The Conversion Cycle

The Traditional Manufacturing Environment

The conversion cycle consists of both physical and information
activities related to manufacturing products for sale.
Production is triggered by customer orders from the revenue
cycle and/or by sales forecasts from marketing. These inputs
are used to set a production target and prepare a production
plan, which drives production activities.
Purchase requisitions for the raw materials needed to meet
production objectives are sent to the purchases procedures,
which prepares purchase orders for vendors.
Labor used in production is transmitted to the payroll system
for payroll processing.
Manufacturing costs associated with intermediate work-inprocess and finished goods are sent to the general ledger and
financial reporting system.

The Traditional Manufacturing Environment

The Traditional Manufacturing Environment

Depending on the type of product being manufactured, a
company will employ one of the following production
methods:
1. Continuous processing creates a homogeneous product
through a continuous series of standard procedures. Typically,
under this approach firms attempt to maintain finished-goods
inventory at levels needed to meet expected sales demand.
2. Make-to-order processing involves the fabrication of
discrete products in accordance with customer specifications.
3. Batch processing produces discrete groups (batches) of
product. Each item in the batch is similar and requires the
same raw materials and operations. To justify the cost of
setting up and retooling for each batch run, the number of
items in the batch tends to be large.

The Traditional Manufacturing Environment

The Traditional Manufacturing Environment

Batch Processing System
Documents in the batch processing system
- The sales forecast shows the expected demand for a firms
finished goods for a given period. For some firms, marketing may
produce a forecast of annual demand by product. For firms with
seasonal swings in sales, the forecast will be for a shorter period
that can be revised in accordance with economic conditions.
- The production schedule is the formal plan and authorization to
begin production. This document describes the specific products to
be made, the quantities to be produced in each batch, and the
manufacturing timetable for starting and completing production.

The Traditional Manufacturing Environment

The Traditional Manufacturing Environment

- The bill of materials (BOM) specifies the types and quantities of
the raw material (RM) and subassemblies used in producing a single
unit of finished product. The RM requirements for an entire batch
are determined by multiplying the BOM by the number of items in
the batch.
- A route sheet shows the production path that a particular batch of
product follows during manufacturing. It is similar conceptually to a
BOM. Whereas the BOM specifies material requirements, the route
sheet specifies the sequence of operations (machining or assembly)
and the standard time allocated to each task.
- The work order (or production order) draws from BOMs and route
sheets to specify the materials and production for each batch.
These, together with move tickets, initiate the manufacturing
process in the production departments.

The Traditional Manufacturing Environment

The Traditional Manufacturing Environment

The Traditional Manufacturing Environment

- A move ticket records work done in each work center and
authorizes the movement of the job or batch from one work center
to the next.
- A materials requisition authorizes the storekeeper to release
materials (and subassemblies) to individuals or work centers in the
production process. This document usually specifies only standard
quantities. Materials needed in excess of standard amounts require
separate requisitions that may be identified explicitly as excess
materials requisitions.

The Traditional Manufacturing Environment

The Traditional Manufacturing Environment

Batch production activities
- Production planning and control. This consists of two main
activities: (1) specifying materials and operations requirements and
(2) production scheduling.
- Materials and operations requirements. The raw materials
requirement for a batch of any given product is the difference
between what is needed and what is available in the raw material
inventory. A product of this activity is the creation of purchase
requisitions for additional raw materials. The operations
requirements for the batch involve the assembly and/or
manufacturing activities that will be applied to the product. This is
determined by assessing route sheet specifications.

The Traditional Manufacturing Environment

- Production scheduling. The master schedule for a production run
coordinates the production of many different batches. The schedule
is influenced by time constraints, batch size, and specifications
derived from BOMs and route sheets. The scheduling task also
produces work orders, move tickets, and materials requisitions for
each batch in the production run. A copy of each work order is sent
to cost accounting to set up a new work-in-process (WIP) account
for the batch. The work orders, move tickets, and materials
requisitions enter the production process and flow through the
various work centers in accordance with the route sheet.

