!

 

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‡ Questions to be addressed in this chapter

include:
± What are the basic business activities and data
processing operations that are performed in the
production cycle?
± What decisions need to be made in the production
cycle, and what information is needed to make these
decisions?
± How can the company¶s cost accounting system help
in achieving the entity¶s objectives?
± What are the major threats in the production cycle
and the controls that can mitigate those threats?

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‡ The production cycle is a recurring set of

business activities and related data
processing operations associated with the
manufacture of products.

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‡ Information flows ÷ the production cycle

from other cycles, e.g.:
± The revenue cycle provides information on
customer orders and sales forecasts for use
in planning production and inventory levels.
± The expenditure cycle provides information
about raw materials acquisitions and
overhead costs.
± The human resources/payroll cycle provides
information about labor costs and availability.

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‡ Information also flows !
the expenditure

cycle:
± The revenue cycle receives information from the
production cycle about finished goods available for
sale.
± The expenditure cycle receives information about raw
materials needs.
± The human resources/payroll cycle receives
information about labor needs.
± The general ledger and reporting system receives
information about cost of goods manufactured.

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‡ Decisions that must be made in the

production cycle include:
± What mix of products should be produced?
± How should products be priced?
± How should resources be allocated?
± How should costs be managed and
performance evaluated?
‡ These decisions require cost data well
beyond that required for external financial
statements.
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‡ We¶ll be looking at how the three basic AIS

functions are carried out in the production
cycle, i.e.:
± How do we capture and process data?
± How do we store and organize the data for
decisions?
± How do we provide controls to safeguard
resources, including data?

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‡ The four basic activities in the production cycle

are:
± Product design
± Planning and scheduling
± Production operations
± Cost accounting
‡ Accountants are primarily involved in the fourth
activity (cost accounting) but must understand
the other processes well enough to design an
AIS that provides needed information and
supports these activities.

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‡ The four basic activities in the production cycle

are:
± "
 " 
± Planning and scheduling
± Production operations
± Cost accounting
‡ Accountants are primarily involved in the fourth
activity (cost accounting) but must understand
the other processes well enough to design an
AIS that provides needed information and
supports these activities.

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‡ The objective of product design is to

design a product that strikes the optimal
balance of:
± Meeting customer requirements for quality,
durability, and functionality; and
± Minimizing production costs.
‡ Simulation software can improve the
efficiency and effectiveness of product
design.
|
 
       

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‡ Key documents and forms in product

design:
± O

 !÷ 
 *ists the components that
are required to build each product, including
part numbers, descriptions,and quantity.
±  ÷  ÷: *ists the sequence of steps
required to produce each product, including
the equipment needed and the amount of time
required.

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‡ Role of the accountant in product design:

± Participate in the design, because η V0% of
product cost is determined at this stage.
± Add value by:
‡ Designing an AIS that measures and collects the
needed data.

‡   

+ ,
‡    
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" 
,
‡ %  +  " .
   "  
" 
  " " ,

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‡ Role of the accountant in product design:

± Participate in the
‡ + design,

 because

+ η
. V0% of
+0
"
    " ,
product cost is determined at this stage.
‡ +
 -+ " " 
 
± Add value by:
    " ,
+0
"
‡ / "
‡ Designing an 
AIS .
that "  "-
measures 
 the
and collects 
+"
 
 " +  ,
needed data.
‡  +   "     " 
+/ +  ,

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‡ The four basic activities in the production cycle

are:
± Product design
±    " 
" 
± Production operations
± Cost accounting
‡ Accountants are primarily involved in the fourth
activity (cost accounting) but must understand
the other processes well enough to design an
AIS that provides needed information and
supports these activities.

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‡ The objective of the planning and

scheduling activity is to develop a
production plan that is efficient enough to
meet existing orders and anticipated
shorter-term demand while minimizing
inventories of both raw materials and
finished goods.

