ACCOUNTING INFORMATION SYSTEM ISSUES OF FMS
Accounting information system
issues of FMS
Ram S. Sriram
Traditional accounting practices must change when organizations adopt FMS
In recent years, multinational organizations have been
significantly changing their manufacturing strategies.
Because of the challenges posed by changing market factors
and global-level competitive pressures, organizations have
been showing greater interest in flexible automation.
Organizations believe that switching to flexible automation
such as flexible manufacturing systems (FMS), computer-
integrated manufacturing (CIM),and computer-aided design
(CAD) will bring greater benefits in the form of improved
productivity, customer satisfaction, and larger market share.
As Jack Meredith[1] states “high technology, combined with
robots, computers, and automated machinery, seems to
finally allow the long-hoped-for production wonders of
virtually individual product customization, immediate
response to demand, high quality, and outstanding performance,
all at minimal cost”. To some extent, statements like this
are supported by facts. For example, Ingersoll engineers
report that firms implementing FMS, on an average,
enjoy a 40 per cent reduction in production time, a 30 per
cent reduction in production workers, and a 12 per cent
reduction in cost per piece, in addition to an increase of 30
per cent in machine utilization[2].
However, adopting flexible automation like FMS is not
without problems. Often FMS creates new information needs
and demands a modified approach to collecting information.
These modified approaches often conflict with existing
management practices. An example of this would be
accounting practices. Several articles point out the limitations
of traditional cost measurements in the current technological
environment. After briefly explaining FMS, this article
examines how FMS creates new information needs within
an organization and how the accounting information system
can address some of these needs and help management
function effectively in the new manufacturing environment.
Flexible automation
Flexible manufacturing automation can be implemented
both in process-type and assembly-type manufacturing
Integrated Manufacturing Systems, Vol. 6 No. 1, 1995, pp. 35-40. © MCB University
Press Limited, 0957-6061
35
industries. Flexible automation involves, in varying degrees,
computerizing the manufacturing operation through
computer-control systems such as industrial robots,
numerical control machines, and grouped machine centres
(MC) controlled by a central computer. Process automation
is more common in chemical and other processing industries
while assembly automation is more common in automobile
and other job shops.The extent of flexible automation may
vary from a few numerical control machines to automating
the entire assembly line.
The basic component of FMS is numerically controlled
machine tooling. The machine tools are run and controlled
by a computer. The software instructions from the computer
control and direct tool movement, cutting speed, movement
of parts and inventory, and many other operations normally
controlled by an operator in a traditional manufacturing
operation. The software conveys instructions to different
machines following a predetermined scheduling sequence.
Therefore minimal manual handling of materials and
jobs is required.Also, the computer collects data on items
such as process time, number of units produced and invent-
ory usage, that is useful for planning, scheduling, and
monitoring production. The programmable nature of FMS
enhances the operations of the firm’s existing electrical,
electronic and mechanical systems by combining several
operations and by reducing time and human error[3]. Unlike
a traditional job shop, an FMS job shop requires fewer
operators. The operating staff consists mainly of load/unload
operators, tool setters and set-up operators. Other supporting
staff include computer operators, programmers, system
analysts, and maintenance technicians.
New information needs
In the USA, flexible automation, like FMS, gained importance
because it allowed organizations to achieve the twin object-
ives of efficiency and quality. FMS provides organizations
with the ability to introduce new product lines (at a reasonable
cost), a wider product range, improve product quality
with no rejects or defects and control inefficiencies in
production (see Table I for a profile of FMS).With proper
planning, FMS organizations can reduce inventory levels
36 INTEGRATED MANUFACTURING SYSTEMS 6,1

Table I. A profile of FMS

Advantages Disadvantages Cost and savings

Flexible response to changes in market
Improvement in product
Savings in space
Reduction in inventory costs
Reduction in material handling
costs
Reduction in lead times
Reduction in direct labour
Increase in equipment utilization
Improved control over manufacturing
Real-time measurements and control
Increased revenues and profits
Source: [4]
Lack of true flexibility – depends on
user creativity
High initial investment
Risk of obsolescence
Extensive pre-planning required
Length of time to implement
Adaptability of support systems
to cope
Savings due to reduced downtime, scrap,
rework, etc.
Initial cost of operating equipment,
computer hardware and software
Installation cost
Cost of pre-planning, changes in
support system
Increase in depreciation
Savings in direct and indirect labour
Savings in materials cost (with JIT)
Increase in overheads

and save space, insurance and storage costs. At the same
time, they can improve quality because of faster feedback
loops and improved overview of products and processes[5].
