.
• Restrict access with passwords, user IDs, and
access control matrices to prevent unauthorized
changes to data.
• Use check digits, closed-loop verification, and
validity checks.
• Do periodic physical counts of inventory and
compare to records.
• Do periodic inspections and counts of fixed assets.
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• You can click on any of the threats below to get
GENERAL
– The types of THREATS
problems posed by each threat
• Two general objectives pertain to activities

in every cycle:
– Accurate data should be available when needed
– Activities should be performed efficiently and
effectively
• Threats in the process of ordering goods
include:
– THREAT 7: Loss, Alteration, or Unauthorized Disclos
– THREAT 8: Poor Performance
GENERAL THREATS
• THREAT NO. 7: LOSS, ALTERATION, OR

UNAUTHORIZED DISCLOSURE OF DATA
• Loss or alteration of data could cause:
– Errors in external or internal reporting.
• Unauthorized disclosure of confidential information
can cause:
– Unfair competition
– Loss of business
GENERAL THREATS
• Controls:
– All data files and key master files should be backed
up regularly.
• At least one backup on site and one offsite.
– All disks and tapes should have external and internal
file labels to reduce chance of accidentally erasing
important data.
GENERAL THREATS
– Access controls should be utilized
• User IDs and passwords
• Compatibility matrices
• Controls for individual terminals (e.g., so the receiving
dock can’t enter a sales order).
• Logs of all activities, particularly those requiring specific
authorizations, should be maintained.
– Default settings on ERP systems usually allow users
far too much access to data, so these systems must
be modified to enforce proper segregation of duties.
GENERAL THREATS
– Sensitive data should be encrypted in storage and in
transmission.
– Parity checks, acknowledgment messages, and
control totals should be used to ensure transmission
accuracy.
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GENERAL THREATS
• THREAT NO. 8--POOR PERFORMANCE