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‡ There are two common approaches to

production planning:
± Manufacturing Resource Planning (MRP-II)
± *ean Manufacturing

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‡ There are two common approaches to

production planning:
± 1
  
    21-3
± *ean Manufacturing

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‡ MRP-II is an extension of MRP inventory

control systems:
± Seeks to balance existing production capacity
and raw materials needs to meet forecasted
sales demands.
± Often referred to as 
 manufacturing.

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‡ There are two common approaches to

production planning:
± Manufacturing Resource Planning (MRP-II)
± ( 1
 

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‡ *ean manufacturing is an extension of the

principles of just-in-time inventory
systems:
± Seeks to minimize or eliminate inventories of
raw materials, work in process, and finished
goods.
± Theoretically, produces only in response to
customer orders, but in reality, there are
short-run production plans.
± Often referred to as 


manufacturing.

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‡ Comparison of the two systems:

± Both plan production in advance.
± They differ in the length of the planning horizon.
‡ MRP-II develops plans for up to 12 months ahead.
‡ *ean manufacturing uses shorter planning horizons.
± Consequently:
‡ MRP-II is more appropriate for products with
predictable demand and a long life cycle.
‡ *ean manufacturing more appropriate for products with
unpredictable demand, short life cycles, and frequent
markdowns of excess inventory.

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‡ Key documents and forms:

± 1 +"
  
" 
‡ +
  . 
  
 +"
    +"
" "  
+ " " .,
‡ &   
 "   
 "   "
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  +    4 
. .5  "/
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‡ 
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+ 6    

  
,
‡ .    "  " "  6+ "       
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+"  /   /   "    
+
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‡ Key documents and forms:

± Master production schedule
± "
  "
‡  4 +"
    +
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+"
,  8
± $+    +"
± 9    +"
"
± (
   " /
‡  
 
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 /  

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‡ Key documents and forms:

± Master production schedule
± Production order
± 1   7   
‡  4 /   ""   
     
  ,
‡   "
 "
8
± "
  " 
± %  
±   " 7    .   
"" 2"  "      3

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‡ Key documents and forms:

± Master production schedule
± Production order
± Materials requisition
± 1/ 
5
‡ %
    + "   
  
,

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‡ How can information technology help?

± Improve the efficiency of material-handling
activities by using:
‡ Bar coding of materials to improve speed and
accuracy,
‡ RFID tags can eliminate human intervention in the
scanning process,
‡ &+  :       -
" 
,
‡ # +""  " ,
‡ #  "  "          ,
‡ 1
    
 "" +"
 " "
  

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‡ Role of the accountant:

± Ensure the AIS collects and reports costs in a
manner consistent with the company¶s
production planning techniques.

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‡ The four basic activities in the production cycle

are:
± Product design
± Planning and scheduling
± "
  + 
± Cost accounting
‡ Accountants are primarily involved in the fourth
activity (cost accounting) but must understand
the other processes well enough to design an
AIS that provides needed information and
supports these activities.

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‡ Production operations vary greatly across

companies, depending on the type of product
and the degree of automation.
‡ The use of various forms of IT, such as robots
and computer-controlled machinery is called


÷
÷ ÷

!÷
 .
± Can significantly reduce production costs.
‡ Accountants aren¶t experts on CIM, but they
must understand how it affects the AIS.
± One effect is a shift from mass production to custom-
order manufacturing and the need to accumulate
costs accordingly.
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‡ In a lean manufacturing environment, a

customer order triggers several actions:
± System first checks inventory on hand for sufficiency.
± Calculates labor needs and determines whether
overtime or temporary help will be needed.
± Based on bill of materials, determines what
components need to be ordered.
‡ Necessary purchase orders are sent via EDI.
± The master production schedule is adjusted to include
the new order.

