CHAPTER 11 SUMMARY

 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 productive activity that drives their business, conversion processes are applicable to most companies.
However, this chapter focuses on manufacturing companies whose primary activity is the production of finished
goods.

Conversion processes may be initiated by the receipt of a sales order from a customer or as a result of sales forecasts
that indicate a need to launch production. Regardless of the reason for initiating production, all companies should
have in place an organized approach to their conversion processes.

 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.
 Capital budgeting, which plans the capital resources needed to support production.
 Engineering, which is responsible for product specifications, including the bill of materials and operations
list. These documents detail the required components and the necessary production instructions,
respectively.
 Scheduling, which plans the timing for production activities in a manner that 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 equipment. The maintenance of these resources involves
keeping them in good working condition; the control of these resources involves monitoring them in order to
promote efficiency and effectiveness.
 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 the stages of the conversion processes. Its goal is to minimize the
cost of maintaining inventories. Inventory flows from their origin as raw materials within the stores function,
and is routed through work-in-process to their destination as a finished good within the related warehousing
function. Economic order quantities (EOQ) should be determined based on the relative costs of ordering
materials and maintaining inventories. Inventory status reports are prepared at various stages of the process
in order to document the extent of work completed and the resulting level of inventory.
○ 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

This study source was downloaded by 100000793596153 from CourseHero.com on 05-09-2023 01:32:14 GMT -05:00

https://www.coursehero.com/file/67825045/Chapter-11-Conversion-Processes-and-controlsdocx/
 complexity or number of locations, operations must follow a designated physical flow through a process. Exhibits
11-5 through 11-7 are pictorial presentations of this physical flow.
The final hub in the logistics function is quality control, where products are inspected before they are moved to a
warehouse or shipping area. Any problems with defective products may result in rework, which is the additional
production that may be needed to bring a product up to its required specifications.

 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 labor, and overhead (indirect materials and labor, and production facility maintenance costs).
The establishment of standard costs is important for monitoring actual costs and for allocating overhead to products.
Variances represent the differences between actual costs and standard costs applied to products. Unfavorable
variances should be investigated to determine whether logistics changes are needed to improve the conversion
processes.

Most manufacturing companies maintain perpetual inventory systems to record the flow of inventories throughout
all stages of production. However, some smaller companies use periodic systems, where inventory and cost of sales
records are updated only at the end of the period.

 Risks and Controls in Conversion Processes. Because conversion processes involve the physical movement of
inventory throughout the operating facility and may 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, and quantity determination.
 initiating production orders
 issuing materials into production
 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 storeroom and warehouse and those issuing the movement of inventories into and out of these areas should
be segregated from the production stations and the cost accounting functions.
○ Adequate Records and Documents. Complete, up-to-date, and accurate documentation on production orders,
inventory and cost of sales records, and inventory status reporting is needed to support the conversion process.
The creation and monitoring of variance reports is another control that is especially important in the conversion
process; their usefulness depends upon the integrity 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

2|Page
This study source was downloaded by 100000793596153 from CourseHero.com on 05-09-2023 01:32:14 GMT -05:00

https://www.coursehero.com/file/67825045/Chapter-11-Conversion-Processes-and-controlsdocx/
 using periodic systems, and is also usually performed in perpetual systems as a means of determining the
accuracy of perpetual records. Other important controls include:
 production orders should be reconciled with records of work-in-process and finished goods inventories.
 labor reports should be reconciled with employee time sheets.
 routing slips should be reconciled with records of inventory transfers into the warehouse and shipping areas.
 cost variance reports should be investigated in order to implement process 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
 inventory items are particularly valuable and susceptible to thef
 inconsistent or high levels of inventory movements
 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 ofen
difficult to keep current inventory and production records with manual systems. Computerized systems provide many
benefits in terms of productivity, quality, flexibility, and time savings. In addition, when a company’s processing
applications are integrated with planning, resource management, and cost accounting functions, even greater
benefits may be realized in terms of workforce efficiency, paperwork reduction, and other cost reductions. When
programmed constraints are incorporated in these systems, error reports may be automatically generated, which
provides an enhancement to internal controls.

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 and schedules, routing slips, time sheets, and inventory
status reports. Once the data has been entered, many documents and reports can be automatically generated. A
database containing conversion process information must include files for each category of inventory (raw materials,
work-in-process, and finished goods), as well as for transactions for each stage of inventory and standard versus
actual data.

