Chapter 7 Accounting
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Chapter 7 Accounting

Course Number: BUS 3000, Fall 2010

College/University: Texas Woman's...

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A companys conversion cycle transforms (converts) input resources, such as raw materials, labor, and overhead, into finished products or services for sale. The conversion cycle exists conceptually in all organizations, including those in service and retail industries. It is most formal and apparent, however, in manufacturing firms, which is the focus of this chapter. We begin with a review of the traditional batch...

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companys A conversion cycle transforms (converts) input resources, such as raw materials, labor, and overhead, into finished products or services for sale. The conversion cycle exists conceptually in all organizations, including those in service and retail industries. It is most formal and apparent, however, in manufacturing firms, which is the focus of this chapter. We begin with a review of the traditional batch production model, which consists of four basic processes: (1) plan and control production, (2) perform production operations, (3) maintain inventory control, and (4) perform cost accounting. The discussion focuses on the activities, documents, and controls pertaining to these traditional processes. The chapter then examines manufacturing techniques and technologies in world-class companies. Many firms pursuing world-class status follow a philosophy of lean manufacturing. This approach evolved from the Toyota Production System (TPS). The goal of lean manufacturing is to improve efficiency and effectiveness in product design, supplier interaction, factory operations, employee management, and customer relations. Key to successful lean manufacturing is achieving manufacturing flexibility, which involves the physical organization of production facilities and the employment of automated technologies, including computer numerical controlled (CNC) machines, computer-integrated manufacturing (CIM), automated storage and retrieval systems (AS/RS), robotics, computer-aided design (CAD), and computer-aided manufacturing (CAM). The chapter then examines problems associated with applying standard cost accounting techniques in a highly automated environment. The key features of two alternative accounting models are discussed: (1) activity-based costing (ABC) and (2) value stream accounting. The chapter concludes with a discussion of the information systems commonly associated with lean manufacturing and world-class companies. Materials requirements planning (MRP) systems are used to determine how much raw materials are required to fulfill production orders. Manufacturing resources planning (MRP II) evolved from MRP to integrate additional functionality into the manufacturing process, including sales, marketing, and accounting. Enterprise resource planning (ERP) systems take MRP II a step further by integrating all aspects of the business into a set of core applications that use a common database. The Traditional Manufacturing Environment The conversion cycle consists of both physical and information activities related to manufacturing products for sale. The context-level data flow diagram (DFD) in Figure 7-1 illustrates the central role of the conversion cycle and its interactions with other business cycles. Production is triggered by customer orders from the revenue cycle and/or by sales forecasts from marketing. These inputs are used to set a production target and prepare a production plan, which drives production activities. Purchase requisitions for the raw materials needed to meet production objectives are sent to the purchases procedures (expenditure cycle), which prepares purchase orders for vendors. Labor used in production is transmitted to the payroll system (expenditure cycle) for payroll processing. Manufacturing costs associated with intermediate work-in-process and finished goods are sent to the general ledger and financial reporting system. Depending on the type of product being manufactured, a company will employ one of the following production methods: 1. Continuous processing creates a homogeneous product through a continuous series of standard procedures. Cement and petrochemicals are produced by this manufacturing method. Typically, under this approach firms attempt to maintain finished-goods inventory at levels needed to meet expected sales demand. The sales forecast in conjunction with information on current inventory levels triggers this process. 2. Make-to-order processing involves the fabrication of discrete products in accordance with customer specifications. This process is initiated by sales orders rather than depleted inventory levels. 3. Batch processing produces discrete groups (batches) of product. Each item in the batch is similar and requires the same raw materials and operations. To justify the cost of setting up and retooling for each batch run, the number of items in the batch tends to be large. This is the most common method of production and is used to manufacture products such as automobiles, household appliances, canned goods, automotive tires, and textbooks. The discussion in this chapter is based on a batch processing environment. Batch Processing System The DFD in Figure 7-2 provides a conceptual overview of the batch processing system, which consists of four basic processes: plan and control production, perform production operations, maintain inventory control, and perform cost accounting. As in previous chapters, the conceptual system discussion is intended to be technology-neutral. The tasks described in this section may be performed manually or by computer. The figure also depicts the primary information flows (documents) that integrate these activities and link them to other cycles and systems. Again, system documents are technology-neutral and may be hard copy or digital. We begin our study of batch processing with a review of the purpose and content of these documents. Documents in the Batch Processing System A manufacturing process such as that in Figure 7-2 could be triggered by either individual sales orders from the revenue cycle or by a sales forecast the marketing system provides. For discussion purposes, we will assume the latter. The sales forecast shows the expected demand for a firms finished goods for a given period. For some firms, marketing may produce a forecast of annual demand by product. For firms with seasonal swings in sales, the forecast will be for a shorter period (quarterly or monthly) that can be revised in accordance with economic conditions. The production schedule is the formal plan and authorization to begin production. This document describes the specific products to be made, the quantities to be produced in each batch, and the manufacturing timetable for starting and completing production. Figure 7-3 contains an example of a production schedule. The bill of materials (BOM), an example of which is illustrated in Figure 7-4, specifies the types and quantities of the raw material (RM) and subassemblies used in producing a single unit of finished product. The RM requirements for an entire batch are determined by multiplying the BOM by the number of items in the batch. A route sheet, illustrated in Figure 7-5, shows the production path that a particular batch of product follows during manufacturing. It is