CH 14 THE EXPENDITURE

CYCLE
production cycle - The recurring set of business activities and
related data processing operations associated with the manufacture of products.
- Revenue cycle information system provides the information (customer orders and sales forecasts) used to plan
production and inventory levels
o production cycle information system sends information
about finished goods that have been produced and
are available for sale.
- Information about raw materials from revenue needs is sent to
the expenditure cycle information system in the form of
purchase requisitions
o expenditure cycle system provides information about
raw material acquisitions and also about other
expenditures included in manufacturing overhead
- Information about labor needs is sent to the human resources
cycle, which in return provides data about labor costs and
availability.
- information about the cost of goods manufactured is sent to
the general ledger and reporting information system
four basic production cycle activities:
1. product design 3. production operations
2. planning and scheduling 4. cost accounting

PRODUCTION CYCLE INFORMATION

SYSTEM
PROCESS
1. engineering department is responsible for developing
product specifications.
- bill of materials file stores information about product
components
- operations list file contains information about how to
manufacture each product.
o engineering accesses both files to examine the
design of similar products.
o It also accesses the general ledger and
inventory files for information about the costs
of alternative product designs
2. sales department enters information about sales forecasts and customer orders.
3. production planning department uses that information, plus data about current inventory levels, to develop the master
production schedule and create new records in the production order file to authorize the production of specific goods.
4. Materials requisitions are sent to the inventory stores department to authorize the release of raw materials.
5. The computer-integrated manufacturing (CIM) interface sends detailed instructions to factory workstations.
- CIM interface also collects cost and operational data that is used to update the work-in-process and production order
files,
6. the open purchase order file to plan for and verify the validity of deliveries

Threats and Controls

(1) Inaccurate or invalid master data.
 incorrect costing of products and valuation of inventory.
 result in either failure to timely manufacture finished goods or unnecessary production.
 Errors in product specifications (bills of materials and operations lists) can result in poorly designed
products.
 Control:
 a) use the various processing integrity controls (CH10) to minimize the risk of data input errors.
b) restrict access to production cycle master data and configure the system so that only authorized employees
can make changes to master data
- Enforcing proper access controls and segregation of duties requires that the controller or CFO
review and suggest appropriate configuration of user rights in integrated ERP systems.
c) logs of all activities, especially any actions involving managerial approval, should be recorded and
maintained for later review
(2) Unauthorized disclosure of production information
 trade secrets and process improvements that provide a company with a competitive advantage
 Control:
a) configure the system to employ strong access controls that limit who can view such information (limit
employees’ ability to use the system’s built-in query capabilities to access only those specific tables and
fields
b) sensitive data should be encrypted both while in storage and during transmission over the Internet to
manufacturing plants and business partners.
(3) loss or destruction of production data.
 Control:
a) regular backing up of all data files is imperative (CH10).
- Additional copies of key master files, such as open production orders and raw materials inventory,
should be stored off-site.
- To reduce the possibility of accidental erasure of important files, all disks and tapes should have both
external and internal file labels

PRODUCT DESIGN
PROCESS
1. bill of materials - A document that specifies the part number, description, and quantity of each component used in a
product.
2. operations list - A document that specifies the sequence of steps to follow in making a product, which equipment to use,
and how long each step should take.
product life-cycle management (PLM) software - help improve the efficiency and effectiveness of the product design process.
- consists of three key components:
1. computer-aided design (CAD) software to design new products
- enables manufacturers to design and test virtual 3-D models of products, eliminating the costs associated
with creating and destroying physical prototype
- facilitates collaboration by design teams and eliminates the costs associated with exchanging static copies
of product designs.
2. digital manufacturing software that simulates how those products will be manufactured
- determine labor, machine, and process requirements to optimally produce items in different facilities
across the globe in order to minimize costs.
3. product data management software that stores all the data associated with products
- provides easy access to detailed engineering specifications and other product data to facilitate product
redesign, modification, and post-sale maintenance
Threats and Controls
(4) Poor product design
 Using too many unique components when producing similar products increases the costs
 results in inefficient production processes because of excessive complexity in changing from the production of
one product to another.
 Control:
a) accountants should participate in the product design activity
b) accountants can use information from the revenue cycle about repair and warranty cost associated with
existing products to identify the primary causes of product failure and suggest opportunities to redesign
products to improve quality