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‡ Sharing information across cycles helps

companies be more efficient by timing
purchases to meet the actual demand.
‡ Although the nature of production processes and
the extent of CIM vary, all companies need data
on:
± Raw materials used
± *abor hours expended
± Machine operations performed
± Other manufacturing overhead costs incurred

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‡ The four basic activities in the production cycle

are:
± Product design
± Planning and scheduling
± Production operations
±  

 
‡ Accountants are primarily involved in the fourth
activity (cost accounting) but must understand
the other processes well enough to design an
AIS that provides needed information and
supports these activities.

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‡ The objectives of cost accounting are:

± To provide information for planning,
controlling, and evaluating the performance of
production operations;
± To provide accurate cost data about products
for use in pricing and product mix decisions;
and
± To collect and process information used to
calculate inventory and COGS values for the
financial statements.
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‡ The objectives of cost accounting are:

±  +/ "    +  

  " /   
+
  +"
  + ;
‡ ± To provide 
 

+  accurate cost 

  0
 / data about products

 
  - 
"
for 
usein
+

pricing and  +"
 
product 
 /   
mix decisions;

 5    "
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and
‡ <% 
 
  +
   +  ,,8
± To collect and
± "
  + process information used to
" +
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±  +    
   +
  ,
calculate inventory and COGS values for the
financial statements.
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‡  

+   
" "  " 0
 /   
‡ The objectives

 
 of cost

  /  accounting

  are: +


"   
+"
 "  4   ,
‡ ±7 
To provide

 information

"  
for planning,
" " 
 
  

controlling,

 and evaluating
   
" the 
 "  . performance of
"  + 
++,
production operations;
±  +/ " 


 " 
+"
    +
 " +"

 6 "
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± 
 
 " +
   " 


  / " $* /  
  
 ,
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‡ Types of cost accounting systems:

± = "
 
‡  
   +

+"
  
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‡ &" .  +"
  /

   " 
 
"    ,
‡ !6+ 8 ,

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‡ Types of cost accounting systems:

± Job order costing
± 

 
‡  
  
 +
  .5
  
+"
 

,
‡ 
   /
     +"
",
‡ &" .    "  /
  +"
" 
 7   " " 
  
>   
"  ",
‡ !6+ 8  ,

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‡ Accounting for fixed assets:

± The AIS must collect and process information
about the property, plant, and equipment used
in the production cycle.
± These assets represent a significant portion of
total assets for many companies and need to
be monitored as an investment.

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‡ The following information should be

maintained about each fixed asset:

‡ ID number ‡ Expected life

‡ Serial number ‡ Expected salvage value
‡ *ocation ‡ Depreciation method
‡ Cost ‡ Accumulated depreciation
‡ Acquisition date ‡ Improvements
‡ Vendor info ‡ Maintenance performed

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‡ The purchase of fixed assets follows the same

processes as other purchases in the expenditure
cycle (order § receive § pay).
‡ But the amounts involved necessitate some
modification to the process:
± +  /  "" 
‡ 1
  " 7 + +
    .
/ /   7 
+  /  ",

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‡ The purchase of fixed assets follows the same

processes as other purchases in the expenditure
cycle (order § receive § pay).
‡ But the amounts involved necessitate some
modification to the process:
± Competitive bidding
± #  ++  / /"
‡ 1 ++   5    / /"  / .   "
  6" ,

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‡ The purchase of fixed assets follows the same

processes as other purchases in the expenditure
cycle (order § receive § pay).
‡ But the amounts involved necessitate some
modification to the process:
± Competitive bidding
± Number of people involved
± 
‡ 
   6"    + "  
  
"  ,

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‡ The purchase of fixed assets follows the same

processes as other purchases in the expenditure
cycle (order § receive § pay).
‡ But the amounts involved necessitate some
modification to the process:
± Competitive bidding
± Number of people involved
± Payment ‡ 
   6"  0     
±  
   "  
" 8
± 1 
  " " 
"  
 ,
± <%  8
‡ 1  
 