similar conceptually to a BOM. Whereas the BOM specifies material requirements, the route sheet specifies the sequence of operations (machining or assembly) and the standard time allocated to each task. The work order (or production order) draws from BOMs and route sheets to specify the materials and production (machining, assembly, and so on) for each batch. These, together with move tickets (described next), initiate the manufacturing process in the production departments. Figure 7-6 presents a work order. A move ticket, shown in Figure 7-7, records work done in each work center and authorizes the movement of the job or batch from one work center to the next. A materials requisition authorizes the storekeeper to release materials (and subassemblies) to individuals or work centers in the production process. This document usually specifies only standard quantities. Materials needed in excess of standard amounts require separate requisitions that may be identified explicitly as excess materials requisitions. This allows for closer control over the production process by highlighting excess material usage. In some cases, less than the standard amount of material is used in production. When this happens, the work centers return the unused materials to the storeroom accompanied by a materials return ticket. Figure 7-8 presents a format that could serve all three purposes. Batch Production Activities The flowchart in Figure 7-9 provides a physical view of the batch processing system. The flowchart illustrates the organization functions involved, the tasks performed in each function, and the documents that trigger or result from each task. To emphasize the physical flows in the process, documents are represented in Figure 7-9 as hard copy. Many organizations today, however, make this data transfer digitally via computerized systems that utilize data entry screens or capture data by scanning bar code tags. In this section, we examine three of the four conversion cycle processes depicted by the DFD in Figure 7-2. Cost accounting procedures are discussed later. Production Planning and Control. We first examine the production planning and control function. This consists of two main activities: (1) specifying materials and operations requirements and (2) production scheduling. Materials and Operations Requirements. The raw materials requirement for a batch of any given product is the difference between what is needed and what is available in the raw material inventory. This information comes from analysis of inventory on hand, the sales forecast, engineering specifications (if any), and the BOM. A product of this activity is the creation of purchase requisitions for additional raw materials. Procedures for preparing purchase orders and acquiring inventories are the same as those described in Chapter 5. The operations requirements for the batch involve the assembly and/or manufacturing activities that will be applied to the product. This is determined by assessing route sheet specifications. Production Scheduling. The second activity of the planning and control function is production scheduling. The master schedule for a production run coordinates the production of many different batches. The schedule is influenced by time constraints, batch size, and specifications derived from BOMs and route sheets. The scheduling task also produces work orders, move tickets, and materials requisitions for each batch in the production run. A copy of each work order is sent to cost accounting to set up a new work-in-process (WIP) account for the batch. The work orders, move tickets, and materials requisitions enter the production process and flow through the various work centers in accordance with the route sheet. To simplify the flowchart in Figure 7-9, only one work center is shown. Work Centers and Storekeeping. The actual production operations begin when workers obtain raw materials from storekeeping in exchange for materials requisitions. These materials, as well as the machining and the labor required to manufacture the product, are applied in compliance with the work order. When the task is complete at a particular work center, the supervisor or other authorized person signs the move ticket, which authorizes the batch to proceed to the next work center. To evidence that a stage of production has been completed, a copy of the move ticket is sent back to production planning and control to update the open work order file. Upon receipt of the last move ticket, the open work order file is closed. The finished product along with a copy of the work order is sent to the finished goods (FG) warehouse. Also, a copy of the work order is sent to inventory control to update the FG inventory records. Work centers also fulfill an important role in recording labor time costs. This task is handled by work center supervisors who, at the end of each work week, send employee time cards and job tickets to the payroll and cost accounting departments, respectively. Inventory Control. The inventory control function consists of three main activities. First, it provides production planning and control with status reports on finished goods and raw materials inventory. Second, the inventory control function is continually involved in updating the raw material inventory records from materials requisitions, excess materials requisitions, and materials return tickets. Finally, upon receipt of the work order from the last work center, inventory control records the completed production by updating the finished goods inventory records. An objective of inventory control is to minimize total inventory cost while ensuring that adequate inventories exist to meet current demand. Inventory models used to achieve this objective help answer two fundamental questions: 1. When should inventory be purchased? 2. How much inventory should be purchased? A commonly used inventory model is the economic order quantity (EOQ) model. This model, however, is based on simplifying assumptions that may not reflect the economic reality. These assumptions are: 1. Demand for the product is constant and known with certainty. 2. The lead timethe time between placing an order for inventory and its arrivalis known and constant 3. All inventories in the order arrive at the same time. 4. The total cost per year of placing orders is a variable that decreases as the quantities ordered increase. Ordering costs include the cost of preparing documentation, contacting vendors, processing inventory receipts, maintaining vendor accounts, and writing checks. 5. The total cost per year of holding inventories (carrying costs) is a variable that increases as the quantities ordered increase. These costs include the opportunity cost of invested funds, storage costs, property taxes, and insurance. 