However, FMS does not ensure automatic success. Success
results only when the organization makes suitable changes
in its organizational set-up, particularly its information
system.
The need to reorganize the information system is important
for two reasons. First, the monetary investment in FMS
is significant. However, the direct and indirect benefits
of FMS, like reduced inventory cost, reduced product cost
and improvements in product quality, customer satisfaction
and competitiveness, accrue only over a long time. Because
achievement of these benefits is important to the goals
of an organization, the information system should monitor
and report on these benefits. Second, in traditional
organizations, financial and accounting measurements
are geared more towards short-term external financial
reporting. However, FMS demands a long-term and strategic
orientation of information reporting. Therefore, the
information system must develop new criteria to measure
and report on the long-term strategic performance of the
organization.
Changing the accounting and financial reporting
systems
Accounting is one of the important information subsystems
where the impact of FMS is greatest. This is because, in
most organizations, the accounting information system
measures and reports short-term information on tangible
costs and benefits that are easy to quantify. Traditional
accounting practices are often ill-suited to measuring the
intangible and long-term benefits of FMS, which are
subject to a high degree of uncertainty and variability.
These measurement issues are exacerbated because FMS
increases the level of automation and changes the factory
layout.
Impact of increased automation
The increase in the level of automation shifts production
expenses from direct to indirect and capital costs. In
turn, the increase in indirect and capital costs increases
overhead costs, owing to costs of automated equipment,
engineering and design, and restructuring the factory floor.
Indirect labour costs increase owing to maintenance expenses,
expenses towards supervision, software/system develop-
ment costs, and cost of training a skilled workforce. On
the other hand, direct labour costs decrease because of
fewer machine operators and reduced machine set-up time.
The shifts in the cost mix make the traditional overhead
cost-allocation bases (e.g. direct labour) less suitable and
require new allocation bases (e.g. machine hours)[6]. Because
of the increased importance given to product development
and design activities along with production activities, FMS
organizations are reconsidering their traditional cost meas-
ures and are experimenting with new cost analyses and
control techniques such as transformation cost, activity-
based costing, and target costing.
 ACCOUNTING INFORMATION SYSTEM ISSUES OF FMS
Transformation cost
It is not unusual for traditional manufacturing organizations
to use a plant-wide or departmental rate to allocate the
overhead costs to products. These organizations collect
the indirect manufacturing costs incurred in a plant into
a common pool and then allocate the cost to products on
the basis of direct labour hours. Although product cost
computed on such allocation fulfils the needs of external
financial reporting (where the total cost is more important
than individual product costs), it is unsatisfactory for
making product-related decisions such as product pricing,
sales promotion, product mix etc. where accurate cost of
individual products is important. In FMS organizations,
product cost based on the direct labour cost allocation
becomes even less accurate because direct labour compo-
nent of manufacturing decreases and it is difficult to identify
the overhead costs with individual products. A viable
alternative would be to use transformation cost for allocation
purposes.
Transformation cost consists of all manufacturing costs
except direct material cost. The cost is allocated to products
based on individual machine tools and not on a plant-wide
overhead application rate. In FMS firms, it is easy to collect
accurate information on machine hours. The central
computer would automatically collect information on
processing times for each product and job. Dhavale[3]
recommends a transformation cost that includes the follow-
ing five cost elements as the most desirable from the
viewpoint of product costing: manufacturing equipment
depreciation, operating expenses, service department
expenses, software and other system development amortization,
and production set-up cost.
Manufacturing equipment depreciation consists of
depreciation expenses on flexible equipment directly used
in production and depreciation expenses on equipment
commonly shared by the flexible production equipment.
The depreciation method is usually based on machine
hours. Operating expenses consist of electricity costs,
heating/cooling costs, other utility expenses, custodial
services, and factory building depreciation. The operating
expenses will be allocated to a product either on the basis
of area occupied by a machine or by machine centre
costs. Service department costs include administrative
expenses on such items as personnel, payroll, accounting,
design, drafting, etc. Service department costs will be
allocated on the basis of percentage of utilization of their
services by machine centres. Set-up cost generally consists
of deciding machine requirements, developing the
program to run the production operations, cost of initial
runs, removing bugs, and final implementation as well
as costs of tool setter and setup operator wages. The
treatment of setup and software development costs
would vary from firm to firm. According to Dhavale,
37
some firms capitalize these costs while others expense
them.