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       ‡ <



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‡ The purchase of fixed assets follows the same

processes as other purchases in the expenditure
cycle (order § receive § pay).
‡ But the amounts involved necessitate some
modification to the process:
± Competitive bidding
± Number of people involved
± Payment
± Controls ‡ >
 
    ++/ "
± % + 

  
"     " +
  6" ,

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‡ A typical AIS would look something like

the following:
± "
 " 
‡ !   +

     . 
"
        "  + 
  ,
‡ 
      

 
   / . "      +"
,
‡    

   " "

/        " ,

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‡ A typical AIS would look something like

the following:
± Product design
± "
  +  
‡    "+    
 "

 +
 "  ,
‡ "
  +       "
" 
 / /   "/ + 
 +"
  
" ,
‡ #. 
"  """   +"
  "
    4  +"
   ",

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‡ A typical AIS would look something like

the following:
± Product design
± Production planning
±  

 
‡ #. 
"  """   .5- -+

   

 
 ",

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‡ A typical AIS would look something like

the following:
± Product design
± Production planning
± Cost accounting
± "
  + 
‡    +    +"  " + " 
.5 ,
‡ 
        1 
   "
+   
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‡ 1   7       /    4
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‡ Such a system can be used for a job-order or

process costing system.
‡ Both require that data be accumulated about:
± Raw materials
± Direct labor
± Machinery and equipment usage
± Manufacturing overhead
‡ The choice of method:
± Does not affect how data are collected
± Does affect how costs are assigned to products

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‡ Raw material usage data:
± When production is initiated, the issuance of a
materials requisition triggers a debit (increase) to
work in process and a credit (decrease) to raw
materials inventory.
± Work in process is credited and raw materials are
debited for any amounts returned to inventory.
± Many raw materials are bar coded so that usage data
is collected by scanning.
± RFID tags improve the efficiency of tracking material
usage.
± Usage may be entered online for materials such as
liquids that are not conducive to tagging.

|
 
       

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‡ Direct labor costs:

± Historically, job time tickets were used to
record the time a worker spent on each job
task.
± Currently, workers may:
‡ Enter the data on online terminals.
‡ Use coded ID badges, which are run through a
badge reader at the beginning and end of each
job.

|
 
       

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‡ Machinery and equipment usage:

± Machinery costs make up an ever-increasing
proportion of production costs.
± Data about machinery and equipment are collected at
each production step, often with data about labor
costs.
± Until recently, data was collected by wiring the factory
so all equipment was linked to the computer system.
‡ *imits the ability to rearrange the shop floor.
± Ö-D simulations can be used to assess the impact of
altering floor layout.

|
 
       

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‡ Manufacturing overhead costs:

± Includes costs that can¶t be easily traced to
jobs or processes, such as utilities,
depreciation, supervisory salaries.
± Most of these costs are collected in the
expenditure cycle.
± An exception is supervisory salaries, which
are collected in the HRM/payroll cycle.

|
 
       

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± Accountants help control overhead by

assessing how product mix changes will affect
overhead costs.
± They should also identify the factors that drive
the changes in these costs.
‡ This information can be used to realign processes
and layout.
± Accurate and complete information about
production cycle activities are required to
perform these analyses.

|
 
       

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#% $!%&!
‡ In the production cycle (or any cycle), a well-designed
AIS should provide adequate controls to ensure that the
following objectives are met:
± All transactions are properly authorized.
± All recorded transactions are valid.
± All valid and authorized transactions are recorded.
± All transactions are recorded accurately.
± Assets are safeguarded from loss or theft.
± Business activities are performed efficiently and effectively.
± The company is in compliance with all applicable laws and
regulations.
± All disclosures are full and fair.

|
 
       

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#% $!%&!
‡ There are several actions a company can take
with respect to any cycle to reduce threats of
errors or irregularities. These include:
± Using simple, easy-to-complete documents with
clear instructions (enhances accuracy and
reliability).
± Using appropriate application controls, such as
validity checks and field checks (enhances
accuracy and reliability).
± Providing space on forms to record who completed
and who reviewed the form (encourages proper
authorizations and accountability).

