UNIT 6: PRODUCTION CYCLE

Contents
6.0 Introduction
6.1 Objectives
6.2 Production-Cycle Applications
6.3 Property Accounting Application
6.4 Summary
6.5 Answers to Check Your Progress

6.0 INTRODUCTION

Production control, inventory control, inventory control, cost accounting are typical functions
in the production cycle of manufacturing firms. Few if any production-cycle activities exist
as separate functions in non manufacturing firms, but to same existent moat organization hold
some inventories and manage some type of production control are relevant to most
organizations. This section discusses accounting applications systems found in an
organization’s production cycles. The central feature of the illustrated applications is the
segregation of duties to achieve organizational independence.

6.1 OBJECTIVES

Careful study of this unit will enable the reader to:

 describe the major features of a production control system.
 describe the major features of a property accounting application system.

6.2 PRODUCTION-CYCLE PPLICATIONS

6.2.0 Overview
This section provides an overview of the transaction flows necessary to support the function
of production control, inventory control, and cost accounting within a manufacturing firm.

6.2.1 Objectives
After careful reading of this section the reader must be able to:

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  describe the major features of a production control system.
Production control
Cost accounting system focus on the management of manufacturing inventories: materials,
work-in process (WIP), and finished goods. Job costing is a procedure in which costs are
distributed to particular jobs or production orders. It requires a production order control
system.
In process costing, costs are complied in process or department accounts by periods (day,
week, or month). At the end of each period, the cost of each process is divided by the units
produced to determine the average cost per unit. Process costing is used where it is not
possible or desirable to identify successive jobs or production lots. A classification of process
or departments may be set up for both cost distribution and production reporting purposes.
This classification serves the purposes of process cost accounting and repetitive order
production control. Costs in either job or process costing may be actual costs or
predetermined (i.e., standard) costs.

Figure 1 is a data flow diagram of a production control application system. Cost accounting
system encompasses both production and inventory control; both are closely related to order-
entry, billing, payroll, shipping, and purchasing procedures.

Internal control over inventories and production is based on separation of functions and basic
records and documentation, such as production orders, material requisition forms, and labor
time cards. Protection of inventories from physical theft involves security and access
provisions as well as periodic physical counts and tests against independent records.

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 Product
ion
departm
production
ent order data

Cost
Production Accounti
control ng
Management

Inve Genera
ntory l
contr ledger
ol

Inventory data

Data Flow key

1. Production order 7. Completed production
2 .production order 8. Completed production orders
3. Material authorized 9. Materials card
4. Material issuance 10. Cost of goods completed
5. Material requisition 11. Cost of production report
6. Job time card

File and Reports

Production control involves planning which products to produce and scheduling production to
make optimal use of resources. Basic production requirements are provided by the bill of
materials and master operations list. Detailed materials specifications for a product are
recorded on the bill of materials. The bill of materials lists all required parts and their
descriptions in subassembly order. The bill can be used as a ready reference for replacement
parts, as an aid in troubleshooting subassemblies, or as a parts list for the end user. By
distributing copies of bills to all affected departments, management can ensure uniform access
to accurate, up-to-date information at every operations, their sequencing, and their related
machine requirements are specified in the master operations list for a product. The bill of
materials and the master operation list are used extensively in the production control function.

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In a standard cost system , the standard material and labor costs might be included on the bill
of materials and master operations list.

Determining what products to manufacture requires an integration of the demand for a

product, the product requirements, and the production resources available to the firm.
Resources available for production are communicated to the production control function
through inventory status reports and factor availability reports. A few material status report
details the material resource in inventory that are available for production. A factory
availability report communicates the availability of labor and machine resources. Demand
requirements for a product depend on whether it is custom-manufactured per customer order
or routinely manufactured for inventory. If the product is manufactured for inventory,
production requirements depend on a sales forecast, which may be sent to production control
from the sales or marketing department. sales forecast must be related to the amount of a
product held in inventory. This information is provided in a finished goods status report,
which lists the quantities of products plan lists

Transaction flows
The production order serves as authorization for the production departments to make certain
products. Materials requisitions are issued for each production order to authorize the
inventory department to release materials to the production department. The items and
quantities shown on a materials requisition are determined from the specifications in the
product’s bill of materials requisition are determined from the specifications in the products
bill of materials. Note the flow of the materials requisition and production order in figure 1
the cost accounting function receives a copy of the production order directly from producer is
complete. In similar fashion, cost accounting receives copies of materials requisitions from
both the inventory control function and the production departments. This distribution of
documents implements an adequate segregation of duties and provides accountability for the
production departments.