• Quality control problems increase expenses and
reduce future sales
– Controls:
• Prepare and review performance reports
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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
– Percent of defects discovered by customers
NEEDS
• In traditional systems, this type of data
was not well linked with financial data, and
cost accounting systems were separate
from production operations information
systems.
• However, both financial and operating
information are needed to manage and
evaluate these activities.
NEEDS
• Two major criticisms have been directed
at traditional cost accounting systems:
– Overhead costs are inappropriately allocated
to products
– Reports do not accurately reflect effects of
factory automation
NEEDS
– Overhead costs are inappropriately
allocated to products
factory automation
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Traditional cost accounting systems use
volume-driven bases such as direct labor
hours or machine hours to apply
overhead.
• However, overhead does not vary with
production volume.
• EXAMPLE: Purchasing costs vary with
the number of purchase orders processed.
• Allocating overhead based on output
volume:
– Overstates the costs of products
manufactured in large quantities
– Understates the costs of products
manufactured in small batches
• Also, allocating overhead based on direct
labor input can distort costs.
• Example of Two Products:
– Product 1 uses:
• $5 of materials
• 1 hour of labor
• 5 minutes of machine time
– Product 2 uses:
• $5 of materials
• 1 hour of labor
• 42 hours of machine time on very expensive
equipment
• Example of Two Products:
– Product 1 uses:
Under a traditional
• $5 of materials cost accounting
• 1 hour of labor system, both
products will
• 5 minutes of machine time appear to have the
– Product 2 uses: same cost.
• $5 of materials
• 1 hour of labor
• 42 hours of machine time on very expensive
equipment
• Solution to Criticism 1: Activity Based
Costing (ABC)
– ABC can refine and improve cost allocations
under either job-order or process costing
systems.
• ABC traces costs to the activities that create them
and allocates them accordingly.
• ABC aims to link costs to corporate strategy.
– Corporate strategy results in decisions about
what goods and services to produce.
• These activities incur costs.
• So corporate strategy determines costs.
– By measuring the costs of the basic activities,
ABC provides information to management for
evaluating the consequences of their decisions.
• ABC vs. Traditional Cost Systems:
– There are three significant differences between
ABC and traditional approaches.
• Tracing of overhead costs
• Number of cost pools
• Identification of cost drivers
ABC and traditional cost accounting approaches.
• ABC directly traces a larger proportion of
overhead costs to products.
• This tracing is made possible by advances
in IT.
• ABC uses a greater number of cost pools
• EXAMPLES: Setup, inspection, and material
to accumulate indirect
handling costs. costs
(manufacturing overhead).
• Accumulated for a batch and allocated to the
products in that batch.
• Most systems lump all
• Consequently, overhead
costs per product together,
will be less
but ABC distinguishes
when products arethree
made incategories:
larger quantities.
- Batch-related overhead
• ABC uses• aExamples:
greaterR&D, number of cost
environmental pools and
regulations,
purchasing costs.
to accumulate
• Theseindirect
costs are costs
related to the diversity of the
company’s product line.
• ABC attempts to link these costs to the products
• Most systems
thatlump
generateallthem.
overhead together,
but ABC distinguishes three
• For example, purchasing categories:
costs might be
allocated to products based on the number of
purchase orders generated for each product.
- Product-related overhead
• ABC uses a greater number of cost pools
to accumulate indirect costs
• Most systems lump all overhead together,
but ABC distinguishes three
• EXAMPLE: Rentcategories:
or depreciation.
• These costs are applied to all products
and allocated according to departmental
- Product-related overhead
or plant rates.
- Company-wide overhead
• Benefits of ABC Systems
– ABC systems are more costly and complex.
– But proponents argue two important benefits:
• More accurate cost data result in better product
mix and pricing decisions.
• More detailed cost data improve management’s
ability to control and manage total costs.
• More accurate cost data result in better
product mix and pricing decisions
• Better Decisions
– ABC avoids problems of applying too much or
too little overhead to products and
consequently results in better price decisions.
– ABC uses the data collected to improve
product design.
– ABC provides management with the
information about the costs associated with
specific activities, resulting in better analysis
and decisions.
• More accurate cost data result in better product
mix and pricing decisions
• Improved Cost Management
– ABC measures the results of managerial
actions on overall profitability.
– ABC measures both the amount spent to
acquire resources and the amount spent to
consume them.
– ABC measures unused capacity:
• Cost of activity capability = Cost of activity used +
Cost of unused capacity
• EXAMPLE: A publishing company has five
employees who operate printing presses.
• The employees each have annual salaries of
$25,000 for a total salary cost of $125,000.
• Each employee should be able to print about 10,000
books per year.
• The total capacity, therefore is 50,000 books.
• The salary cost per book would be $125,000 /
50,000 books = $2.50 per book.
• During the most recent year, the presses produced
47,000 books.
• The employees• The
eachcosthave
of theannual
activity capability
salaries isofthe total
booksalary
$25,000 for a total capacity for the
cost year of 50,000 books times
of $125,000.
the salary cost per book of $2.50.
• Each employee should
• 50,000 be xable
books $2.50to= print about 10,000
$125,000.
books per year.
47,000 books.
• The employees each have annual salaries of
• The cost of the activity used is the number of
• Each employeebooks
should be able
actually to print
produced about
times 10,000
the salary cost
books per year.per book of $2.50.
• The total capacity,
• 47,000 books x $2.50
therefore = $117,500.
is 50,000 books.
47,000 books.
• The unused capacity is the difference between
the activity capability ($125,000) and the cost of
ALLOCATION OF OVERHEAD
the activity used ($117,500). COSTS
• $125,000 - $117,500 = $7,500 unused capacity.
• EXAMPLE: A • publishing company
Alternately, unused has can
capacity fivebe calculated
employees whoasoperate
the cost printing presses.
per book of $2.50 times the
• The employeesdifference
each have between the books
annual thatof
salaries could be
produced and the books that were actually
produced.
• Each employee should
• $2.50 be able
x (50,000 to print
possible booksabout 10,000
– 47,000 actual
books per year.books) = $7,500 unused capacity.
47,000 books.
• Management may be able to improve
profitability by:
- Applying the unused capacity to other
revenue-generating activities; or
- Eliminating the unused capacity.
NEEDS
– Overhead costs are inappropriately allocated
to products
factory automation
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.
• Solution to Criticism 2: 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.
• Solution to Criticism 2: 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
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.
– Productive Capacity = Total Units Produced /
Processing Time
– Productive Processing Time = Processing
Time / Total Time
• The opposite of downtime.
– Better maintenance to reduce machine downtime.
– Better scheduling of deliveries to reduce wait time.
– Productive Capacity = Total Units Produced /
Processing Time
– Productive Processing Time = Processing
Time / Total Time
– Yield = Good Units / Total Units
– Using better raw materials
– Improving worker skills
• 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 1
hour of machine downtime and waiting time for materials. One
hundred of the bottles were defective.
– PRODUCTIVE CAPACITY = 1,000 bottles / 9 productive hours =
111.11 bottles / hour.
– PRODUCTIVE PROCESSING TIME = 9 productive hours / 10 total
hours = .90.
– YIELD = 900 good units / 1,000 total units = .90
– THROUGHPUT = 111.11 x .90 x .90 = 90.
QUALITY CONTROL
• Information About Quality Control