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#% $!%&!
± Pre-numbering documents (encourages recording
of valid and only valid transactions).
± Restricting access to blank documents (reduces
risk of unauthorized transaction).
± Using RFID tags when feasible to improve data
entry accuracy.

‡ In the following sections, we¶ll discuss the

threats that may arise in the four major steps of
the production cycle, as well as general
threats, EDI-related threats, and threats related
to purchases of services.

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‡ The major threats in the product design

process is:
± THREAT 1: Poor product design
‡ '


5    /   
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± 
  
     ,

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‡ ! #$, ? +"

 " 
± Why is this a problem?
‡ Higher materials purchasing and carrying costs.
‡ Costs for inefficient production.
‡ Higher repair and warranty costs.
± Controls:
‡ Accurate data about the relationship between
components and finished goods.
‡ Analysis of warranty and repair costs to identify
primary causes of product failure to be used in re-
designing product.
  * 
 1 #6 

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!%&(#*
‡ Threats in the planning and scheduling
process include:
± THREAT 2: Over- or under-production
± THREAT Ö: Suboptimal investment in fixed
assets
‡ '


5      /  
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±  +  +  +"  
 
± 
  
     ,

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!%&(#*
‡ ! #$,
?$/-  "-+"
 
± Why is this a problem?
‡ Over-production may result in:
± Excess goods for short-run demand and potential cash
flow problems.
± Obsolete inventory.
‡ Under-production may result in:
± *ost sales.
± Customer dissatisfaction.

|
 
       

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!%&(#*
± Controls:
‡ More accurate production planning, including accurate
and current:
± Sales forecasts
± Inventory data
‡ Investments in production planning.
‡ Regular collection of data on production
performance to adjust production schedule.
‡ Proper authorization of production orders.
‡ Restriction of access to production scheduling
program.
‡ Validity checks on production orders.
  * 
 1 #6 
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!%&(#*
‡ ! #$, @?+  / 
 6" 
± Why is this a problem?
‡ Over-investment causes excess costs.
‡ Under-investment impairs productivity.
± Controls:
‡ Proper authorization of fixed asset transactions:
± *arger purchases should be reviewed by a senior
executive or executive committee.
± Smaller purchases (<$10,000) can be handled with
departmental budgets, with managers being held
responsible for department return.

|
 
       

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 !  # (###* #%
!%&(#*
± Competitive bids should be sought via requests for
proposals (RFPs).
» The capital investment committee should review and
select the winning bid.
± Once a supplier is selected, acquisition may be handled
through the expenditure cycle process.

  * 
 1 #6 

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$! $#
‡ Threats in the production operations
process include:
± THREAT s: Theft of inventories and fixed
assets
± THREAT ·: Disruption of operations
‡ '


5      /  
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±  +  +  +"  
 ,
± 
  
     ,

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$! $#
‡ ! #$, :?   /  "
 6" 
± Why is this a problem?
‡ *oss of assets.
‡ Misstated financial data.
‡ Potential underproduction of inventory.
± Controls:
‡ Physical access to inventory should be restricted.
‡ All internal movement of inventory should be
documented.