6. There are no quantity discounts. Therefore, the total purchase price of inventory for the year is constant. The objective of the EOQ model is to reduce total inventory costs. The significant parameters in this model are the carrying costs and the ordering costs. Figure 7-10 illustrates the relationship between these costs and order quantity. As the quantity ordered increases, the number of ordering events decreases, causing the total annual cost of ordering to decrease. As the quantity ordered increases, however, average inventory on hand increases, causing the total annual inventory carrying cost to increase. Because the total purchase price of inventory is constant (Assumption 6), we minimize total inventory costs by minimizing the total carrying cost and total ordering costs. The combined total cost curve is minimized at the intersection of the ordering-cost curve and the carrying-cost curve. This is the EOQ. In simple models, both I and d are assumed to be known with certainty and are constant. For example, if: d = 5 units, and I = 8 days, then ROP = 40 units. The assumptions of the EOQ model produce the saw-toothed inventory usage pattern illustrated in Figure 7-11. Values for Q and ROP are calculated separately for each type of inventory item. Each time inventory is reduced by sales or used in production, its new quantity on hand (QOH) is compared to its ROP. When QOH = ROP, an order is placed for the amount of Q. In our example, when inventory drops to 40 units, the firm orders 346 units. If the parameters d and I are stable, the organization should receive the ordered inventories just as the quantity on hand reaches zero. If either or both parameters are subject to variation, however, then additional inventories called safety stock must be added to the reorder point to avoid unanticipated stock-out events. Figure 7-12 shows an additional 10 units of safety stock to carry the firm through a lead time that could vary from 8 to 10 days. The new reorder point is 50 units. Stock-outs result in either lost sales or back-orders. A back-order is a customer order that cannot be filled because of a stock-out and will remain unfilled until the supplier receives replenishment stock. When an organizations inventory usage and delivery patterns depart significantly from the assumptions of the EOQ model, more sophisticated models such as the back-order quantity model and the production order quantity model may be used. A discussion of these models is, however, beyond the scope of this text. Cost Accounting Activities Cost accounting activities of the conversion cycle record the financial effects of the physical events that are occurring in the production process. Figure 7-13 represents typical cost accounting information tasks and data flows. The cost accounting process for a given production run begins when the production planning and control department sends a copy of the original work order to the cost accounting department. This marks the beginning of the production event by causing a new record to be added to the work-in- process (WIP) file, which is the subsidiary ledger for the WIP control account in the general ledger. As materials and labor are added throughout the production process, documents reflecting these events flow to the cost accounting department. Inventory control sends copies of materials requisitions, excess materials requisitions, and materials returns. The various work centers send job tickets and completed move tickets. These documents, along with standards provided by the standard cost file, enable cost accounting to update the affected WIP accounts with the standard charges for direct labor, material, and manufacturing overhead (MOH). Deviations from standard usage are recorded to produce material usage, direct labor, and MOH variances. The receipt of the last move ticket for a particular batch signals the completion of the production process and the transfer of products from WIP to the FG inventory. At this point cost accounting closes the WIP account. Periodically, summary information regarding charges (debits) to WIP, reductions (credits) to WIP, and variances are recorded on journal vouchers and sent to the general ledger (GL) department for posting to the control accounts. Controls in the Traditional Environment Recall from previous chapters the six general classes of internal control activities: transaction authorization, segregation of duties, supervision, access control, accounting records, and independent verification. Specific controls as they apply to the conversion cycle are summarized in Table 7-1 and further explained in the following section. Transaction Authorization The following describes the transaction authorization procedure in the conversion cycle. 1. In the traditional manufacturing environment, production planning and control authorize the production activity via a formal work order. This document reflects production requirements, which are the difference between the expected demand for products (based on the sales forecast) and the finished goods inventory on hand. 2. Move tickets signed by the supervisor in each work center authorize activities for each batch and for the movement of products through the various work centers. 3. Materials requisitions and excess materials requisitions authorize the storekeeper to release materials to the work centers. Segregation of Duties One objective of this control procedure is to separate the tasks of transaction authorization and transaction processing. As a result, the production planning and control department is organizationally segregated from the work centers. Another control objective is to segregate record keeping from asset custody. The following separations apply: 1. Inventory control maintains accounting records for raw material and finished goods inventories. This activity is kept separate from the materials storeroom and from the FG warehouse functions, which have custody of these assets. 2. Similarly, the cost accounting function accounts for WIP and should be separate from the work centers in the production process. Finally, to maintain the independence of the GL function as a verification step, the GL department must be separate from departments keeping subsidiary accounts. Therefore, the GL department is organizationally segregated from inventory control and cost accounting. Supervision The following supervision procedures apply to the conversion cycle: 1. The supervisors in the work centers oversee the usage of RM in the production process. This helps to ensure that all materials released from stores are used in production and that waste is minimized. Employee time cards and job tickets must also be checked for accuracy. 2. Supervisors also observe and review timekeeping activities. This promotes accurate employee time cards and job tickets. Access Control The conversion cycle allows both direct and indirect access to assets. Direct Access to Assets. The nature of the physical product and the production process influences the type of access controls needed. 1. Firms often limit access to sensitive areas, such as storerooms, production work centers, and FG warehouses. Control methods used include identification badges, security guards, observation devices, and various electronic sensors and alarms. 