Activity-based costing
Similar to transformation cost, activity-based costing
(ABC) is a useful alternative method to allocate indirect
costs to products. The traditional overhead apportionment
rates are too broad because they apportion overhead based
on production volume even when production is driven by
variables other than volume. Thus, costs are allocated to
cost centres regardless of their ability to control costs
and it misrepresents the true cost of the product and cost
centres and is often useless for cost control.
Activity-based costing (ABC) modifies the cost allocation
by using multiple allocation bases. These multiple alloc-
ation bases are in some cases related to unit volume and
in other cases, are not related to unit volume[7]. The basic
premiss of ABC is that a product incurs costs when it gives
rise to activities (e.g. initiating purchase orders, machine
set-ups, run-time labour etc.). ABC groups the product-
related costs into cost pools and then allocates the cost to
products based on activity drivers. A costing rate is
determined based on the estimated cost and the activity-
driver. For example, the cost of a machine or a group of
machines is determined by the total estimated cost of
machine depreciation, power usage, and machine mainten-
ance costs. A product is charged with machine centre
cost to the extent to which the machine or machines were
used to produce the product. Costs that are not directly
identifiable with a group of machines, e.g. material handling
cost, are not treated as part of the machine centre costs.
Instead, these costs are assigned to a separate cost centre
and apportioned to the product by establishing a suitable
activity-driver. Thus, ABC uses multiple overhead rates
– a rate based on activity and a rate based on non-
activity drivers. ABC provides relevant costs during product
pricing and product drop decisions and the overhead rates
can be used during the design phase of a product to control
costs. However, an organization should be careful while
choosing the activity-drivers[7]. The drivers should
satisfactorily proxy for the number of different activities
carried out during manufacture.
Impact of changed factory layout
The accounting information system faces new measurement
issues also because FMS changes the layout of manufacturing
plants. It divides a manufacturing plant into multiple cells,
each concentrating on making a family of products. Each
cell is close-knit, self-managing and is highly responsive
to changing market demands and needs. The reorganization
changes the manufacturing process from functional lines
to flow lines. Because functional cost centres are no longer
the main focus of attention, management expects the
38 INTEGRATED MANUFACTURING SYSTEMS 6,1
accounting system to measure along product lines and
provide information that is useful to market and sell the
final product. Management requires information that is
useful to determine the cost of a product with reasonable
accuracy on a timely basis and to set an optimal price to
make the product profitable. Management also requires
“effectiveness” information – information on such items
as product quality, setups, plant design, and vendor quality.
It demands an accounting information system to identify,
measure and supply information on such items as cost of
defective and faulty production, build-up of inventory and
its relation to shipping schedules, and superfluous activities
that must be eliminated. The accounting information system
now reports on such non-traditional items as machine
utilization rates, amount of non-productive time where a
machine is waiting for arrival of parts or is idle because
of inspection or maintenance[8]. Other non-traditional items
reported include energy costs, cost of training, increases
in wages due to improvement in skills, personnel
accident rates, etc.[6]. Thus, the accounting information
system begins to play “more of an influencing role than
an informing role”[9].
The future – strategic management accounting
The idea that accounting information will play an influenc-
ing role suggests that, in FMS organizations, management
accounting will monitor the long-range performance of the
organization in the marketplace and report on the achieve-
ments of strategic plans and goals. Most organizations
must realize that cost, product characteristics, and market
strategies are interdependent and cannot be studied in
isolation. Therefore, an accounting information system
must change its focus from reporting only on product costs
to also reporting on the product characteristics that
make the product competitive in the marketplace. In addition
to collecting and reporting internally generated information,
accountants must report on important external information
such as market demand for the product being offered,
demand and price changes owing to changes in product
characteristics and monitor the strategy of each rival
competitor[8].
The accounting information system will monitor and report
on such product attributes as operating performance
variables, reliability and warranty arrangements, physical
attributes such as degree of finish and trim, and service-
related attributes such as commitment on supply and after
sales service[10]. Most of such information is important
to evaluate the cost advantages which an organization
enjoys over its competitors to support its strategic market
position. Similarly, the accounting system can help in
measuring and improving productivity because, when
properly planned and executed, FMS improves productivity.