PLANNING AND SCHEDULING

Production Planning Methods
manufacturing resource planning (MRP-II) - An extension of materials resource
planning that seeks to balance existing production capacity and raw materials needs
to meet forecasted sales demands.
- Also referred to as push manufacturing because goods are produced in
expectation of customer demand.
lean manufacturing - Extends the principles of just-in-time inventory systems to the
entire production process to minimize or eliminate inventories of raw materials, work
in process, and finished goods.
- often referred to as pull manufacturing because goods are produced in
response to customer demand
 both MRP-II and lean manufacturing systems plan production in advance.
 Differ in the length of the planning horizon
MRP-II systems - develop production plans for up to 12
months in advance - In contrast, a lean manufacturing approach is more
- If demand for a company’s product is predictable appropriate if a company’s products are characterized
and the product has a long life cycle, then an MRP- by short life cycles, unpredictable demand, and
II approach is justified frequent markdowns of excess inventory
lean manufacturing systems use much shorter planning
horizons.
Key Documents and Forms
master production schedule (MPS) - Specifies how much of each product is to be produced during the planning period and when
that production should occur.
- used to develop a detailed timetable that specifies daily production and to determine whether raw materials
need to be purchased
- bill of materials to determine the immediate raw materials requirements for meeting the production goals
- if additional materials are needed, purchase requisitions are generated and sent to the purchasing department
to initiate the acquisition process
production order - A document authorizing the manufacture of a specified quantity of a particular product
- production order number, date of issue, and, based on the bill of materials, the part numbers and quantities
of all necessary raw materials
materials requisition - Authorizes the removal of the necessary quantity of raw materials from the storeroom to the factory
move tickets - Documents that identify the internal transfer of parts, the location to which they are transferred, and the time of the
transfer
bar-coding and RFID tags provides opportunities to improve the efficiency and accuracy of these materials handling activities
by eliminating the need for manual entry of data.
- RFID also facilitates locating specific inventory because the scanning devices are not limited to reading only those items
that are directly in line-of-sight. This can be especially useful in large warehouse and storage facilities, where items may
get moved around to make room for new shipments.
integrating information about customer orders (from the revenue cycle) with information about purchases from suppliers
(expenditure cycle), along with information about labor availability (from the HR/payroll cycle).
Threats and Controls
(5) Over or underproduction
 Overproduction can result in a supply of goods in excess of short-run
 Overproduction also increases the risk of carrying inventory that becomes obsolete
 underproduction can result in lost sales and customer dissatisfaction because of lack of availability of desired
items
 important for companies that produce new, innovative products, such as current fashion clothing, because the
demand for such products is much more volatile than the demand for staples and commodities
 Control:
a) Production planning systems - Improvement requires accurate and current sales forecasts and data
about inventory stocks, information that the revenue and expenditure cycle systems can provide.
- information about production performance, particularly concerning trends in total time to
manufacture each product, should be regularly collected
b) Proper approval and authorization of production orders/Careful review and approval also ensures that
the correct production orders are released
c) restricting access to the production scheduling program

PRODUCTION OPERATIONS
PROCESS:
computer-integrated manufacturing (CIM) - A manufacturing approach in which much of the manufacturing process is
performed and monitored by computerized equipment, in part through the use of robotics and real-time data collection of
manufacturing activities.
- Accountants need not be experts on every facet of CIM, but they must understand how it affects both operations and
cost accounting.
Threats and Controls
(6) Theft of inventories
 Control:
a) physical access to inventories should be restricted
b) all internal movements of inventory should be documented
- Both the inventory control clerk and the production employee receiving the raw materials should
sign the requisition to acknowledge release of the goods to production.
- additional materials in excess of the amounts specified in the bill of materials should be documented
and authorized by supervisory personnel.
- Move tickets should be used to document subsequent movement of inventory through various stages
of the production process
 - return of any materials not used in production also should be documented.
- RFID tags or bar codes should be used to automate the tracking of inventories
c) Proper segregation of duties – safeguard inventory
- Maintaining physical custody of the raw materials and finished goods inventories is the
responsibility of the inventory stores department.
- Department or factory supervisors have primary responsibility for work-in-process inventories.
- The authorization function, represented by the preparation of production orders, materials
requisitions, and move tickets, is the responsibility of the production planners or, increasingly, of
the production information system itself
d) proper access controls and compatibility tests are important to ensure that only authorized personnel
have access to those records
e) an employee without any custodial responsibility should periodically count inventory on hand
(7) Theft of fixed assets
 Control:
a) all fixed assets must be identified and recorded
b) security measures should be in place to control physical access to fixed assets
c) formally approve and accurately record their sale or disposal
(8) Poor performance
 Control:
a) regularly prepare and review reports on performance
b) Training
(9) suboptimal investment in fixed assets
 Overinvesting in fixed assets can create excess costs; underinvestment can impair productivity
 Control:
a) proper authorization of fixed-asset transactions

request for proposal (RFP) - A request by an organization or department for suppliers to bid to supply a fixed asset that possesses
specific characteristics
- Once a supplier has been selected, the acquisition of the asset may be handled through the regular expenditure cycle process
- formal purchase order is prepared, receipt of the asset is formally documented using a receiving report, and a
disbursement voucher is used to authorize payment to the supplier

