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Hapter 12: © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart
Hapter 12: © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 1 of 122
INTRODUCTION
• Questions to be addressed in this chapter
include:
– What are the basic business activities and data
processing operations that are performed in the
production cycle?
– What decisions need to be made in the production
cycle, and what information is needed to make these
decisions?
– How can the company’s cost accounting system help
in achieving the entity’s objectives?
– What are the major threats in the production cycle
and the controls that can mitigate those threats?
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INTRODUCTION
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INTRODUCTION
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INTRODUCTION
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INTRODUCTION
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PRODUCTION CYCLE ACTIVITIES
• The four basic activities in the production cycle
are:
– Product design
– Planning and scheduling
– Production operations
– Cost accounting
• Accountants are primarily involved in the fourth
activity (cost accounting) but must understand
the other processes well enough to design an
AIS that provides needed information and
supports these activities.
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PRODUCTION CYCLE ACTIVITIES
• The four basic activities in the production cycle
are:
– Product design
– Planning and scheduling
– Production operations
– Cost accounting
• Accountants are primarily involved in the fourth
activity (cost accounting) but must understand
the other processes well enough to design an
AIS that provides needed information and
supports these activities.
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PRODUCT DESIGN
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PRODUCT DESIGN
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PRODUCTION CYCLE ACTIVITIES
• The four basic activities in the production cycle
are:
– Product design
– Planning and scheduling
– Production operations
– Cost accounting
• Accountants are primarily involved in the fourth
activity (cost accounting) but must understand
the other processes well enough to design an
AIS that provides needed information and
supports these activities.
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PLANNING AND SCHEDULING
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PLANNING AND SCHEDULING
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PLANNING AND SCHEDULING
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PLANNING AND SCHEDULING
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PLANNING AND SCHEDULING
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PLANNING AND SCHEDULING
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PLANNING AND SCHEDULING
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PLANNING AND SCHEDULING
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PLANNING AND SCHEDULING
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PLANNING AND SCHEDULING
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PLANNING AND SCHEDULING
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PLANNING AND SCHEDULING
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PRODUCTION CYCLE ACTIVITIES
• The four basic activities in the production cycle
are:
– Product design
– Planning and scheduling
– Production operations
– Cost accounting
• Accountants are primarily involved in the fourth
activity (cost accounting) but must understand
the other processes well enough to design an
AIS that provides needed information and
supports these activities.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 28 of 122
PRODUCTION OPERATIONS
• Production operations vary greatly across
companies, depending on the type of product
and the degree of automation.
• The use of various forms of IT, such as robots
and computer-controlled machinery is called
computer-integrated manufacturing (CIM).
– Can significantly reduce production costs.
• Accountants aren’t experts on CIM, but they
must understand how it affects the AIS.
– One effect is a shift from mass production to custom-
order manufacturing and the need to accumulate
costs accordingly.
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PRODUCTION OPERATIONS
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PRODUCTION OPERATIONS
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PRODUCTION CYCLE ACTIVITIES
• The four basic activities in the production cycle
are:
– Product design
– Planning and scheduling
– Production operations
– Cost accounting
• Accountants are primarily involved in the fourth
activity (cost accounting) but must understand
the other processes well enough to design an
AIS that provides needed information and
supports these activities.
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COST ACCOUNTING
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COST ACCOUNTING
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COST ACCOUNTING
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COST ACCOUNTING
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COST ACCOUNTING
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COST ACCOUNTING
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COST ACCOUNTING
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COST ACCOUNTING
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COST ACCOUNTING
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COST ACCOUNTING
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COST ACCOUNTING
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COST ACCOUNTING
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COST ACCOUNTING
• Raw material usage data:
– When production is initiated, the issuance of a
materials requisition triggers a debit (increase) to
work in process and a credit (decrease) to raw
materials inventory.
– Work in process is credited and raw materials are
debited for any amounts returned to inventory.
– Many raw materials are bar coded so that usage data
is collected by scanning.
– RFID tags improve the efficiency of tracking material
usage.
– Usage may be entered online for materials such as
liquids that are not conducive to tagging.
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COST ACCOUNTING
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COST ACCOUNTING
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COST ACCOUNTING
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COST ACCOUNTING
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CONTROL: OBJECTIVES, THREATS,
AND PROCEDURES
• In the production cycle (or any cycle), a well-designed
AIS should provide adequate controls to ensure that the
following objectives are met:
– All transactions are properly authorized.
– All recorded transactions are valid.
– All valid and authorized transactions are recorded.
– All transactions are recorded accurately.
– Assets are safeguarded from loss or theft.
– Business activities are performed efficiently and effectively.
– The company is in compliance with all applicable laws and
regulations.