An organization must therefore evaluate whether improve-
ments in productivity actually occurred. If the accounting
information system is to measure improvement in product-
ivity in realistic terms, the traditional price and quantity
variances, overhead analysis, and financial ratio indices
have to be supplemented by additional measurement
techniques. The measurement techniques must concentrate
more on the ratio of inputs to outputs and how improvements
in quality, preventive maintenance of machines and equipment,
and activity levels, affect the input to output ratio. This
would include reports on such items as:
● the proportion of total production that were reworked
because of defects;
● the causes and remedial measures taken to reduce
defects;
● the progress in defect reduction; and
● the relationship between decreases in percentage
of defects and long-term manufacturing costs.
The benefit analysis would include, in addition to the
traditional financial measures, the manufacturing cost
reduction and sales increases that accrued because of
improvement in quality[11].
In the future, accounting information systems will use
learning curves to a greater degree to help organizations
to understand the link between the firm’s product and
process. A firm enjoys the benefits of being a low-cost
producer, only if the higher cost of manufacturing under
FMS is matched by a higher volume of sales over time.
Frequently, FMS firms have an extreme learning curve.
Long-run production experience would lower the production
costs. But, the cost reduction may be offset by competitors
reproducing the firm’s product and lowering the profit
margins.Therefore, the accounting information system
must constantly monitor and report whether the new
manufacturing flexibility is actually resulting in greater
reductions in work-in-progress and finished goods invent-
ories, and shortening of design and throughput time[12].
Co-ordinate the information systems
In an FMS organization, the accounting information system
can be successful only if it can co-operate and co-ordinate
its work with other functional departments like finance,
purchasing, design, engineering, and with sources external
to the organization such as suppliers, customers, and
financial institutions. Also, the traditional functional
definitions and links change considerably after a firm
implements FMS. For example, most FMS organizations
synchronize their material, tools and parts purchases
and manage their purchase operations strategically. In
these organizations, because unit cost and product quality
are affected by the decisions of the purchasing department,
the purchasing department is often viewed as a profit
generating unit rather than as a cost-control unit. Similar
changes can be observed in other functional areas.
 ACCOUNTING INFORMATION SYSTEM ISSUES OF FMS
Often, FMS organizations support the new technology with
a well-functioning materials management system such as
MRP or JIT that co-ordinates the inventory supply and
production operations. The objective of the materials manage-
ment system is to reduce inventories, identify causes of
bottlenecks in inventory flow and find solutions to
resolve them. The organization is successful in achieving
these objectives only when the functional units within the
organization such as purchasing, production, finance, account-
ing, design, engineering, and others co-ordinate with each
other and share important strategic information[13]. Purchasing
requires strategic internal and external information like
material price, availability and supplier issues. Purchasing
departments, in turn, supply other departments with
professional advice on forecasting, sourcing, delivery and
supplier information necessary to succeed in the market-
place[14]. Purchasing departments become effective only
when they have access to and share information about
issues such as cost reduction, profit improvement, supplier
evaluation, value analysis, make-or-buy, capital investment
decisions, quality control and vendor capacity[14]. Because
these issues have significant financial implications for a firm,
an accounting information system must co-ordinate the
information flow between functional units and help manage-
ment in planning and achieving corporate-wide strategy.
An accounting information system can help management
also in the area of investment analysis. To evaluate and
control the FMS implementation, an organization needs
information on projected and actual cost and the causes of
variances during the implementation phase. It needs
information that will minimize the risks and maximize the
strategic advantages. After implementation, the
organization needs reliable data on the benefits (both
tangible and intangible) of the new technology. For the
accounting information system, this translates into identifying
and reporting on the dimensions that are of strategic
importance to the organization. The reports must cover
costs and benefits of such dimensions as the ability to produce
new products (product flexibility), the ability to accommodate
changes in product volumes (volume flexibility), the
ability to reroute manufacturing processes to accommodate
breakdowns, maintenance, etc. (routeing flexibility), the
ability to vary the operational sequences (operational
flexibility), and the ability to change the mix of material,
labour, or overhead components of a product family (process
flexibility)[15].
In an FMS organization, the accounting information system
can play an effective role only if the system recognizes the
following developments:
● The accounting information system will be expected
to participate in flexible manufacturing automation
projects from the planning stages.
● Flexible automation is not an isolated and discrete
organizational project but a technological innovation
that is continuous over time.
39
● Managers of the accounting information system
must develop a basic understanding of the technical
and operational areas of flexible automation such
as communication networks, software development,
and data management.
● The accounting information system must take
responsibility for collecting and sharing strategic
information relating to FMS implementation with
other functional units within the organization;
accounting will play a greater role in integrating
the automated information systems within the
factory and between different functional areas[16].
● As flexible automation increases, many of the
organization’s traditional accounting subsystems,
such as inventory, sales, purchasing, and cost
management will undergo substantial changes in
the way in which data are collected and processed.
