Page 1 of 16
CHAPTER 14
THE PRODUCTION CYCLE
Instructor’s Manual
Learning Objectives:
1. Describe the major business activities and related information
processing operations performed in the production cycle.
3. Identify major threats in the production cycle, and evaluate the
4. Discuss the key decisions that must be made in the production
cycle, and identify the information required to make those
decisions.
Introduction
The production cycle is a recurring set of business activities and
related information processing operations associated with the
manufacture of products.
A company’s AIS plays a vital role in the production cycle. Accurate
and timely cost accounting information is essential input to decisions
about the following:
1. Product mix (what to produce)
3. Resource allocation and planning (e.g., whether to make or buy
a product, relative profitability of different products)
This chapter examines the three major functions of the AIS in the
production cycle:
2. Storing and organizating the data to support decision making
Page 2 of 16
Production Cycle Activities
Figure 14-2 on page 407 shows the four basic activities in the
production cycle:
2. Planning and scheduling
4. Cost accounting
Figure 12-2 also depicts the principal information flows between each
of those activities and the other AIS cycles.
Product Design
The first step in the production cycle is product design (circle
1.0 in Figure 14-2).
FOCUS 14-1 on page 411 explains how simulation software is
constantly improving the efficiency and effectiveness of product
design.
Product life-cycle management (PLM) software consists of
three key components:
1. Computer-aided design (CAD) software to design
new products
3. Product data management software that stores all
the data associated with products
Page 3 of 16
GM estimates that it costs approximately $500,000 to run
crash tests with real cars and hopes that CAD software can
reduce the number of such tests by 85 percent.
A survey found that almost 50 percent of companies using
CAD software had to redesign products because of
incompatibilities between CAD software used by different
design teams.
However, Boeing, using PLM software, will reduce the
time to roll out its new Dreamliner by at least one
year. This would result in a savings of more than $2
billion.
Key Documents and Forms
The product design activity creates two main documents:
1. Bill of materials which specifies the part number,
2. An operations list, which specifies the sequence of
steps to follow in making the product, which equipment
to use, and how long each step should take.
Role of the Accountant
Accountants should participate in product design because 65
percent to 80 percent of product costs are determined at the
product design stage.
Planning and Scheduling
The second setup in the production cycle is planning and
scheduling (circle 2.0 in Figure 14-2).
Page 4 of 16
Planning Methods
Two common methods of production planning are management resource
planning and lean manufacturing.
Lean manufacturing extends the principles of just-in-time
systems to the entire production process.
Both MRP-II and lean manufacturing systems plan production
in advance.
Key Documents and Forms
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 (Refer to Figure 14-6 on page 412).
The MPS is used to develop a detailed timetable that specifies
daily production and to determine if raw materials need to be
purchased. To do this, it is necessary to “explode” the bill of
materials to meet the production goals as listed in the MPS (see
Table 14-2 on page 413). This figure shows that the planning and
scheduling activity produces three other documents:
1. A production order which authorizes the manufacture of a
2. A materials requisition authorizes the removal of the
page 414.
Page 5 of 16
3. Subsequent transfers of raw materials throughout the factor
are documented on move tickets, which identify the parts
being transferred, the location to which they are
transferred and the time of transfer. A sample of the move
ticket is provided in Figure 14-9 on page 415.
the desired product.
Role of the Accountant
The accountant must ensure that the AIS collects and reports
costs in a manner consistent with the production planning
techniques of the company.
Production Operations
The third step in the production cycle is the actual manufacture
of products (circle 3.0 in Figure 14-2).
Using various forms of IT in the production process, such as
robots and computer-controlled machinery, is referred to as
computer-integrated manufacturing (CIM).