(10) both inventories and fixed assets are subject to loss due to fire or other disasters
 Control:
a) Physical safeguard such as fire suppression systems, are designed to prevent such disasters
b) purchase adequate insurance to cover such losses and provide for replacement of those assets.
(11) disruption of production activities
 Control:
a) Backup power sources (e.g., generators and uninterruptible power supply devices) to ensure that critical
equipment and machinery is not damaged by sudden unexpected loss of power and that important
production processes can continue on schedule

COST ACCOUNTING
three principal objectives of the cost accounting system:
1. to provide information for planning, controlling, and evaluating the performance of production operations;
2. to provide accurate cost data about products for use in pricing and product mix decisions;
3. to collect and process the information used to calculate the inventory and cost of goods sold values that appear in the
company’s financial statements
PROCESS:
To successfully accomplish the first objective:
- cost accounting system must be designed to collect real-time data about the performance of production activities so that
management can make timely decisions
To successfully accomplish the other objectives:
- the cost accounting system must classify costs by various categories and then assign those costs to specific products and
organizational units
o requires careful coding of cost data during collection, because often the same costs may be allocated in multiple
ways, for several different purposes.

job-order costing - A cost system that assigns costs to specific production batches or jobs.
- used when the product or service being sold consists of discretely identifiable items
process costing - A cost system that assigns costs to each process, or work center, in the production cycle, and then calculates the
average cost for all units produced
- used when similar goods or services are produced in mass quantities and discrete units cannot be readily identified
RAW MATERIALS USAGE DATA.
 - When production is initiated, the issuance of a materials requisition triggers a debit to work in process for the raw
materials sent to production.
- If additional materials are needed, another debit is made to work in process.
- Conversely, work in process is credited for any materials not used and returned to inventory.
- Increasingly, manufacturers are using RFID tags to further improve the efficiency of tracking materials usage.
- It is difficult, however, to use bar codes or RFID tags for some items, such as liquids.
- Inventory clerks and factory workers must use online terminals to enter usage data for such items

DIRECT LABOR COSTS

- job-time ticket - A document used to collect data about labor activity by recording the amount of time a worker spent on
each specific job task
- coded identification cards, which workers would run through a badge reader or bar-code scanner when they start and finish
any task.

MACHINERY AND EQUIPMENT USAGE

- implement CIM to automate the production process, an ever larger proportion of product costs relate to the machinery and
equipment used to make that product.
- Data about machinery and equipment usage are collected at each step in the production process, often in conjunction
with data about labor costs.
- Consequently, many manufacturing companies are replacing such wired connections with wireless technology
o enables to use new 3-D simulation software to evaluate the effects of modifying shop-floor layout and workflow and
to easily and quickly implement beneficial changes.
MANUFACTURING OVERHEAD COSTS
- Manufacturing costs that are not economically feasible to trace directly to specific jobs or processes are considered
manufacturing overhead.
- Examples include the costs of water, power, and other utilities; miscellaneous supplies; rent, insurance, and property
taxes for the factory plant; and the salaries of factory supervisors.
o Most of these costs are collected by the expenditure cycle information system with the exception of supervisory
salaries, which are processed by the human resources cycle information system
- Accountants can play a key role in controlling overhead costs by carefully assessing how changes in product mix affect
total manufacturing overhead.
- This information then can be used to adjust production plans and factory layout to maximize efficiency and profitability