2. The use of standard costs provides a type of access control. By specifying the quantities of material and labor authorized for each product, the firm limits unauthorized access to those resources. To obtain excess quantities requires special authorization and formal documentation. Indirect Access to Assets. Assets, such as cash and inventories, can be manipulated through access to the source documents that control them. In the conversion cycle, critical documents include materials requisitions, excess materials requisitions, and employee time cards. A method of control that also supports an audit trail is the use of prenumbered documents. Accounting Records As we have seen in preceding chapters, the objective of this control technique is to establish an audit trail for each transaction. In the conversion cycle this is accomplished through the use of work orders, cost sheets, move tickets, job tickets, materials requisitions, the WIP file, and the FG inventory file. By prenumbering source documents and referencing these in the WIP records, a company can trace every item of FG inventory back through the production process to its source. This is essential in detecting errors in production and record keeping, locating batches lost in production, and performing periodic audits. Independent Verification Verification steps in the conversion cycle are performed as follows: 1. Cost accounting reconciles the materials and labor usage taken from materials requisitions and job tickets with the prescribed standards. Cost accounting personnel may then identify departures from prescribed standards, which are formally reported as variances. In the traditional manufacturing environment, calculated variances are an important source of data for the management reporting system. 2. The GL department also fulfills an important verification function by checking the total movement of products from WIP to FG. This is done by reconciling journal vouchers from cost accounting and summaries of the inventory subsidiary ledger from inventory control. 3. Finally, internal and external auditors periodically verify the RM and FG inventories on hand through a physical count. They compare actual quantities against the inventory records and make adjustments to the records when necessary. World-Class Companies and Lean Manufacturing The traditional conversion cycle described in the previous section represents how many manufacturing firms operate today. Over the past three decades, however, rapid swings in consumer demands, shorter product life cycles, and global competition have radically changed the rules of the marketplace. In an attempt to cope with these changes, manufacturers have begun to conduct business in a dramatically different way. The term worldclass defines this modern era of business. The pursuit of world-class status is a journey without destination because it requires continuous innovation and continuous improvement. A recent survey of corporate executives revealed that 80 percent of them claim to be pursuing principles that will lead their companies to world-class status. Skeptics argue, however, that as few as 10 or 20 percent of these firms are truly on the right path. What Is a World-Class Company? The following features characterize the world-class company: World-class companies must maintain strategic agility and be able to turn on a dime. Top management must be intimately aware of customer needs and not become rigid and resistant to paradigm change. World-class companies motivate and treat employees like appreciating assets. To activate the talents of everyone, decisions are pushed to the lowest level in the organization. The result is a flat and responsive organizational structure. A world-class company profitably meets the needs of its customers. Its goal is not simply to satisfy customers, but to positively delight them. This is not something that can be done once and then forgotten. With competitors aggressively seeking new ways to increase market share, a world-class firm must continue to delight its customers. The philosophy of customer satisfaction permeates the world-class firm. All of its activities, from the acquisition of raw materials to selling the finished product, form a chain of customers. Each activity is dedicated to serving its customer, which is the next activity in the process. The final paying customer is the last in the chain. Finally, manufacturing firms that achieve world-class status do so by following a philosophy of lean manufacturing. This involves doing more with less, eliminating waste, and reducing production cycle time. The following section reviews the principles of lean manufacturing. The remainder of the chapter examines the techniques, technologies, accounting procedures, and information systems that enable it. Principles of Lean Manufacturing Lean manufacturing evolved from the Toyota Production System (TPS), which is based on the just-in-time (JIT) production model. This manufacturing approach is in direct opposition to traditional manufacturing, which is typified by high inventory levels, large production lot sizes, process inefficiencies, and waste. The goal of lean production is improved efficiency and effectiveness in every area, including product design, supplier interaction, factory operations, employee management, and customer relations. Lean involves getting the right products to the right place, at the right time, in the right quantity while minimizing waste and remaining flexible. Success depends, in great part, on employees understanding and embracing lean manufacturing principles. Indeed, the cultural aspects of this philosophy are as important as the machines and methodologies it employs. The following principles characterize lean manufacturing. Pull Processing. Products are pulled from the consumer end (demand), not pushed from the production end (supply). Under the lean approach, inventories arrive in small quantities from vendors several times per day, just in time to go into production. They are pulled into production as capacity downstream becomes available. Unlike the traditional push process, lean does not create batches of semifinished inventories at bottlenecks. Perfect Quality. Success of the pull processing model requires zero defects in raw material, work-in-process, and finished goods inventory. Poor quality is very expensive to a firm. Consider the cost of scrap, reworking, scheduling delays, and extra inventories to compensate for defective parts, warranty claims, and field service. In the traditional manufacturing environment, these costs can represent between 25 and 35 percent of total product cost. Also, quality is a basis on which world-class manufacturers compete. Quality has ceased to be a trade-off against price. Consumers demand quality and seek the lowest-priced quality product. Waste Minimization. All activities that do not add value and maximize the use of scarce resources must be eliminated. Waste involves financial, human, inventory, and fixed assets. The following are examples of waste in traditional environments, which lean manufacturing seeks to minimize. Overproduction of products, which includes making more than needed and/or producing earlier than needed. Transportation of products farther than is minimally necessary. Bottlenecks of products waiting to move to the next production step. Idle workers waiting for work to do as production bottlenecks clear. Inefficient motion of workers who must walk more than necessary in the completion of their assigned tasks. Islands of technology created by stand-alone processes that are not linked to upstream or downstream processes. Production defects that require unnecessary effort to inspect and/or correct. Safety hazards that cause injuries and lost work hours and associated expenses. Inventory Reduction. The hallmark of lean manufacturing firms is their success in inventory reduction. Such firms often experience annual inventory turnovers of 100 times per year. While other firms carry weeks and even months of inventories, lean firms have only a few days or sometimes even a few hours of inventory on hand. The three common problems outlined below explain why inventory reduction is important. 