– All disclosures are full and fair.
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CONTROL: OBJECTIVES, THREATS,
AND PROCEDURES
• There are several actions a company can take
with respect to any cycle to reduce threats of
errors or irregularities. These include:
– Using simple, easy-to-complete documents with
clear instructions (enhances accuracy and
reliability).
– Using appropriate application controls, such as
validity checks and field checks (enhances
accuracy and reliability).
– Providing space on forms to record who completed
and who reviewed the form (encourages proper
authorizations and accountability).
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CONTROL: OBJECTIVES, THREATS,
AND PROCEDURES
– Pre-numbering documents (encourages recording
of valid and only valid transactions).
– Restricting access to blank documents (reduces
risk of unauthorized transaction).
– Using RFID tags when feasible to improve data
entry accuracy.
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THREATS IN PRODUCT DESIGN
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THREATS IN PLANNING AND
SCHEDULING
• Threats in the planning and scheduling
process include:
– THREAT 2: Over- or under-production
– THREAT 3: Suboptimal investment in fixed
assets
• You can click on any of the threats above to get
more information on:
– The types of problems posed by each threat
– The controls that can mitigate the threats.
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THREATS IN PRODUCTION
OPERATIONS
• Threats in the production operations
process include:
– THREAT 4: Theft of inventories and fixed a
ssets
– THREAT 5: Disruption of operations
• You can click on any of the threats above to get
more information on:
– The types of problems posed by each threat.
– The controls that can mitigate the threats.
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THREATS IN COST ACCOUNTING
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• You can click on any of the threats below to get
more information on:
GENERAL
– The types of THREATS
problems posed by each threat.
– The controls that can mitigate the threats.
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PRODUCTION CYCLE INFORMATION
NEEDS
• In a manufacturing environment, the focus
must be on total quality management.
Managers need info on:
– Defect rates
– Breakdown frequency
– Percent of finished goods needing rework
– Percent of defects discovered by customers
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PRODUCTION CYCLE INFORMATION
NEEDS
• In traditional systems, this type of data
was not well linked with financial data, and
cost accounting systems were separate
from production operations information
systems.
• However, both financial and operating
information are needed to manage and
evaluate these activities.
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PRODUCTION CYCLE INFORMATION
NEEDS
• Two major criticisms have been directed at
traditional cost accounting systems:
– Overhead costs are inappropriately allocated
to products.
– Reports do not accurately reflect effects of
factory automation.
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PRODUCTION CYCLE INFORMATION
NEEDS
• Two major criticisms have been directed at
traditional cost accounting systems:
– Overhead costs are inappropriately
allocated to products.
– Reports do not accurately reflect effects of
factory automation.
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CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Traditional cost accounting systems use
volume-driven bases such as direct labor
hours or machine hours to apply
overhead.
• However, overhead does not vary with
production volume.
• EXAMPLE: Purchasing costs vary with the
number of purchase orders processed.
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CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Allocating overhead based on output
volume:
– Overstates the costs of products
manufactured in large quantities.
– Understates the costs of products
manufactured in small batches.
• Also, allocating overhead based on direct
labor input can distort costs.
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CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Example of two products:
– Product one uses:
• $5 of materials
• 1 hour of labor
• 5 minutes of machine time
– Product two uses:
• $5 of materials
• 1 hour of labor
• 42 hours of machine time on very expensive
equipment
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CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Example of two products:
– Product one uses:
Under a traditional
• $5 of materials cost accounting
• 1 hour of labor system, both
products will
• 5 minutes of machine time appear to have the
– Product two uses: same cost.
• $5 of materials
• 1 hour of labor
• 42 hours of machine time on very expensive
equipment
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CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Solution to criticism 1: Activity Based
Costing (ABC)
– ABC can refine and improve cost allocations
under either job-order or process costing
systems.
• ABC traces costs to the activities that create them
and allocates them accordingly.
• ABC aims to link costs to corporate strategy.
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CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
– Corporate strategy results in decisions about
what goods and services to produce.
• These activities incur costs.
• So corporate strategy determines costs.
– By measuring the costs of the basic activities,
ABC provides information to management for
evaluating the consequences of their decisions.
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CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• ABC vs. traditional cost systems:
– There are three significant differences between
ABC and traditional approaches.
• Tracing of overhead costs
• Number of cost pools
• Identification of cost drivers
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CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• ABC vs. traditional cost systems:
– There are three significant differences between
ABC and traditional cost accounting approaches.
• Tracing of overhead costs
• Number of cost pools
• Identification of cost drivers
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CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• ABC directly traces a larger proportion of
overhead costs to products.
• This tracing is made possible by advances
in IT.