The Traditional Manufacturing Environment

- Work centers and storekeeping. The actual production operations
begin when workers obtain raw materials from storekeeping in
exchange for materials requisitions.
When the task is complete at a particular work center, the
supervisor or other authorized person signs the move ticket, which
authorizes the batch to proceed to the next work center. To
evidence that a stage of production has been completed, a copy of
the move ticket is sent back to production planning and control to
update the open work order file.
Upon receipt of the last move ticket, the open work order file is
closed. The finished product along with a copy of the work order is
sent to the finished goods (FG) warehouse. Also, a copy of the work
order is sent to inventory control to update the FG inventory
records.

The Traditional Manufacturing Environment

- Inventory control. It provides production planning and control with
status reports on finished goods and raw materials inventory.
The inventory control function is continually involved in updating
the raw material inventory records from materials requisitions,
excess materials requisitions, and materials return tickets.
Upon receipt of the work order from the last work center, inventory
control records the completed production by updating the finished
goods inventory records.
An objective of inventory control is to minimize total inventory cost
while ensuring that adequate inventories exist to meet current
demand.

The Traditional Manufacturing Environment

Cost accounting activities
- Cost accounting activities of the conversion cycle record the
financial effects of the physical events that are occurring in the
production process. The cost accounting process for a given
production run begins when the production planning and control
department sends a copy of the original work order to the cost
accounting department. This marks the beginning of the production
event.
As materials and labor are added throughout the production
process, documents reflecting these events flow to the cost
accounting department.
The receipt of the last move ticket for a particular batch signals the
completion of the production process and the transfer of products
from WIP to the FG inventory.

Controls in the Traditional Environment

Controls in the Traditional Environment

Transaction authorization
- The following describes the transaction authorization procedure in
the conversion cycle.
1. Production planning and control authorize the production
activity via a formal work order. This document reflects production
requirements, which are the difference between the expected
demand for products and the finished goods inventory on hand.
2. Move tickets signed by the supervisor in each work center
authorize activities for each batch and for the movement of
products through the various work centers.
3. Materials requisitions and excess materials requisitions
authorize the storekeeper to release materials to the work centers.

The Traditional Manufacturing Environment

Segregation of duties
- to separate the tasks of transaction authorization and transaction
processing
- to segregate record keeping from asset custody
- The following separations apply:
1. Inventory control maintains accounting records for raw material
and finished goods inventories. This activity is kept separate from
the materials storeroom and from the FG warehouse functions,
which have custody of these assets.
2. The cost accounting function accounts for WIP and should be
separate from the work centers in the production process.

The Traditional Manufacturing Environment

Supervision
- The following supervision procedures apply to the conversion
cycle:
1. The supervisors in the work centers oversee the usage of RM in
the production process. This helps to ensure that all materials
released from stores are used in production and that waste is
minimized.
2. Supervisors also observe and review timekeeping activities. This
promotes accurate employee time cards and job tickets.

The Traditional Manufacturing Environment

Access Controls
- The conversion cycle allows both direct and indirect access to
assets.
Direct access to assets
- The nature of the physical product and the production process
influences the type of access controls needed.
1. Control methods include identification badges, security guards,
observation devices, and various electronic sensors and alarms.
2. By specifying the quantities of material and labor authorized for
each product, the firm limits unauthorized access to those
resources. To obtain excess quantities requires special
authorization and formal documentation.

The Traditional Manufacturing Environment

Indirect access to assets
- Assets, such as cash and inventories, can be manipulated through
access to the source documents that control them. In the
conversion cycle, critical documents include materials requisitions,
excess materials requisitions, and employee time cards. A method
of control that also supports an audit trail is the use of prenumbered documents.

Accounting Records
- to establish an audit trail for each transaction
- By pre-numbering source documents and referencing these in the
WIP records, a company can trace every item of FG inventory back
through the production process to its source. This is essential in
detecting errors in production and record keeping, locating batches
lost in production, and performing periodic audits.

The Traditional Manufacturing Environment

Independent Verification
- Verification steps in the conversion cycle are performed as follows:
1. Cost accounting reconciles the materials and labor usage taken
from materials requisitions and job tickets with the prescribed
standards. Cost accounting personnel may then identify
departures from prescribed standards, which are formally reported
as variances.
2. The GL department checks the total movement of products
from WIP to FG. This is done by reconciling journal vouchers from
cost accounting and summaries of the inventory subsidiary ledger
from inventory control.
3. Internal and external auditors periodically verify the RM and FG
inventories on hand through a physical count. They compare actual
quantities against the inventory records and make adjustments to
the records when necessary.