1. Inventories cost money. They are an investment in materials, labor, and overhead that cannot be realized until sold. Inventories also contain hidden costs. They must be transported throughout the factory. They must be handled, stored, and counted. In addition, inventories lose value through obsolescence. 2. Inventories camouflage problems. production Bottlenecks and capacity imbalances in the manufacturing process cause WIP inventory to build up at the choke points. Inventories also build up when customer orders and production are out of sync. 3. Willingness to maintain inventories can precipitate overproduction. Because of setup cost constraints, firms tend to overproduce inventories in large batches to absorb the allocated costs and create the image of improved efficiency. The true cost of this dysfunctional activity is hidden in the excess inventories. Production Flexibility. Long machine setup procedures cause delays in production and encourage overproduction. Lean companies strive to reduce setup time to a minimum, which allows them to produce a greater diversity of products quickly, without sacrificing efficiency at lower volumes of production. Established Supplier Relations. A lean manufacturing firm must have established and cooperative relationships with vendors. Late deliveries, defective raw materials, or incorrect orders will shut down production immediately since this production model allows no inventory reserves to draw upon. Team Attitude. Lean manufacturing relies heavily on the team attitude of all employees involved in the process. This includes those in purchasing, receiving, manufacturing, shipping everyone. Each employee must be vigilant of problems that threaten the continuous flow operation of the production line. Lean requires a constant state of quality control along with the authority to take immediate action. When Toyota first introduced TPS, its production employees had the authority to shut down the line when defects were discovered. In the early days, the line was often shut down to bring attention to a problem. Whether caused by a defective part from a vendor or a faulty machine in a cell, the problem was properly addressed so that it did not recur. After an adjustment period, the process stabilized. Techniques and Technologies that Promote Lean Manufacturing Modern consumers want quality products, they want them quickly, and they want variety of choice. This demand profile imposes a fundamental conflict for traditional manufacturers, whose structured and inflexible orientation renders them ineffective in this environment. In contrast, lean companies meet the challenges of modern consumerism by achieving manufacturing flexibility. This section examines techniques and technologies that lean manufacturing firms employ to achieve manufacturing flexibility. Physical Reorganization of the Production Facilities Traditional manufacturing facilities tend to evolve in piecemeal fashion over years into snakelike sequences of activities. Products move back and forth across shop floors, and upstairs and downstairs through different departments. Figure 7-14 shows a traditional factory layout. The inefficiencies inherent in this layout add handling costs, conversion time, and even inventories to the manufacturing process. Furthermore, because production activities are usually organized along functional lines, this structure tends to create parochialism among employees, promoting an us-versus-them mentality, which is contrary to a team attitude. A much simplified facility, which supports flexible manufacturing, is presented in Figure 7-15. The flexible production system is organized into a smooth-flowing stream of activities. Computer-controlled machines, robots, and manual tasks that comprise the stream are grouped together physically into factory units called cells. This arrangement shortens the physical distances between the activities, which reduces setup and processing time, handling costs, and inventories flowing through the facility. Automation of the Manufacturing Process Automation is at the heart of the lean manufacturing philosophy. By replacing labor with automation, a firm can reduce waste, improve efficiency, increase quality, and improve flexibility. The deployment of automation, however, varies considerably among manufacturing firms. Figure 7-16 portrays automation as a continuum with the traditional manufacturing model at one end and the fully CIM model at the other. Traditional Manufacturing The traditional manufacturing environment consists of a range of different types of machines, each controlled by a single operator. Because these machines require a great deal of setup time, the cost of setup must be absorbed by large production runs. The machines and their operators are organized into functional departments, such as milling, grinding, and welding. The work-in-process follows a circuitous route through the different operations across the factory floor. Islands of Technology Islands of technology describes an environment where modern automation exists in the form of islands that stand alone within the traditional setting. The islands employ computer numerical controlled (CNC) machines that can perform multiple operations with little human involvement. CNC machines contain computer programs for all the parts that are manufactured by the machine. Under a CNC configuration, humans still set up the machines. A particularly important benefit of CNC technology is, however, that little setup time (and cost) is needed to change from one operation to another. Computer-Integrated Manufacturing Computer-integrated manufacturing (CIM) is a completely automated environment with the objective of eliminating non-value-added activities. A CIM facility makes use of group technology cells comprised of various types of CNC machines to produce an entire part from start to finish in one location. In addition to CNC machines, the process employs automated storage and retrieval systems and robotics. CIM supports flexible manufacturing by allowing faster development of high-quality products, shorter production cycles, reduced production costs, and faster delivery times. Figure 7-17 depicts a CIM environment and shows the relationship between various technologies employed. Automated Storage and Retrieval Systems (AS/RS). Many firms have increased productivity and profitability by replacing traditional forklifts and their human operators with automated storage and retrieval systems (AS/RS). AS/RS are computer- controlled conveyor systems that carry raw materials from stores to the shop floor and finished products to the warehouse. The operational advantages of AS/RS technology over manual systems include reduced errors, improved inventory control, and lower storage costs. Robotics. Manufacturing robots are programmed to perform specific actions over and over with a high degree of precision and are widely used in factories to perform jobs such as welding and riveting. They are also useful in hazardous environments or for performing dangerous and monotonous tasks that are prone to causing accidents. Computer-Aided Design (CAD). Engineers use computer-aided design (CAD) to design better products faster. CAD systems increase engineers productivity, improve accuracy by automating repetitive design tasks, and allow firms to be more responsive to market demands. Product design has been revolutionized through CAD technology, which was first applied to the aerospace industry in the early 1960s. CAD technology greatly shortens the time frame