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CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• ABC vs. traditional cost systems:
– There are three significant differences between
ABC and traditional cost accounting approaches.
• Tracing of overhead costs
• Number of cost pools
• Identification of cost drivers
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CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• ABC uses a greater number of cost pools
• EXAMPLES: Setup, inspection, and material
to accumulate indirect
handling costs. costs
(manufacturing overhead).
• Accumulated for a batch and allocated to the
products in that batch.
• Most systems lump all
• Consequently, overhead
costs per product together,
will be less
but ABC distinguishes
when products arethree
made incategories:
larger quantities.
- Batch-related overhead
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CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• ABC uses• aExamples:
greaterR&D, number of cost
environmental pools and
regulations,
purchasing costs.
to accumulate indirect
• These costs arecosts
related to the diversity of the
(manufacturing overhead).
company’s product line.
• ABC attempts to link these costs to the products
• Most systems
thatlump
generateallthem.
overhead together,
but ABC distinguishes three
• For example, purchasing categories:
costs might be
allocated to products based on the number of
- Batch-related overhead
purchase orders generated for each product.
- Product-related overhead
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CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• ABC uses a greater number of cost pools
to accumulate indirect costs
(manufacturing overhead).
• Most systems lump all overhead together,
but ABC distinguishes three
• EXAMPLE: Rentcategories:
or depreciation.
- Batch-related overhead
• These costs are applied to all products
and allocated according to departmental
- Product-related overhead
or plant rates.
- Company-wide overhead
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 96 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• ABC vs. traditional cost systems:
– There are three significant differences between
ABC and traditional cost accounting approaches.
• Tracing of overhead costs
• Number of cost pools
• Identification of cost drivers
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 97 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Benefits of ABC systems
– ABC systems are more costly and complex.
– But proponents argue two important benefits:
• More accurate cost data result in better product
mix and pricing decisions.
• More detailed cost data improve management’s
ability to control and manage total costs.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 98 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Benefits of ABC systems
– ABC systems are more costly and complex.
– But proponents argue two important benefits:
• More accurate cost data result in better
product mix and pricing decisions
• More detailed cost data improve management’s
ability to control and manage total costs.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 99 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Better decisions
– ABC avoids problems of applying too much or
too little overhead to products and
consequently results in better price decisions.
– ABC uses the data collected to improve
product design.
– ABC provides management with the
information about the costs associated with
specific activities, resulting in better analysis
and decisions.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 100 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Benefits of ABC systems
– ABC systems are more costly and complex.
– But proponents argue two important benefits:
• More accurate cost data result in better product
mix and pricing decisions.
• More detailed cost data improve management’s
ability to control and manage total costs.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 101 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Improved cost management
– ABC measures the results of managerial
actions on overall profitability.
– ABC measures both the amount spent to
acquire resources and the amount spent to
consume them.
– ABC measures unused capacity:
• Cost of activity capability = Cost of activity used +
Cost of unused capacity
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CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• EXAMPLE: A publishing company has five
employees who operate printing presses.
• The employees each have annual salaries of
$25,000 for a total salary cost of $125,000.
• Each employee should be able to print about 10,000
books per year.
• The total capacity, therefore is 50,000 books.
• The salary cost per book would be $125,000 /
50,000 books = $2.50 per book.
• During the most recent year, the presses produced
47,000 books.
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CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• EXAMPLE: A publishing company has five
employees who operate printing presses.
• The employees• The
eachcosthave
of theannual salaries is
activity capability ofthe total
booksalary
$25,000 for a total capacity for the
cost year of 50,000 books times
of $125,000.
the salary cost per book of $2.50.
• Each employee should
• 50,000 be xable
books $2.50to= print about 10,000
$125,000.
books per year.
• The total capacity, therefore is 50,000 books.
• The salary cost per book would be $125,000 /
50,000 books = $2.50 per book.
• During the most recent year, the presses produced
47,000 books.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 104 of 122
CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• EXAMPLE: A publishing company has five
employees who operate printing presses.
• The employees each have annual salaries of
$25,000 for a total salary cost of $125,000.
• The cost of the activity used is the number of
• Each employeebooks
should be able
actually to print
produced about
times 10,000
the salary cost
books per year.per book of $2.50.
• 47,000
• The total capacity, therefore is 50,000
books x $2.50 books.
= $117,500.
• The salary cost per book would be $125,000 /
50,000 books = $2.50 per book.
• During the most recent year, the presses produced
47,000 books.
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CRITICISM 1: INAPPROPRIATE
• The unused capacity is the difference between
the activity capability ($125,000) and the cost of
ALLOCATION OF OVERHEAD
the activity used ($117,500). COSTS
• $125,000 - $117,500 = $7,500 unused capacity.