● To make information useful for decision making,
accounting must report the information on a timely
basis. FMS will speed up and reduce the expense
of collecting and processing data and will facilitate
real-time measurements. For example, even with
such simple automated techniques as scanning
barcodes, a firm can collect information on inventory
quantities, vendor history, and compute purchase,
material, and other inventory related variances
within seconds[8].
Summary
The current competitive environment facing manufactur-
ing industries is encouraging organizations to implement
FMS technology. FMS provides organizations with several
strategic advantages. However, the strategic benefits will
be realized only if the organization can revamp its inform-
ation system, particularly the accounting and financial
reporting systems. The technology integrates design,
engineering, plant control and accounting and financial
information systems and expects these systems to co-
operate and co-ordinate the data collection, measurement,
and reporting functions.
The accounting information systems of FMS organizations
find the conventional accounting techniques restrictive
in their ability to measure strategic costs and benefits.
However, many organizations are becoming innovative
and adopting new accounting and financial measures that
evaluate the strategic importance of FMS. The new accounting
techniques appear to change the role of the accounting
information system from cost measurements and cost
control to managing flexible automation and increasing
the overall prosperity of the organization[5]. These systems
do not relegate their role to studying the costs of flexible
automation but also extend to the study of the strategic
impact of indirect costs such as the cost of maintaining
higher quality, customer satisfaction, product variability,
marketing, and distribution costs.
40 INTEGRATED MANUFACTURING SYSTEMS 6,1
References
1. Meredith, J.R., “The strategic advantages of the factory of
the future”, California Management Review, Spring 1987,
pp. 27-41.
2. D’Iribarne, A. and Lutz, B., “Work organization in
flexible manufacturing systems: first findings from
international comparisons”, in Martin, T. (Ed.), Design of
Work in Automated Manufacturing Systems, Pergamon
Press, Oxford, 1984, pp. 127-32.
3. Dhavale, D.G., “Product costing in flexible manufacturing
systems”, Journal of Management Accounting Research,
Fall 1989, pp. 67-88.
4. Sriram, R.S. and Gupta, Y.P., “Strategic cost measurement
for flexible manufacturing systems”, Long Range Planning,
Vol. 24, 1990, pp. 34-40.
5. Bolwijn, P.T. and Kumpe, T., “Manufacturing in the 1990s
– productivity, flexibility and innovation”, Long Range
Planning, August 1990, pp. 44-57.
6. Gupta, Y.P., “Organizational issues of flexible manufacturing
systems”, Technovation, 1988, pp. 255-69.
7. Noreen, E., “Conditions under which activity-based cost
systems provide relevant costs”, Journal of Management
Accounting Research, Fall 1991, pp. 159-68.
8. Hiromoto, T., “Another hidden edge – Japanese management
accounting”, Harvard Business Review, July/August
1988, pp. 22-6.
Ram S. Sriram is an Associate Professor in the Department of Accounting, College of Business, Louisiana State University,
Baton Rouge, Louisiana, USA.
9. Bromwich, M., “The case for strategic management accounting:
the role of accounting information for strategy in competitive
markets”, Accounting Organizations and Society, Vol. 15,
1990, pp. 17-46.
10. Kaplan, R.S., “Measuring manufacturing performance:
a new challenge for managerial accounting research”,
Accounting Review, October 1983, pp. 686-706.
11. Williams, J.R. and Novak, R., “Aligning CIM strategies to
different markets”, Long Range Planning, June 1990,
pp. 91-9.
12. Yoo, S., “An information system for just-in-time”, Long
Range Planning, December 1989, pp. 117-26.
13. Pearson, J.N. and Gritzmacher, K.J., “Integrating purchases
into strategic management”, Long Range Planning, June
1990, pp. 91-9.
14. Bessant, J. and Haywood, B., “Flexibility in manufacturing
systems”, Omega: The International Journal of Management
Science, Vol. 14 No. 6, 1986, pp. 465-73.
15. Saraph, J.V. and Guimaraes, T., “The role of IS in manufacturing
automation”, Journal of Information System Management,
Winter 1991, pp. 58-66.
16. Phillips, E.J., “Flexible manufacturing systems: an overview”,
and Sullivan, W.G., “Replacement decisions in high technology
industries – where are those models when you need them”,
in Meredith, J.R. (Ed.), Justifying New Manufacturing
Technology, Industrial Engineering and Management Press,
Norcross, GA, 1986.