between initial and final design. This allows firms to adjust their production quickly to changes in market demand. It also allows them to respond to customer requests for unique products. The CAD systems often have an interface to the external communication network to allow a manufacturer to share its product design specifications with its vendors and customers. This communications link also allows the manufacturer to receive product design specifications electronically from its customers and suppliers for its review. Advanced CAD systems can design both product and process simultaneously. Thus, aided by CAD, management can evaluate the technical feasibility of the product and determine its manufacturability. Computer-Aided Manufacturing (CAM). Computer-aided manufacturing (CAM) is the use of computers to assist the manufacturing process. CAM focuses on the shop floor and the control of the physical manufacturing process. The output of the CAD system (see Figure 7-17) is fed to the CAM system. The CAD design is thus converted by CAM into a sequence of processes such as drilling, turning, or milling by CNC machines. The CAM system monitors and controls the production process and routing of products through the cell. Benefits from deploying a CAM technology include improved process productivity, improved cost and time estimates, improved process monitoring, improved process quality, decreased setup times, and reduced labor costs. Value Stream Mapping The activities that constitute a firms production process are either essential or they are not. Essential activities add value; nonessential activities do not and should be eliminated. A companys value stream includes all the steps in the process that are essential to producing a product. These are the steps for which the customer is willing to pay. For example, balancing the wheels of each car off the production line is essential because the customer demands a car that rides smoothly and is willing to pay the price of the balancing. Companies pursuing lean manufacturing often use a tool called a value stream map (VSM) to graphically represent their business processes to identify aspects of it that are wasteful and should be removed. A VSM identifies all of the actions required to complete processing on a product (batch or single item), along with key information about each action item. Specific information will vary according to the process under review, but may include total hours worked, overtime hours, cycle time to complete a task, and error rates. Figure 7-18 presents a VSM of a production process from the point at which an order is received to the point of shipping the product to the customer. Under each processing step, the VSM itemizes the amount of overtime, staffing, work shifts, process uptime, and task error rate. The VSM shows the total time required for each processing step and the time required between steps and identifies the types of time spent between steps such as the outbound batching time, transit time, and inbound queue time. The VSM in Figure 7-18 reveals that considerable production time is wasted between processing steps. In particular, the transit time of raw materials from the warehouse to the production cell contributes significantly to the overall cycle time. Also, the shipping function appears to be inefficient and wasteful with a 16 percent overtime rate and a 7 percent error rate. To reduce total cycle time, perhaps the distance between the warehouse and production cell should be shortened. The shipping functions overtime rate may be due to a bottleneck situation. The high error rate may actually be due to errors in the upstream order-taking function that are passed to downstream functions. Some commercial VSM tools produce both a current-state map and a future-state map depicting a leaner process with most of the waste removed. From this future map, action steps can be identified to eliminate the non-value-added activities within the process. The future-state VSM thus is the basis of a lean implementation plan. VSM works best in highly focused, high-volume processes where real benefit is derived from reducing repetitive processes by even small amounts of time. This technique is less effective at eliminating waste in low-volume processes where the employees are frequently switched between multiple tasks. Accounting in a Lean Manufacturing Environment The lean manufacturing environment carries profound implications for accounting. Traditional information produced under conventional accounting techniques does not adequately support the needs of lean companies. They require new accounting methods and new information that: 1. Shows what matters to its customers (such as quality and service). 2. Identifies profitable products. 3. Identifies profitable customers. 4. Identifies opportunities for improvement in operations and products. 5. Encourages the adoption of value-added activities and processes within the organization and identifies those that do not add value. 6. Efficiently supports multiple users with both financial and nonfinancial information. In this section, we examine the nature of the accounting changes underway. The discussion reviews the problems associated with standard cost accounting and outlines two alternative approaches: (1) activity-based costing and (2) value stream accounting. Whats Wrong with Traditional Accounting Information? Traditional standard costing techniques emphasize financial performance rather than manufacturing performance. The techniques and conventions used in traditional manufacturing do not support the objectives of lean manufacturing firms. The following are the most commonly cited deficiencies of standard accounting systems. Inaccurate Cost Allocations. An assumption of standard costing is that all overheads need to be allocated to the product and that these overheads directly relate to the amount of labor required to make the product. A consequence of automation is the restructuring of manufacturing cost patterns. Figure 7-19 shows the changing relationship between direct labor, direct materials, and overhead cost under different levels of automation. In the traditional manufacturing environment, direct labor is a much larger component of total manufacturing costs than in the CIM environment. Overhead, on the other hand, is a far more significant element of cost under automated manufacturing. Applying standard costing leads to product cost distortions in a lean environment, causing some products to appear to cost more and others to appear to cost less than they do in reality. Poor decisions regarding pricing, valuation, and profitability may result. Promotes Nonlean Behavior. Standard costing motivates nonlean behavior in operations. The primary performance measurements used in standard costing are personal efficiency of production workers, the effective utilization of manufacturing facilities, and the degree of overhead absorbed by production. In addition, standard costing conceals waste within the overhead allocations and is difficult to detect. To improve their personal performance measures, management and operations employees are inclined to produce large batches of products and build inventory. This built-in motivation is in conflict with lean manufacturing. Time Lag. Standard cost data for management reporting are historic in nature. Data lag behind the actual manufacturing activities on the assumption that control can be applied after