– Quality control costs can be divided
into four categories:
• Prevention costs
• Costs incurred to reduce product defect rates.
QUALITY CONTROL

• Inspection costs
• Costs incurred to ensure products meet quality
standards.
QUALITY CONTROL

• Internal failure costs
• Costs of rework and scrap when products are
identified as defective prior to sale.
QUALITY CONTROL

• Costs when defective products are sold to
customers, e.g., warranty and repair costs,
• Inspection costs costs, costs of customer
product liability
• dissatisfaction
Internal and damage to reputation.
failure costs
• External failure costs
QUALITY CONTROL
• Internal failure costs
• External failure costs
– The objective of quality control is to
minimize the sum of these four costs.
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
– Cost accounting
• You’ve learned how IT can improve the
efficiency and effectiveness of these processes.
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.

Hapter 12: © 2006 Prentice Hall Business Publishing Accounting Information Systems, 10/e Romney/Steinbart

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C HAPTER 12

The Production Cycle

• The production cycle is a recurring set of

• Information flows to the production cycle

• Information also flows from the expenditure

• Decisions that must be made in the

• We’ll be looking at how the three basic

• The objective of product design is to

• Key documents and forms in product

• Role of the accountant in product design:

• Role of the accountant in product design:

• The objective of the planning and

• There are two common approachs to

• There are two common approaches to

• MRP-II is an extension of MRP inventory

• There are two common approaches to

• Lean manufacturing is an extension of the

• Comparison of the two systems:

• Key documents and forms:

• Key documents and forms:

• Key documents and forms:

• Key documents and forms:

• How can information technology help?

• Role of the accountant:

• In a lean manufacturing environment, a

• Sharing information across cycles helps

• The objectives of cost accounting are:

• The objectives of cost accounting are:

• Types of cost accounting systems:

• Types of cost accounting systems:

• Accounting for Fixed Assets:

• The following information should be

• ID number • Expected life

• The purchase of fixed assets follows the same

• The purchase of fixed assets follows the same

• The purchase of fixed assets follows the same

• The purchase of fixed assets follows the same

• The purchase of fixed assets follows the same

• A typical AIS would look something like

• A typical AIS would look something like

• A typical AIS would look something like

• A typical AIS would look something like

• Such a system can be used for a job-order or

• Direct Labor Costs:

• Machinery and Equipment Usage:

• Manufacturing Overhead Costs:

– Accountants help control overhead by

• In the following sections, we’ll discuss the

• The major threats in the product design

• THREAT NO. 1—POOR PRODUCT DESIGN

• You can click on any of the threats above to get

• You can click on any of the threats above to get

• Threats in the cost accounting process

• You can click on the threat above to get more

• THREAT 6--INACCURATE RECORDING

• Two general objectives pertain to activities

• THREAT NO. 7: LOSS, ALTERATION, OR

• THREAT NO. 8--POOR PERFORMANCE

• When an organization transitions from a

• Solution to Criticism 2: Better Reports and

• Solution to Criticism 2: Better Reports and

• Information About Quality Control

• Information About Quality Control