Every firm requires cost accounting data about the following four
facets of its production operations:
2. Labor hours expended
4. Other manufacturing overhead costs incurred
Multiple Choice 1
The following are the basic activities in the production cycle:
1. production operations
2. product design
Which of the following is the correct sequence of the basic activities?
a. 2, 3, 1, and 4
b. 2, 1, 4, and 3
c. 2, 4, 1, and 3
d. 2, 1, 3, and 4
Multiple Choice 2
A production planning method that is based on goods being produced
based on customer demand is:
Multiple Choice 3
_____ percent to _____ percent of product costs are determined in the
product design stage of the production process.
a. 60; 80
Multiple Choice 4
A __________ authorizes the removal of raw materials from the storeroom
to the factory and a __________ documents the transfers of raw
materials throughout the factory.
a. materials requisition; moving ticket
Multiple Choice 5
A form of IT that involves robots is:
a. CIS
b. MRP
c. RFID
d. CIM
Page 7 of 16
Cost Accounting
The final step in the production cycle is cost accounting (circle
4.0 in Figure 14-2).
The three principal objectives of the cost accounting system are:
1. Provide information for planning, controlling, and
evaluating the performance of production operations.
Types of Accounting Systems
Most companies use either job-order or process costing to assign
production costs.
Accounting for Fixed Assets
The AIS must also collect and process information about the
property, plant, and equipment used in the production cycle.
At a minimum, every organization should maintain the following
information about each fixed asset:
1. Identifying number
2. Serial number
3. Location
4. Cost date of acquisition, vendor name, and address
Page 8 of 16
10. Maintenance services performed
Orders for machinery and equipment almost always involve a formal
request for competitive bids by potential suppliers.
In addition, acquisitions of fixed assets often are paid for in
installments, including interest.
Information Processing Procedures
Figure 12-8 on page 474 depicts a typical online AIS for the production
cycle.
Both systems require accumulating data about four basic kinds of costs:
1) raw materials, 2) direct labor, 3) machinery and equipment, and 4)
manufacturing overhead.
Raw Materials Usage Data
When production is initiated, the issuance of materials requisition
triggers a debit to work-in-process for the raw materials sent to
Direct Labor Costs
As shown in Figure 12-8, a worker enters the data on time spent on each
specific job task using online terminals at each factory workstation.
Machinery and Equipment Usage
Companies implement computer-integrated (CIM) to automate the
production process.
Manufacturing Overhead Costs
Page 9 of 16
Multiple Choice 6
When raw materials are issued into production, the recording involves a
debit to __________ and a credit to __________ when unused materials
are returned to inventory.
a. raw materials; work-in-process
b. manufacturing overhead; finished goods
c. work-in-process; work-in-process
d. raw materials; raw materials
Multiple Choice 7
Organizations should maintain the following information about each
fixed asset:
Control Objectives, Threats, and Procedures
A second function of a well-designed AIS is to provide adequate
controls to meet the following production cycle objectives:
1. All production activities and fixed asset acquisitions are
properly authorized.
Learning Objective Three
Identify major threats in the production cycle
and evaluate the adequacy of various control
procedures for dealing with those threats.
Page 10 of 16
6. Production cycle activities are performed efficiently and
effectively.
Wherever feasible, use of RFID tags or bar codes can further improve
data entry accuracy.
Product Design
Threat 1—Poor Product Design
Planning and Scheduling
Threat 2—Over- or Underproduction
Two related threats in the planning and scheduling process are
overproduction and underproduction.
Overproduction can result in a supply of goods in excess of short-run
demands; thereby creating potential cash flow problems. There is also a
risk of carrying inventory items that become obsolete.
Threat 3—Suboptimal Investment in Fixed Assets
Overinvesting in fixed assets can create excess costs and
underinvestment can impair productivity. Both problems reduce
profitability.
Proper authorization of fixed-asset transactions is important.
Page 11 of 16
Production Operations
Threat 4—Theft of Inventories and Fixed Assets
To reduce the risk of inventory loss, physical access to inventories
should be restricted and all internal movements of inventory should be
documented.
Finally, inventories and fixed assets are also subject to loss due to
fire or other disasters. Therefore, adequate insurance covered should
be maintained to cover such losses and provide for the replacement
costs of these assets.
Threat 5—Disruption of Operations
The high level of automation in production cycle activities means that
disasters that disrupt the functioning of information systems can also
disrupt manufacturing activities.
General Threats
Threat 7—Loss, Alteration, or Unauthorized Disclosure of Data
Loss or alteration of production data hinders the monitoring of
inventory and fixed assets and makes it difficult to ensure that
manufacturing activities are being performed efficiently and
effectively.