• EXAMPLE: A• publishing
Alternately, company has five
unused capacity can be calculated
employees whoasoperate
the cost printing presses.
per book of $2.50 times the
• The employeesdifference
each have between the books
annual thatof
salaries could be
produced and the books that were actually
$25,000 for a total salary cost of $125,000.
produced.
• Each employee should
• $2.50 be able
x (50,000 to print
possible about
books 10,000
– 47,000 actual
books per year.books) = $7,500 unused capacity.
• The total capacity, therefore is 50,000 books.
• The salary cost per book would be $125,000 /
50,000 books = $2.50 per book.
• During the most recent year, the presses produced
47,000 books.
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CRITICISM 1: INAPPROPRIATE
ALLOCATION OF OVERHEAD COSTS
• Management may be able to improve
profitability by:
- Applying the unused capacity to other
revenue-generating activities; or
- Eliminating the unused capacity.
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PRODUCTION CYCLE INFORMATION
NEEDS
• Two major criticisms have been directed at
traditional cost accounting systems:
– Overhead costs are inappropriately allocated
to products.
– Reports do not accurately reflect effects of
factory automation.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 108 of 122
CRITICISM 2: REPORTS DO NOT ACCURATELY
REFLECT EFFECTS OF AUTOMATION
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CRITICISM 2: REPORTS DO NOT ACCURATELY
REFLECT EFFECTS OF AUTOMATION
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THROUGHPUT: A MEASURE OF
PRODUCTION EFFECTIVENESS
• Throughput = Productive Capacity x
Productive Processing Time x Yield
– Productive Capacity = Total Units
Produced / Processing Time
• Can be improved by:
– Improving machine or labor efficiency.
– Improving factory layout.
– Simplifying product design specifications.
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THROUGHPUT: A MEASURE OF
PRODUCTION EFFECTIVENESS
• Throughput = Productive Capacity x
Productive Processing Time x Yield
– Productive Capacity = Total Units Produced /
Processing Time
– Productive Processing Time = Processing
Time / Total Time
• The opposite of downtime.
• Can be improved by:
– Better maintenance to reduce machine downtime.
– Better scheduling of deliveries to reduce wait time.
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THROUGHPUT: A MEASURE OF
PRODUCTION EFFECTIVENESS
• Throughput = Productive Capacity x
Productive Processing Time x Yield
– Productive Capacity = Total Units Produced /
Processing Time
– Productive Processing Time = Processing
Time / Total Time
– Yield = Good Units / Total Units
• Can be improved by:
– Using better raw materials.
– Improving worker skills.
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THROUGHPUT: A MEASURE OF
PRODUCTION EFFECTIVENESS
• Throughput = Productive Capacity x Productive
Processing Time x Yield
– Productive Capacity = Total Units Produced / Processing Time
– Productive Processing Time = Processing Time / Total Time
– Yield = Good Units / Total Units
• EXAMPLE: Manster Co. produced 1,000 bottles of Zithmowash in
a 10-hour period. During this period there was a total of 1 hour
of machine downtime and waiting time for materials. One
hundred of the bottles were defective.
– PRODUCTIVE CAPACITY = 1,000 bottles / 9 productive hours =
111.11 bottles / hour.
– PRODUCTIVE PROCESSING TIME = 9 productive hours / 10 total
hours = .90.
– YIELD = 900 good units / 1,000 total units = .90
– THROUGHPUT = 111.11 x .90 x .90 = 90
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QUALITY CONTROL
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QUALITY CONTROL
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QUALITY CONTROL
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QUALITY CONTROL
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QUALITY CONTROL
• Information about quality control
– Quality control costs can be divided
into four categories:
• Prevention costs have found that the most
• Some companies
• importantcosts
Inspection management decision involves
• switching
Internal from
failure the traditional "management by
costs
exception" philosophy to a "continuous
• External failure costs
improvement" viewpoint. Continuous
– The improvement
objective of quality
focuses control actual
on comparing is to
performance
minimize to the of
the sum ideal (i.e., perfection).
these four costs.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 120 of 122
SUMMARY
• You’ve learned about the basic business
activities and data processing operations that
are performed in the production cycle, including:
– Product design
– Production planning and scheduling
– Production operations
– Cost accounting
• You’ve learned how IT can improve the
efficiency and effectiveness of these processes.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 121 of 122
SUMMARY
• You’ve learned about decisions that need to be
made in the production cycle and the information
required to make these decisions.
• You’ve also learned about the major threats that
present themselves in the production cycle and
the controls that can mitigate those threats.
• Finally, you’ve learned how the company’s cost
accounting system can help in achieving the
entity’s objectives.
© 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart 122 of 122