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Chapter 11 – Conversion Processes and Controls
Instructor Manual
➢ Basic Features of Conversion Processes. A company’s conversion processes
involve the activities related to the transformation of resources (materials, labor, and
overhead) into goods or services. Since most companies have some sort of
➢ The Components of the Logistics Function. The major function within the
conversion process is the logistics function. Logistics is the logical, systematic flow
of resources throughout the organization. It involves the well-planned and
coordinated efforts of many departments in order to make the most efficient use of
the resources available. The three primary components of the logistics function are
planning, resource management, and operations.
○ Planning. The planning component is concerned with determining what products
should be produced, how many products should be produced, what resources
should be available, and what timing is needed. It is supported by the following
efforts:
• Research and development, which involves investigation and development of
new, innovative products and production methods.
fulfills customer needs and optimizes company resources.
○ Resource Management. There are many resources that feed the conversion
processes. Although the specific resources vary from company to company, they
tend to fall into the following categories:
• Maintenance and control, which is concerned with maintaining the capital
resources that support production, including production facilities and
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• Human resources, which is responsible for managing the placement and
development of sufficient qualified personnel, including hiring, training, and
performance management.
• Inventory control, which manages the movement and recordkeeping for
inventory as it is transferred through many departments or stations throughout
○ Operations. The day-to-day performance of production or manufacturing
activities is commonly referred to as operations. It may be carried out by
continuous processing, batch processing, or custom, made-to-order processing.
In addition, it may take place in a single operating facility or in multiple locations.
Regardless of its complexity or number of locations, operations must follow a
designated physical flow through a process. Exhibits 11-5 through 11-7 are
➢ Cost Accounting Reports Generated by Conversion Processes. Cost
accounting relates directly to the conversion processes and the preparation of cost
analyses, inventory records, and standard costing information needed to make
decisions. Once a bill of materials and operations lists have been developed by the
engineering function, standard costs may be determined. Standard costs are cost
projections for the resources needed for a product, including direct materials, direct
➢ Risks and Controls in Conversion Processes. Because conversion processes
involve the physical movement of inventory throughout the operating facility and may
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be spread among multiple locations, departments, and employees, it is important
that sufficient internal controls be included in the related business processes.
○ Authorization of Transactions. Designated activities within the conversion
processes should require express authorization, including the following:
• purchasing raw materials, including quality specifications, vendor selection,
• transferring finished goods to the warehousing or shipping areas.
○ Segregation of Duties. Custody of inventories and the accounting for
inventories and cost of sales need to be segregated in order to maintain good
internal controls. Likewise, those responsible for custody of inventories in the
○ Adequate Records and Documents. Complete, up-to-date, and accurate
documentation on production orders, inventory and cost of sales records, and
of the underlying system and the timeliness of its preparation.
○ Security of Assets and Documents. Physical controls should be in place in the
company’s storerooms, warehouses, and production facilities in order to
safeguard the inventories held therein. In addition, only authorized employees
should handle inventories and access inventory records.
○ Independent Checks and Reconciliations. The most important review activity
for the conversion processes is the physical inventory count and related physical
inventory reconciliation. These control procedures should be performed for all
categories of inventories. The physical count of inventories on hand is required
for companies using periodic systems, and is also usually performed in perpetual
improvements.
○ Cost-Benefit Considerations. The more products a company has and the more
complex its conversion processes, the more internal controls should be in place
to monitor and safeguard its assets. Other conditions that may call for additional
controls include the following:
• inventory items that are difficult to differentiate or inspect
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• inventory items are held at multiple locations
• inventory valuation is particularly complex.
➢ IT Systems of Conversion Processes. Because of the potentially large number of
inventory items maintained by a company and the variety of processing flows that
may affect them throughout the conversion processes, it is often difficult to keep
current inventory and production records with manual systems. Computerized
Computer-based conversion processes typically require a significant amount of input
for all of the data supporting the bill of materials, operations lists, production orders
Additional trends in computer systems that enhance the conversion processes
include the following:
• Computer-aided design (CAD)
• Computer-aided manufacturing (CAM)
A radio-frequency identification (RFID) system uses pin-head sized tags to monitor
and account for inventories through the receiving, stores, production, warehousing,
and shipping functions. In a manufacturing company, the RFID system can
automatically trigger routing slips, update inventory status reports, allocate labor and
overhead to inventory units, and monitor the exact location of the related products.
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➢ Ethical Issues Related to Conversion Processes. The conversion process is the
target of many types of fraud schemes. Most of these involve the falsification of
inventory quantities, hiding inventory costs, or manipulation of the gross profit figure.
➢ Corporate Governance in Conversion Processes. The conversion systems,
processes, and controls described in this chapter are part of a corporate governance
structure. When management designs and implements conversion processes, it
assigns responsibility for executing the related logistics and reporting functions to
various managers and employees. It must be mindful of the risks of stolen or