Page 12 of 16
Unauthorized access also increases the risk of damage to important data
files.
Passwords and user IDs can limit access to sensitive files.
Threat 8—Poor Performance
Inefficiencies in production operations result in increased expenses.
Thus, manufacturing activities must be closely monitored and prompt
action taken to correct any deviations from standards.
Multiple Choice 8
Accurate and current sales forecasts are a control for dealing with
a. disruption of operations
Multiple Choice 9
The best control procedure to ensure that data entry is accurate is to
automate date collection using:
a. RFID technology
Production Cycle Information Needs
A third function of the AIS is to provide information useful for
decision making.
Learning Objective Four
Discuss the key decisions that must be made in
the production cycle and identify the information
required to make those decisions.
Page 13 of 16
The traditional cost systems have been criticized for not providing
adequate information to manage production operations.
There are two major criticisms:
1. Overhead costs are inappropriately allocated to
products.
2. Reports do not accurately reflect the effect of factory
automation.
Criticism 1—Inappropriate Allocation of Overhead Costs
Traditional cost systems use volume-driven bases, such as direct labor
or machine hours, to apply overhead to products.
Solution to Criticism 1—Activity Based Costing
Activity Based Costing refines a costing system by identifying
individual activities as the fundamental cost objects. An activity is
Note to Instructor: For the above definition, refer to page 144,
Chapter 5, of the Prentice Hall Cost Accounting Textbook, 12th edition.
Activity Based Costing versus Traditional Cost Systems
Following are three significant differences between ABC and traditional
approaches to product costing:
1. ABC systems attempt to directly trace a larger proportion of
overhead costs to products. Advances in IT make this
feasible.
Page 14 of 16
3. ABC systems attempt to rationalize the allocation of overhead
to products by identifying cost drivers.
A cost driver is anything that has a cause and effect
relationship on costs. For example, the number of purchase
orders processed is one cost driver of purchasing
department costs.
Benefits of ABC Systems
ABC systems cost more to run than traditional cost systems because they
require the collection of more production-related data and in greater
detail. They are also more complex.
Better Decisions. Traditional cost systems tend to apply too much
overhead to some products and too little to others. This leads to two
types of problems:
1. Companies may accept sales contracts for some products
2. Companies may overprice other products.
ABC systems avoid these problems.
ABC also uses data to improve product design.
Finally, ABC data improve managerial decision making by providing
information about the costs associated with specific activities,
instead of classifying those costs by financial statement category.
Page 15 of 16
To illustrate, consider the receiving function at a manufacturing firm
such as AOE.
Assume the following:
2. Receiving employees can handle 500 shipments.
4. Assume that 400 shipments are actually received.
The cost of the receiving activity is $80,000 ($200 X 400
shipments). The remaining $20,000 ($100,000 – $80,000) in salary
expense represents the cost of unused capacity.
Criticism 2—Misleading Reports
The modern approaches to production differ significantly from
traditional mass production.
The reason being is that the traditional approach treats
inventory as an asset. Thus, the cost of production
inventory is not recognized until the products are sold.
Solution to Criticism 2—Better Reports and Measures
CPAs have now added and supplemented the traditional financial
statements with reports based on lean accounting. One suggested change
involves assigning costs to product lines instead of departments.
Throughput = (Total units produced/Processing time) X (Processing
time/Total time) X (Good units/Total units)
Page 16 of 16
Productive capacity: the first term in the formula, shows the maximum
number of units that can be produced using current technology.
Information About Quality Control
Quality control costs can be divided into four areas:
1. Prevention costs are associated with changes to production
processes designed to reduce the product defect rate.
3. Internal failure costs are associated with reworking, or
4. External failure costs result when defective products are sold
to customers. They include such costs as product liability
claims, warranty and repair expenses, loss of customer
satisfaction, and damage to the company’s reputation.
The ultimate objective of quality control is to “get it right the first
time.”
Multiple Choice 10
The __________ overhead includes purchasing.
a. batch-related
b. company-wide
c. product-related
d. none of the above