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 !  # $%& $#
$! $#
‡ Materials requisitions should be used to authorize
release of raw materials.
± Should be signed by both inventory control clerk and
production employee to establish accountability.
‡ Requests in excess of the bill of materials should
be documented and have supervisory
authorization.
‡ RFID tags and bar codes can be used to track
inventory through production.

|
 
       

        Îå of 122

 !  # $%& $#
$! $#
‡ Proper segregation of duties should be enforced:
± Inventory stores has custody of raw materials and
finished goods.
± Factory supervisors are responsible for work in process.
± Authorization of production orders, materials requisitions,
and move tickets, should be done by production planners
or the information system.
‡ *ogical and physical access controls should be
enforced for production records.
‡ An independent party should count inventory and
investigate discrepancies.
‡ Fixed assets must be identified and recorded.

|
 
       

        ÎV of 122

 !  # $%& $#
$! $#
‡ Managers should be held accountable for assets
under their control.
‡ Fixed assets should be physically secured.
‡ Disposal of assets should be authorized and
documented.
‡ Periodic reports of fixed asset transactions should
be reviewed by the controller.
‡ Adequate insurance should be maintained.

  * 
 1 #6 

|
 
       

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 !  # $%& $#
$! $#
‡ ! #$, A?% +   + 
± Why is this a problem?
‡ Disasters can disrupt functioning and destroy
assets
± Controls:
‡ Backup power sources, such as generators and
uninterruptible power supplies.
‡ Investigate disaster preparedness of key suppliers
and identify alternative sources for critical
components.
  * 
 1 #6 

|
 
       

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 !  # $ $&# #*

‡ Threats in the cost accounting process

include:
± THREAT Î: Inaccurate recording and
processing of production activity data
‡ '


5    /   
  8
±  +  +  +"   ,
± 
  
     ,

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‡ ! B?

 
"  "
+
   +"
  
 /  "
± C     + D
‡ Diminishes effectiveness of production scheduling.
‡ Undermines management¶s ability to monitor and
control operations.
± Controls:
‡ Automate data collection with RFID technology,
bar code scanners, and badge readers to ensure
accurate data entry.

|
 
       

        å2 of 122

 !  # $ $&# #*

‡ Use online terminals for data entry.

‡ Restrict access with passwords, user IDs, and
access control matrices to prevent unauthorized
changes to data.
‡ Use check digits, closed-loop verification, and
validity checks.
‡ Do periodic physical counts of inventory and
compare to records.
‡ Do periodic inspections and counts of fixed assets.

  * 
 1 #6 

|
 
       

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 ‡ '


5       .  
   8
*!#!( !
±  +  +  
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+" 
± 
  
     ,

‡ .  0
 / +   
 /  
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8
± Accurate data should be available when needed.
± Activities should be performed efficiently and
effectively.
‡    +
  "  "

"8
± THREAT å: *oss, alteration, or unauthorized
disclosure of data
± THREAT V: Poor performance

|
 
       

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 *!#!( ! 

‡ ! #$, E8 (    

 4" " 
  "
± Why is this a problem?
‡ *oss or alteration of data could cause:
± Errors in external or internal reporting.
‡ Unauthorized disclosure of confidential information
can cause:
± Unfair competition
± *oss of business

|
 
       

        å· of 122

 *!#!( ! 

‡ Controls:
± All data files and key master files should be backed
up regularly.
‡ At least one backup on site and one offsite.
± All disks and tapes should have external and internal
file labels to reduce chance of accidentally erasing
important data.
± Promptly, remove all access rights of employees who
quit or are fired

|
 
       

        åÎ of 122

 *!#!( ! 

± Access controls should be utilized:

‡ User IDs and passwords.
‡ Compatibility matrices.
‡ Controls for individual terminals (e.g., so the receiving
dock can¶t enter a sales order).
‡ *ogs of all activities, particularly those requiring specific
authorizations, should be maintained.
± Default settings on ERP systems usually allow users
far too much access to data, so these systems must
be modified to enforce proper segregation of duties.

|
 
       

        åå of 122

 *!#!( ! 

± Sensitive data should be encrypted in storage and in

transmission.
± Parity checks, acknowledgment messages, and
control totals should be used to ensure transmission
accuracy.

  * 
 1 #6 

|
 
       

        åV of 122

 *!#!( ! 

‡ ! #$, ? +


± Why is this a problem?
‡ Quality control problems increase expenses and
reduce future sales.
± Controls:
‡ Prepare and review performance reports.