Labor operations are recorded on job time cards. These cards are posted to production orders
and forwarded to the cost accounting department. The periodic reconciliation of time cards to
production labor reports is an important internal control function. This function was detailed
in the discussion of payroll processing in chapter 7.

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Production status reports are periodically sent from the production department to the
production control function. A production status report details the work completed on
individual production orders as they move through the production process. It is used to
monitor the status of open production orders and to revise the departmental production
schedules as necessary.

The central document in the foregoing process is the production order. A copy of the
production order is sent to the cost accounting function to establish a WIP record for each job.
Cost Accounting

The cost accounting department is responsible for maintaining a file of WIP cost records.
New records are added to this file upon receipt of new production orders. Initiated by
production control. Materials costs are posted to this file from copies of materials requisition.
Direct labor costs are posted from job time tickets. Overhead costs are often applied on the
basis of direct labor hours or direct labor costs and, therefore, are posted at the same time as
labor costs. Cost accounting initiates a journal voucher reflecting each batch of job time
tickets posted that contains a debit to WIP and credits to payroll and manufacturing overhead.
This journal voucher is transmitted and posted to the general ledger.
As production orders are completed and goods are transferred to inventory, several documents
must be update. Productions control the production order from its file of open production
orders. Cost accounting closes the related WIP record , summarizes this activity, and
communicates a completed production cost summary to various managers. The finished goods
inventory records are updated to reflect the availability of the product.

Control of production efficiency requires comparisons of actual production with scheduled

production and an analysis of related variances. Production control also requires a comparison
and analysis of other factors, including budgeted cost versus actual cost for individual
production order and /or departments, and facility usage versus facility availability by
department. The control of inventory loss and the maintenance of optimal inventory levels are
also important to overall production control.

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Inventory control
The control of inventories is accomplished through a series of inventory records and reports
that provide such information as inventory use, inventory balances, and minimum and
maximum levels of stock. Recorder points and procedures are established. A reorder point is
the level of inventory at which it is desirable to order or produce additional items to avoid an
out-or-stock condition. The development of reorder points requires an analysis of product
demand, ordering or production lead time, inventory holding costs, and the costs associated
with an out-of-stock condition such as lost sales or inefficient use of production facilities.

Because inventory control aims at minimizing total inventory cost, an important decision to
be made is the size of each purchase order quantity, that is, the most economic order quantity
(EOQ). The reorder quantity must balance two system costs- total carrying costs and total
ordering costs. A formula for calculating the EOQ is
2 R S
EOQ 
P I

where
EOQ = economic order quantity (units)
R= requirements for the item this period (units)
S= purchasing cost per order
P= unit cost
I = inventory carrying cost per period, expressed as a percentage of the
period inventory value

Once the EOQ has been calculated, the timing of the order must be decided; that is, the
reorder point must be determined. If the order lead time and the inventory usage rate are
known, determining the reorder point is straightforward. Lead time is the time between
placing an order and the receipt of the goods. The inventory usage rate is the quantity of the
goods used over a period of time. The reorder point should be where the inventory level
reaches the number of units that would be consumed during the lead time. In a formula:

Reorder point = lead time x average inventory usage rate

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Perpetual inventory records are the best source of the inventory information necessary to
calculate the EOQ. The units in the beginning inventory, on order, receipts, issues, and
balance on hand, should be included in these records. Appropriate control over inventories
requires periodic verification of items on hand. This can be done on a rotating basis when
perpetual inventory records exist, or it can be done with a periodic physical count.

An important part of inventory control is the evaluation of inventory turnover to determine the
age, condition, and status of stock. Special controls should be established to write down
obsolete and slow-moving inventory items and to compare the balance to an appropriately
established inventory level. A stock status report showing detailed use by period is especially
helpful in maintaining the inventory at a proper level and controlling slow-moving items.

Control over inventory includes methods of storing and handling. Items need to be classified
and properly identified so that they can be located appropriately and so that proper
verification and reporting are possible. The storage and handling of items must provide
security against embezzlement, protection against damage or spoilage, avoidance of
obsolescence, and assurance of proper control.

Inventory is a substantial investment. An inventory control system should provide status

reports on each active product so that the company can reasonably meet customer demands.
Because of the large number of inventory items and the variety of transactions affecting them,
it is difficult to keep inventory and production information up-to-date with manual systems.
A computerized inventory control system can result in a substantial reduction in inventory
investment. These savings include a reduction in inventory without a corresponding decrease
in service, determination of economic order quantities and order points, establishment of
adequate safety stocks, and forecasts of future demand based on current and past information.
Usage records, turnover and obsolescence analyses, reorder cult to generate in purely manual
systems.