Threats and Controls

(12) inaccurate cost data.
 diminish the effectiveness of production scheduling and undermine management’s ability to monitor and control
manufacturing operations.
 Errors in inventory records can lead to either over- or underproduction of goods
 Overstated fixed assets increase expenses through extra depreciation and higher property taxes.
 Inaccuracies in financial statements and managerial reports can distort analyses of past performance and the
desirability of future investments or changes in operations
 Controls:
a) automate data collection - using RFID technology, bar-code scanners, badge readers, and other device
- When this is not feasible, online terminals should be used for data entry and should
employ the various data entry edit controls
o check digits and closed-loop verification should be used to ensure that
information about the raw materials used, operations performed, and employee
number is entered correctly.
o Validity checks, such as comparing part numbers of raw materials to those
listed in the bill of materials file, provide further assurance of accuracy
b) periodic physical counts of inventories and fixed assets should be made and compared with recorded
quantities
(13) poorly designed cost accounting systems misallocate costs to products.
 Controls:
a) activity-based costing (ABC) - A cost system designed to trace costs to the activities that create them
- underlying objective of activity-based costing is to link costs to corporate strategy.
- Corporate strategy results in decisions about what goods and services to produce.
- corporate strategy determines costs
- Activity-based costing systems differ from conventional cost accounting systems in three important ways:
1. Activity-based cost systems attempt to directly trace a larger proportion of overhead costs to
products.
2. Activity-based cost systems use a greater number of cost pools to accumulate indirect costs
(manufacturing overhead).
- most traditional cost systems lump all overhead costs together, activity-based costing
systems distinguish three separate categories of overhead
i. Batch-related overhead. (e.g., setup costs, inspections, and materials handling)
 - products produced in large quantities have lower batch-related overhead
costs per unit than products produced in small quantities.
ii. Product-related overhead. costs are related to the diversity of the company’s
product line. (e.g., research and development, expediting, shipping and
receiving, environmental regulations, and purchasing)
- Activity-based cost systems try to link these costs to specific products
when possible.
- Other costs, such as purchasing raw materials, might be allocated
across products based on the relative number of purchase orders
required to make each product.
iii. Companywide overhead. (e.g., includes such costs as rent or property taxes)
- These costs apply to all products.
- activity-based cost systems typically allocate them using
departmental or plant rates.
3. Activity-based cost systems attempt to rationalize the allocation of overhead to products by
identifying cost drivers.
- cost driver - Anything that has a cause-and-effect relationship to costs.
- ERP systems make it easier to implement activity-based costing because they provide detailed
information about the steps required to process a transaction
(14) produce misleading reports about production cycle activities
 Control:
a) accountants should also develop and refine new measures designed to focus on issues important to
production cycle managers

IMPROVED CONTROL WITH ACTIVITY-BASED COSTING SYSTEMS

- Traditional cost systems use volume-driven bases, such as direct labor or machine hours, to apply overhead to products.
- Many overhead costs, however, do not vary directly with production volume.

BETTER DECISIONS.
- Traditional cost systems tend to apply too much overhead to some products and too little to others, because too few cost
pools are used. This leads to two types of problems:
1. companies may accept sales contracts for some products at prices below their true cost of production
2. companies may overprice other products, thereby inviting new competitors to enter the market
- Activity-based costing also makes better use of production data to improve product design.

IMPROVED COST MANAGEMENT.

- another advantage of activity-based costing is that it clearly measures the results of managerial actions on overall
profitability.
Cost of activity capability=Cost of activity used + Cost of unused capacity
IMPROVED CONTROL WITH INNOVATIVE PERFORMANCE METRICS
- The reason: Traditional financial accounting treats inventory as an asset.
- Thus, the costs of producing inventory are not recognized until the products are sold.
- Generally Accepted Privacy Principles (GAAP) with additional reports based on leanaccounting principles.
o One suggested change involves assigning costs to product lines instead of departments

THROUGHPUT: A MEASURE OF PRODUCTION EFFECTIVENESS.

- throughput - A measure of production efficiency representing the number of “good” units produced in a given period of
time.
Total units produced ProcessingTime Good Units
Throughput= × ×
processing time Total Time Total Units
- Productive capacity - shows the maximum number of units that can be produced using current technology.
o can be increased by improving labor or machine efficiency, by rearranging the factory-floor layout to expedite
the movement of materials, or by simplifying product design specifications.
- Productive processing time -indicates the percentage of total production time used to manufacture the
- product.
o can be improved by improving maintenance to reduce machine downtime or by more efficient scheduling of
material and supply deliveries to reduce wait time.
- Yield represents the percentage of good (nondefective) units produced.
o Using better-quality raw materials or improving worker skills can improve yield.

QUALITY CONTROL MEASURES.

- Information about quality costs can help companies determine the effects of actions taken to improve yield and identify
areas for further improvement.
- Quality control costs can be divided into four areas:
+ Prevention costs - associated with changes to production processes designed to reduce the product defect rate
 + Inspection costs - associated with testing to ensure that products meet quality standard
+ Internal failure costs - associated with reworking, or scrapping, products identified as being defective prior to sale
+ External failure costs - result when defective products are sold to customers.
- include such costs as product liability claims, warranty and repair expenses, loss of customer
satisfaction, and damage to the company’s reputation.
- The ultimate objective of quality control is to “get it right the first time” by manufacturing products that meet
customer specifications.
o This often requires trade-offs among the four quality cost categories