  * 
 1 #6 

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 $%& $# '(! #<$1 $#
#!!%
‡ In a manufacturing environment, the focus
must be on total quality management.
Managers need info on:
± Defect rates
± Breakdown frequency
± Percent of finished goods needing rework
± Percent of defects discovered by customers

|
 
       

        V0 of 122

 $%& $# '(! #<$1 $#
#!!%
‡ In traditional systems, this type of data
was not well linked with financial data, and
cost accounting systems were separate
from production operations information
systems.
‡ However, both financial and operating
information are needed to manage and
evaluate these activities.

|
 
       

        V1 of 122

 $%& $# '(! #<$1 $#
#!!%
‡ Two major criticisms have been directed at
traditional cost accounting systems:
± Overhead costs are inappropriately allocated
to products.
± Reports do not accurately reflect effects of
factory automation.

|
 
       

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 $%& $# '(! #<$1 $#
#!!%
‡ Two major criticisms have been directed at
traditional cost accounting systems:
± $/"
  +++  
 
"  +"
,
± Reports do not accurately reflect effects of
factory automation.

|
 
       

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  1 8 #$ !
(($ $# $< $)!!% $ 
‡ Traditional cost accounting systems use
volume-driven bases such as direct labor
hours or machine hours to apply
overhead.
‡ However, overhead does not vary with
production volume.
‡ EXAMP*E: Purchasing costs vary with the
number of purchase orders processed.

|
 
       

        Vs of 122

  1 8 #$ !
(($ $# $< $)!!% $ 
‡ Allocating overhead based on output
volume:
± Overstates the costs of products
manufactured in large quantities.
± Understates the costs of products
manufactured in small batches.
‡ Also, allocating overhead based on direct
labor input can distort costs.

|
 
       

        V· of 122

  1 8 #$ !
(($ $# $< $)!!% $ 
‡ Example of two products:
± Product one uses:
‡ $· of materials
‡ 1 hour of labor
‡ · minutes of machine time
± Product two uses:
‡ $· of materials
‡ 1 hour of labor
‡ s2 hours of machine time on very expensive
equipment

|
 
       

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  1 8 #$ !
(($ $# $< $)!!% $ 
‡ Example of two products:
± Product one uses:
&"  "  
‡ $· of materials
 

 
‡ 1 hour of labor  
+"
 .
‡ · minutes of machine time ++  / 
± Product two uses: 
,
‡ $· of materials
‡ 1 hour of labor
‡ s2 hours of machine time on very expensive
equipment

|
 
       

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  1 8 #$ !
(($ $# $< $)!!% $ 
‡    
 
 8 
 /  "
  23
± ABC can refine and improve cost allocations
under either job-order or process costing
systems.
‡ ABC traces costs to the activities that create them
and allocates them accordingly.
‡ ABC aims to link costs to corporate strategy.

|
 
       

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  1 8 #$ !
(($ $# $< $)!!% $ 
± Corporate strategy results in decisions about
what goods and services to produce.
‡ These activities incur costs.
‡ So corporate strategy determines costs.
± By measuring the costs of the basic activities,
ABC provides information to management for
evaluating the consequences of their decisions.

|
 
       

        V† of 122

  1 8 #$ !
(($ $# $< $)!!% $ 
‡ ABC vs. traditional cost systems:
± There are three significant differences between
ABC and traditional approaches.
‡ Tracing of overhead costs
‡ Number of cost pools
‡ Identification of cost drivers

|
 
       

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  1 8 #$ !
(($ $# $< $)!!% $ 
‡ ABC vs. traditional cost systems:
± There are three significant differences between
ABC and traditional cost accounting approaches.
‡ 
  /"

‡ Number of cost pools
‡ Identification of cost drivers

|
 
       