Just-in time (JIT) Production

Just-in time (JIT) production is a term used to describe a production system in which parts are
produced only as they are required in subsequent operations. JIT systems differ from
conventional productions systems in the inventories

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 Raw Customer
Vendor materials Operatio Work-in Operatio Finished
Inventory n goods
Process
n Inventory 2 Inventory
1

Figure 2. Just- in Time (JIT) Production.

of Work In – process, raw materials, and finished goods are minimized or totally eliminated.
The raw materials inventory, work –in process inventory, and finished goods inventory are
shown within dash-line boxes to indicate that they are eliminated to the extent possible in JIT
production. The terms minimum inventory production system (MIPS), material as needed
(MAN), and zero inventory productions system (ZIPS) also describe this concept of
minimizing inventories.

Inventories serve as a buffer between different operations. Inventories are eliminated by

carefully analyzing operations to yield a constant production rate that will balance input and
output at the various stages of production. JIT production also emphasizes quality control.
Because inventories are minimized, defective production has to be corrected immediately if
the constant flow of production is to be sustained. Vendors guarantee timely delivery of
defect-free parts that may be placed immediately into production rather than first being placed
into raw materials inventory.

The financial benefits of JIT production stem primarily from the overall re- duct ion in
inventory levels. This reduces a firm’s total investment in inventories. Costs such as handling
and storing materials, obsolescence, storage space, and financing charges on total inventory
cost are reduced, perhaps significantly. Other benefits include possible lower labor costs as
operations are redesigned for constant-flow production, quantity discounts from vendors who
in return receive long-term contracts, and increased emphasis on quality production and the
corresponding reduction in the cost of waste and spoilage.

Learning activity 1
1. What is JIT production system?
________________________________________________________________________
________________________________________________________________________

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2. Describe the EOQ formula
________________________________________________________________________
________________________________________________________________________

6.3 PROPERTY ACCOUNTING APPLICATION

6.3.0 Overview
Property accounting applications concern an organization’s fixed assets and investments. An
important element of effective internal control is the accurate and timely processing of
information relating to fixed assets and investments. Such processing is accomplished
through the use of special accounting applications that provide for accounting, operational,
and management information needs (see Figure 3).

6.3.1 Objectives
After careful reading of this section the reader must be able to:
 describe the major features of a property accounting application system

Fixed Assets
There are four objectives of fixed asset of investment accounting application:
1. Maintain adequate records that identify assists with description, cost, and physical
location.
2. Provide for appropriate deprecation and/or amortization calculations for book and tax
purposes.
3. Provide for reevaluation for insurance and replacement cost purposes.
4. Provide management with reports for planning and controlling the individual asset
items.
Fixed assets are tangible properties such as land, buildings, machinery, equipment, and
furniture that are used in the normal conduct of a business.

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 Property
Transactions

Investments and
Reconcilia
Periodic
fixed asset Compari tion of
son discrepanc
ies

Record
in
property Proper
legers ty
legers

Periodic
processing

Depreciation Other
Calculation Insurance management
&replacemen reports
t costs

These items are relatively permanent and often represent a company’s largest investment.
Transactions that change the amount of investment in fixed assets tend to occur infrequently
and usually involve relatively large amounts of money.

A comp[any accumulates many assets over the life of the business, disposes of assets(by
retirement, sale, or other means), moves assets from one location to another, and match the
costs(other than land) to revenues by means of periodic depreciation charges over the
estimated useful life of the asset. To accomplish these tasks efficiently and to provide
adequate control, an automated system is frequently required.

Every organization, including those on a cash basis, should keep a ledger of fixed assets as an
aid to effective control. A fixed –asset register is a systematic listing of an organizations fixed
assets. A separate section of the fixed asset register is uisually kept for each major category of
asset. This categorization should be consistent with the general ledger account descriptions.
For example, an organization may have separate ledger accounts for buildings, furniture and

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fixtures, and automobiles. There would be a separate section for each of these categories.
Assets themselves should be labeled with identifiers linked to the fixed-asset register.

When each asset is acquired, it should be tagged and entered in the fixed asset register. The
total dollar amount shown in the register should agree with the general ledger control
accounts. For this reason, entries must be made in the fixed-asset register not only to record
addition but also to asset sales or other dispositions.

Several entries must be made when an asset is disposed of. The first records the date of
disposal. The second entry removes the accumulated depreciation taken to date. A fixed-asset
register functions as a subsidiary ledger to the corresponding general ledger control accounts.

Investment
Investments, like fixed assets, require separate records; typically, an investment register is
used to provide accounting control over investments. As with all other assets, custody of
investment should be separate and distinct from record keeping. The investment register
should contain all relevant information, such as certificate number and the par value of
securities, to facilitate identification and control. All investment transaction should be duly
authorized and documented. A common control practice with respect to the physical handling
of investment securities is to require two people to be present when the firms safe deposit box
or other depositor is entered.