the fact to correct errors. In a lean setting, however, shop floor managers need immediate information about abnormal deviations. They must know in real time about a machine breakdown or a robot out of control. After-the-fact information is too late to be useful. Financial Orientation. Accounting data use dollars as a standard unit of measure for comparing disparate items being evaluated. Decisions pertaining to the functionality of a product or process, improving product quality, and shortening delivery time are, however, not necessarily well served by financial information produced through standard cost techniques. Indeed, attempts to force such data into a common financial measure may distort the problem and promote bad decisions. Activity-Based Costing (ABC) Many lean manufacturing companies have sought solutions to these problems through an accounting model called activity-based costing (ABC). ABC is a method of allocating costs to products and services to facilitate better planning and control. It accomplishes this by assigning cost to activities based on their use of resources and assigning cost to cost objects based on their use of activities. These terms are defined below: Activities describe the work performed in a firm. Preparing a purchase order, readying a product for shipping, or operating a lathe are examples of activities. Cost objects are the reasons for performing activities. These include products, services, vendors, and customers. For example, the task of preparing a sales order (the activity) is performed because a customer (the cost object) wishes to place an order. The underlying assumptions of ABC contrast sharply with standard cost accounting assumptions. Traditional accounting assumes that products cause costs. ABC assumes that activities cause costs and products (and other cost objects) create a demand for activities. The first step in implementing the ABC approach is to determine the cost of the activity. The activity cost is then assigned to the relevant cost object by means of an activity driver. This factor measures the activity consumption by the cost object. For example, if drilling holes in a steel plate is the activity, the number of holes is the activity driver. Traditional accounting systems often use only one activity driver. For instance, overhead costs, collected into a single cost pool, are allocated to products on the basis of direct labor hours. A company using ABC may have dozens of activity cost pools, each with a unique activity driver. Figure 7-20 illustrates the allocation of overhead costs to products under ABC. Advantages of ABC ABC allows managers to assign costs to activities and products more accurately than standard costing permits. Some advantages that this offers are: More accurate costing of products/services, customers, and distribution channels. Identifying the most and least profitable products and customers. Accurately tracking costs of activities and processes. Equipping managers with cost intelligence to drive continuous improvements. Facilitating better marketing mix. Identifying waste and non-value-added activities. Disadvantages of ABC ABC has been criticized for being too time-consuming and complicated for practical applications over a sustained period. The task of identifying activity costs and cost drivers can be a significant undertaking that is not completed once and then forgotten. As products and processes change so do the associated activity costs and drivers. Unless significant resources are committed to maintaining the accuracy of activity costs and the appropriateness of drivers, cost assignments become inaccurate. Critics charge that rather than promoting continuous improvement, ABC creates complex bureaucracies within organizations that are in conflict with the lean manufacturing philosophies of process simplification and waste elimination. Value Stream Accounting The complexities of ABC have caused many firms to abandon this method in favor of a simpler accounting model called value stream accounting. Value stream accounting captures costs by value stream rather than by department or activity, as illustrated in Figure 7-21. Notice that value streams cut across functional and departmental lines to include costs related to marketing, selling expenses, product design, engineering, materials purchasing, distribution, and more. An essential aspect in implementing value stream accounting is defining the product family. Most organizations produce more than one product, but these often fall into natural families of products. Product families share common processes from the point of placing the order to shipping the finished goods to the customer. Figure 7-22 illustrates how multiple products may be grouped into product families. Value stream accounting includes all the costs associated with the product family, but makes no distinction between direct costs and indirect costs. Raw material costs are calculated based on how much material has been purchased for the value stream, rather than tracking the input of the raw material to specific products. Thus the total value stream material cost is the sum of everything purchased for the period. This simplified (lean) accounting approach works because raw material and WIP inventories on hand are low, representing perhaps only one or two days of stock. This approach would not work well in a traditional manufacturing environment where several months of inventory may carry over from period to period. Labor costs of employees who work in the value stream are included whether they design, make, or simply transport the product from cell to cell. Labor costs are not allocated to individual products in the traditional way (time spent on a particular task). Instead, the sum of the wages and direct benefits paid to all individuals working in the value stream is charged to the stream. Support labor such as maintenance of machines, production planning, and selling are also included. Wherever possible, therefore, each employee should be assigned to a single value stream, rather than having their time split among several different streams. Typically the only allocated cost in the value stream is a charge per square foot for the value stream production facility. This allocation would include the cost of rent and building maintenance. The logic behind this is to promote efficiency by encouraging value stream team members to minimize the space used to operate the value stream. General overhead costs incurred outside of the value stream, which cannot be controlled by the value stream team, are not attached to the product family. Thus no attempt is made to fully absorb facilities costs. While corporate overhead costs must be accounted for, they are not allocated to value streams. Information Systems that Support Lean Manufacturing In this section we discuss the information systems commonly associated with lean manufacturing and world-class companies. It begins with a review of materials requirements planning (MRP). As the name implies, MRP systems are limited in focus and geared toward determining how much raw materials are required to fulfill production orders. We then review manufacturing resources planning (MRP II). These systems evolved from MRP to integrate additional functionality into the manufacturing process, including sales, marketing, and accounting. Finally, we examine some key features of enterprise resource planning (ERP) systems. ERP takes MRP II a step