Production cycle - Chapter 14


The production cycle is a recurring set of business activities and related information processing operations associated with the manufacture of products. The production cycle contains four basic activities: product design, planning and scheduling, production operations, and cost accounting.

The first step in the production cycle is product design. The objective is to create a product that meets customer requirements in terms of quality, durability, and functionality while simultaneously minimizing production costs.

The product design activity creates two outputs. The first, a bill of materials specifies the part number, description, and quantity of each component used in a finished product. The second is an operation list. This list specifies the sequence of steps to follow in making the product, which equipment to use, and how long each step should take.

The second step in the production cycle is planning and scheduling. The objective is to develop a production plan efficient enough to meet existing orders and anticipated short-term demand while minimizing inventories of both raw materials and finished goods.

Two common methods of production planning are manufacturing resource planning and lean manufacturing. Manufacturing resource planning (MRP-II) is an extension of materials resource planning that seeks to balance existing production capacity and raw materials need to meet forecasted sales demand. MRP-II systems are often 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. The goal of lean manufacturing is to minimize or eliminate inventories of raw materials, work in progress, and finished goods. Lean manufacturing is often referred to as pull manufacturing, because goods are produced in response to customer demand.

Both lean manufacturing and MRP-II systems plan production in advance. They differ, in the length of planning horizon.

Information about customer orders, sales forecasts, and inventory levels of finished goods is used to determine production levels. The result is a master production schedule (MPS), which specifies how much of each product is to be produced during the planning period and when that production should occur.

A production order authorizes the manufacture of a specified quantity of a particular product. It lists the operations that need to be performed, the quantity to be produced, and the location where the finished product should be delivered.

A materials requisition authorizes the removal of the necessary quantity of raw materials from the storeroom to the factory location where they will be used. Subsequent transfers of raw materials throughout the factory are documented on move tickets, which identify the parts being transferred, the location to which they are transferred, and the time of transfer.

The third step in the production cycle is the actual manufacture of products. The manner in which this activity is activity is accomplished varies greatly across companies, differing according to the type of product being manufactured and the degree of automation used in the production process.

Using various forms of information technology (IT) in the production process is referred to as computer-integrated manufacturing (CIM). CIM can significantly reduce production costs. Accountants need not be experts on every facet of CIM, but they must understand how it affects both operations and cost accounting. CIM requires redesign of inventory management systems and work flows to facilitate quick changes in production.

Orders for machinery and equipment almost always involve a formal request for competitive bids by potential suppliers. A document called a request for proposal (RFP), which specifies the desired properties of the asset, is send to each prospective supplier. The capital investment committee should review the responses and select the best bid.

The final step is cost accounting. The three principal objective of the cost accounting systems are to provide information for planning, controlling, and evaluating the performance of production operations. The systems also provide accurate cost data and collect and process the information used to calculate the inventory and cost of goods sold values that appear in the company’s financial statements.

Most companies use either job-order of process costing to assign production costs. Job order costing assigns costs to specific production batches, or jobs, and is used when the product or service being sold consists of discretely identifiable items.

Process costing assigns costs to each process, or work center, in the production cycle and then calculates the average cost for all units produced. Process costing is used when similar goods or services are produced in mass quantities and discrete units cannot be readily identified.

The choice of job-order or process costing affects only the method used to assign cost to products, not the method used to collect that data. A job-time ticket is a paper document to collect data about labor activity. This document recorded the amount of time a worker spent on each specific job task.

Manufacturing costs that are not economically feasible to trace directly to specific jobs or processes are considered manufacturing overhead. For example the cost of water, power and other utilities.

Activity based costing can refine and improve cost allocations under both job-order and process cost systems. It attempts to trace costs to the activities that create them. Corporate strategy is an underlying objective and results in decisions about what goods and services to produce.

Activity based costing systems differ from conventional cost accounting systems in three important ways:

  1. Activity based costing systems attempts to directly trace a larger proportion of overhead costs to products.

  2. Activity based costing systems use a greater number of cost pools to accumulate indirect costs. It distinguish three separate categories of overhead.

    1. Batch-related overhead

    2. Product-related overhead

    3. Companywide overhead

  3. Activity based costing systems attempt to rationalize the allocation of overhead to products by identifying cost drivers. A cost driver is anything that has a cause-and-effect relationship on costs.

A few other advantages of activity based costing

  • Better control

  • Better decisions

  • Improved cost management. Proponents argue that another advantage of activity based costing is that it clearly measures the results of managerial actions on overall profitability.

Throughput represents the number of goods units produced in a given period of time. Its shown in the following formula.

Throughput = (total units produced/processing time) x (processing time/total time) x (goods units/total units)

Information about quality costs can help companies determine the effects of actions taken to improve the yield and identify areas for further improvement. Quality control costs can be divided into four areas:

  • Prevention costs are associated with changes to production processes designed to reduce the production defect rate.

  • Inspection costs are associated with testing to ensure that products meet quality standards.

  • Internal failure costs are associated with reworking, or scrapping, products identified as being defective prior to sale.

  • External failure costs result when defective products are sold to customers.

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