Internal Accounting Control Practices

The following questions suggest the internal accounting control procedures that would be
expected in a property application system.
A. Do procedures require authorization by an official or committee for expenditures
(possibly over certain amounts) for
1. Capital assets?
2. Repairs and maintenance?
B. Are actual expenditures compared to budgets and additional approvals required if budget
authorization is exceeded?
C. Do written procedures exist that provide for distinguishing between capital additions and
repair and maintenance?

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D. Do procedures require formal authorization for the sale retirement, or scrapping of capital
assets?
E. Are these records maintained by people other than those who are responsible for the
property?
F. Are the detailed records balanced at least annually with the general ledger controls?
G. Are the detailed record balanced at least annually with the general ledger controls?
H. Are physical inventories of property taken periodically under the super vision of
employees who are not responsible for the custody of recording of such properties?
I. Are periodic appraisals of property made for insurance purposes?
J. Are significant discrepancies between book records and physical inventories reported to
management?
K. With regard to small tools:
1. Are these physical safeguarded and is responsibility for them clearly defined?
2. Are they issued only upon written authorization?

Learning activity 2
1. Describe the major features of a property accounting application system
_________________________________________________________________________
_________________________________________________________________________

Answers to learning activities

Learning activity 1
3. What is JIT production system?
Just-in time (JIT) production is a term used to describe a production system in which
parts are produced only as they are required in subsequent operations. JIT systems
differ from conventional productions systems in the inventories -

Raw Customer
Vendor materials Operatio Work-in Operatio Finished
Inventory n goods
Process
n Inventory 2 Inventory
1

Just- in Time (JIT) Production.

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 -of Work In – process, raw materials, and finished goods are minimized or totally
eliminated. The raw materials inventory, work –in process inventory, and finished
goods inventory are shown within dash-line boxes to indicate that they are eliminated
to the extent possible in JIT production. The terms minimum inventory production
system (MIPS), material as needed (MAN), and zero inventory productions system
(ZIPS) also describe this concept of minimizing inventories.
4. Describe the EOQ formula
EOQ =
2xRxS
PxI

Where
EOQ = economic order quantity (units)
R= requirements for the item this period (units)
S= purchasing cost per order
P= unit cost
I = inventory carrying cost per period, expressed as a percentage of the
period inventory value
Learning activity 2
2. Describe the major features of a property accounting application system
One of the features of fixed asset includes its objectives;
5. Maintain adequate records that identify assists with description, cost, and
physical location.
6. Provide for appropriate deprecation and/or amortization calculations for book
and tax purposes.
7. Provide for reevaluation for insurance and replacement cost purposes.
8. Provide management with reports for planning and controlling the individual
asset items.

Check You Progress

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1. In a production control application system, which of the following documents serves as
authorization to release raw materials to the production department?
A. Production order
B. Job time card
C. Journal voucher
D. Material requisition
2. In a production control application system, which of the following departments should
receive copies of production orders?
A. Inventory control
B. Cost accounting
C. Purchasing
D. General ledger
3. In a production control application system, which of the following documents serves as
authorizations to the production departments to make certain products?
A. Production order
B. Job time card
C. Material requisition
D. Journal voucher
4. Which of the following is a characteristic of (JIT) production?
A. Parts are produced only as they are required in subsequent
operations
B. A constant flow production rate
C. Both A and B
D. Neither A nor B
9. One of the following is not a fixed asset?
A. Land
B. Building
C. Organization cost
D. Machinery

6.4 SUMMARY

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Production control, inventory control, and property accounting are typical production cycle
applications in manufacturing firms. A production control application system plans and
schedules production and issues production orders to authorize production activities. Material
requisition forms and job time cards are used to trace production costs to individual
production orders. A model production application control application system includes a
separation of the following functions: production control, the production departments,
inventory control, cost accounting and general ledger.

Inventory control is accomplished through a series of records and reports that provide
information concerning inventory use and inventory balances. Perpetual inventory records are
the best source of inventory information. The storage and handling of inventory items must
provide assurance of adequate control.

Property accounting applications concern an organization’s fixed assets and investments.

Property accounting applications maintain records that identify an organization’s fixed assets
and investments, provide for appropriate depreciation for financial and tax purposes, provide
information for insurance purposes, and provide information to management concerning use
and availability of an organization’s fixed assets and investments.

6.5 ANSWERS TO CHECK YOUR PROGRESS

1. D
2. B
3. A
4. C
5. C

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