further by integrating all business functions into a core set of applications that use a common database. Materials Requirement Planning (MRP) MRP is an automated production planning and control system used to support inventory management. Its operational objectives are to: Ensure that adequate raw materials are available to the production process. Maintain the lowest possible level of inventory on hand. Produce production and purchasing schedules and other information needed to control production. Figure 7-23 illustrates the key features of an MRP system. Depending on the manufacturing process in place, inputs to the MRP system will include sales, sales forecasts, finished goods inventory on hand, raw material on hand, and the bill of materials. MRP is a calculation method geared toward determining how much of which raw materials are required and when they should be ordered to fill a production order. By comparing finished goods inventory on hand with the needed levels (based on the sales forecast), MRP calculates the total production requirements and the individual batch lot sizes needed. From this, the BOM is exploded to produce a list of raw materials needed for production, which is compared to the raw materials on hand. The difference is the amount that will be ordered from vendors. The primary outputs from the MRP system are raw material purchase requisitions that are sent to the purchases system. In addition, the system output may include production schedules, management reports, and day-to-day production documents such as work orders and move tickets. Manufacturing Resource Planning (MRP II) MRP II is an extension of MRP that has evolved beyond the confines of inventory management. It is both a system and a philosophy for coordinating a wide range of manufacturing activities. MRP II integrates product manufacturing, product engineering, sales order processing, customer billing, human resources, and related accounting functions. Figure 7-24 shows the functional integration under an MRP II environment. The MRP II system will produce a BOM for the product, fit the production of the product into the master production schedule, produce a rough-cut capacity plan based on machine and labor availability, design a final capacity plan for the factory, and manage the raw material and finished goods inventories. In addition, MRP II will produce a materials requirements plan that will schedule the delivery of the raw materials on a JIT basis. The ordering of raw material must be coordinated with the manufacturing process to avoid waste (early arrival) while ensuring that stock-out situations do not disrupt the production processes. Manufacturing firms can realize considerable benefits from a highly integrated MRP II system. Among these are the following: Improved customer service Reduced inventory investment Increased productivity Improved cash flow Assistance in achieving long-term strategic goals Help in managing change (for example, new product development or specialized product development for customers or by vendors) Flexibility in the production process Enterprise Resource Planning (ERP) Systems In recent years MRP II has evolved into large suites of software called ERP systems. ERP integrates departments and functions across a company into one system of integrated applications that is connected to a single common database. This enables various departments to share information and communicate with each other. An ERP system is comprised of function-specific modules that reflect industry best practices. Designed to interact with the other modules (for example, accounts receivable, accounts payable, purchasing, etc.), these commercial packages support the information needs of the entire organization, not just the manufacturing functions. An ERP can calculate resource requirements, schedule production, manage changes to product configurations, allow for future planned changes in products, and monitor shop floor production. In addition, the ERP provides order entry, cash receipts, procurement, and cash disbursement functions along with full financial and managerial reporting capability. A lean manufacturing company will have an ERP system that is capable of external communications with its customers and suppliers through electronic data interchange (EDI). The EDI communications link (via Internet or direct connection) will allow the firm to electronically receive sales orders and cash receipts from customers, send invoices to customers, send purchase orders to vendors, receive invoices from vendors and pay them, as well as send and receive shipping documents. EDI is a central element of many electronic commerce systems. We will revisit this important topic in Chapter 12. Similarities in functionality between ERP and MRP II systems are quite apparent. Some argue that very little real functional difference exists between the two concepts. Indeed, the similarities are most noticeable when comparing top-end MRP II systems with lowend ERP packages. A primary distinction, however, is that the ERP has evolved beyond the manufacturing marketplace to become the system of choice among nonmanufacturing firms as well. On the other hand, cynics argue that changing the label from MRP II to ERP enabled software vendors to sell MRP II packages to nonmanufacturing companies. The market for ERP systems was for many years limited by high cost and complexity to only the largest companies and was dominated by a few software vendors such as SAP, J.D. Edwards, Oracle, and PeopleSoft. In recent years this market has expanded tremendously with the entry of many small vendors targeting small and mid-sized customers with less expensive and more easily implemented ERP systems. The importance of the ERP phenomenon warrants separate treatment that goes beyond the scope of this chapter. In Chapter 11, therefore, we will examine ERP systems and related topics, including supply chain management (SCM) and data warehousing. This chapter examined the conversion cycle, whereby a company transforms input resources (that is, materials, labor, and capital) into marketable products and services. The principal aim was to highlight the changing manufacturing environment of the contemporary business world and to show how it calls for a shift away from traditional forms of business organization and activities toward a world-class way of doing business. We saw how companies that are attempting to achieve world-class status must pursue a lean manufacturing philosophy. Key to successful lean manufacturing is achieving manufacturing flexibility, which involves the physical organization of production facilities and the employment of automated technologies. We also saw that achieving lean manufacturing requires significant departures from traditional standard costing techniques. In response to deficiencies in traditional accounting methods, lean manufacturing companies have adopted alternative accounting models including activity based costing and value stream accounting. The chapter concluded with a discussion of three information systems commonly associated with lean manufacturing: (1) materials requirements planning (MRP), (2) manufacturing resources planning (MRP II), and enterprise resource planning (ERP)

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Ohio State - STAT - 427
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Ohio State - STAT - 427
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