Additional trends in computer systems that enhance the conversion processes include the following:
 Computer-aided design (CAD)
 Computer-aided manufacturing (CAM)
 Materials resource planning (MRP)
 Manufacturing resource planning (MRP-II)
 Enterprise-wide resource planning (ERP)
 Computer-integrated manufacturing systems (CIM)
 Just-in-time (JIT) production systems

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. With an RFID system, counting inventory,
and tracking the movement of inventory items is much faster, efficient, and accurate. Retail store companies also are
using RFID to track inventory within the stores.
3|Page
This study source was downloaded by 100000793596153 from CourseHero.com on 05-09-2023 01:32:14 GMT -05:00

https://www.coursehero.com/file/67825045/Chapter-11-Conversion-Processes-and-controlsdocx/
 Although automation produces many benefits to the company, there are also moral implications of replacing human
resources with electronic resources. To the extent possible, management should take an active role in the
reassignment (rather than termination) of personnel when production jobs are eliminated as a result of automation.

 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. These types of fraud schemes are generally perpetrated by management in an attempt to
meet or beat earnings targets. Some earnings management techniques include offering sales discounts in order to
artificially boost earnings or gaming the system by overproducing inventories then manipulating recorded amounts
through the use of absorption costing.

 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 misused inventories and fixed assets, alteration of documents
or reports, and other frauds. Accordingly, it must carry out its corporate governance tasks of management oversight,
internal controls and compliance, stewardship, and ethics by implementing and monitoring controls that minimize
these risks. Improved effectiveness and efficiency and reduced risks of fraud tend to accompany workplace
environments marked by effective corporate governance.

41. (SO1) Consider a company that is in the business of producing canned fruits for grocery stores. (It is not in the
business of growing the fruit.) List the items that would likely be included as this company’s direct materials, direct
labor, indirect materials, and other overhead.
The direct materials would be many different kinds of fruits such as pineapple, peaches, grapes, cherries, pears, and
mandarin oranges. The direct materials could also include sugar or fructose. The indirect materials might be water. Direct
labor would be those workers that work directly in the cleaning, peeling, slicing, and packaging of the fruit. Even if these
processes are automated, rather than manual, the workers who operate the slicing or packaging machinery are direct
labor. Other overhead includes other costs of running the canning operation that are not direct materials or direct labor.
This could include utilities, rent, depreciation, machine maintenance, and supplies.

42. (SO2) Give some examples of manufacturing processes that would fit into each of the three different types of
production processes: continuous processing, batch processing, and custom made-to-order.

Continuous processing examples: Sof drink bottling, beer bottling, frozen meal processing (Lean Cuisine, Banquet),
cereal, toy making such as dolls, electronics manufacturing such as i-pods, power generation as in coal-fired plants.

Examples of batch manufacturing might be: wine making, gasoline production, prescription pill production. Many things
that could be continuous production might also be made in batches for convenience or efficient use of machinery. For
example, equipment to bottle sof drinks might be used for a few hours to bottle a batch of Pepsi, then be cleaned and
set to produce a batch of Mountain Dew.
Examples of custom, made-to-order manufacturing would include consumer products identified as customized. For
example, BeyondBikes.com makes custom mountain bikes using specific parts chosen by the customer. Also, many
companies make custom manufactured products for other companies. Examples would include specially machined parts

4|Page
This study source was downloaded by 100000793596153 from CourseHero.com on 05-09-2023 01:32:14 GMT -05:00

https://www.coursehero.com/file/67825045/Chapter-11-Conversion-Processes-and-controlsdocx/
 or components, custom made manufacturing machinery or tools, and print shops that print custom made printed
material.

49. (SO4) Identify several factors that indicate the need for more extensive internal controls covering conversion
processes. The factors include: the number of products made; the value or size of products (valuable or small products
are more likely to be stolen), high levels of inventory movement, inventory held at various locations, and inventories that
are difficult to value.

5|Page
This study source was downloaded by 100000793596153 from CourseHero.com on 05-09-2023 01:32:14 GMT -05:00

https://www.coursehero.com/file/67825045/Chapter-11-Conversion-Processes-and-controlsdocx/
Powered by TCPDF (www.tcpdf.org)