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  1 8 #$ !
(($ $# $< $)!!% $ 
‡ ABC directly traces a larger proportion of
overhead costs to products.
‡ This tracing is made possible by advances
in IT.

|
 
       

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  1 8 #$ !
(($ $# $< $)!!% $ 
‡ ABC vs. traditional cost systems:
± There are three significant differences between
ABC and traditional cost accounting approaches.
‡ Tracing of overhead costs
‡ # 
 + 
‡ Identification of cost drivers

|
 
       

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  1 8 #$ !
(($ $# $< $)!!% $ 
‡ ABC uses a greater number of cost pools
‡ !F1(!8 + +
  "  
to accumulate indirect costs
" 
,
(manufacturing overhead).
‡ 

 "   

 "  
"  
+"
   
,
‡ Most systems lump all
‡ 7  overhead

 + +"
 together,
.  
but ABC distinguishes
. +"
 three
" categories:
 7  ,

- 
- " /"

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(($ $# $< $)!!% $ 
‡ ABC uses‡ a!6+ 8
greaterG% number of cost
/  pools "
  
+
 
,
to accumulate
‡ indirect

 costs
 "   " /   
(manufacturing overhead).

+> +"
 ,
‡  +  5 
   +"

‡ Most systems
lump
all,
overhead together,
but ABC distinguishes three
‡ < 6+  +
  categories:

   
 
"  +"
 "    
- Batch-related overhead
+
 " "  
 +"
,

- "
- " /"

|
 
       

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  1 8 #$ !
(($ $# $< $)!!% $ 
‡ ABC uses a greater number of cost pools
to accumulate indirect costs
(manufacturing overhead).
‡ Most systems lump all overhead together,
but ABC distinguishes three
‡ !F1(!8 categories:
 "+
 ,
- Batch-related overhead
‡ 
  ++ "   +"

"  
" 

"   "+

- Product-related overhead
 +  ,
- +-. " /"

|
 
       

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  1 8 #$ !
(($ $# $< $)!!% $ 
‡ ABC vs. traditional cost systems:
± There are three significant differences between
ABC and traditional cost accounting approaches.
‡ Tracing of overhead costs
‡ Number of cost pools
‡ " 
  
 " /

|
 
       

        †å of 122

  1 8 #$ !
(($ $# $< $)!!% $ 
‡     
± ABC systems are more costly and complex.
± But proponents argue two important benefits:
‡ More accurate cost data result in better product
mix and pricing decisions.
‡ More detailed cost data improve management¶s
ability to control and manage total costs.

|
 
       

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  1 8 #$ !
(($ $# $< $)!!% $ 
‡     
± ABC systems are more costly and complex.
± But proponents argue two important benefits:
‡ 1 


 "    
+"
  6 " +
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‡ More detailed cost data improve management¶s
ability to control and manage total costs.

|
 
       

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  1 8 #$ !
(($ $# $< $)!!% $ 
‡  "
 
± ABC avoids problems of applying too much or
too little overhead to products and
consequently results in better price decisions.
± ABC uses the data collected to improve
product design.
± ABC provides management with the
information about the costs associated with
specific activities, resulting in better analysis
and decisions.
|
 
       

        100 of 122

  1 8 #$ !
(($ $# $< $)!!% $ 
‡     
± ABC systems are more costly and complex.
± But proponents argue two important benefits:
‡ More accurate cost data result in better product
mix and pricing decisions.
‡ 1 " "
 " +/ >
  
 "  
.

|
 
       

        101 of 122

  1 8 #$ !
(($ $# $< $)!!% $ 
‡ +/"
 
± ABC measures the results of managerial
actions on overall profitability.
± ABC measures both the amount spent to
acquire resources and the amount spent to
consume them.
± ABC measures unused capacity:
‡ Cost of activity capability = Cost of activity used +
Cost of unused capacity

|
 
       

        102 of 122

  1 8 #$ !
(($ $# $< $)!!% $ 
‡ EXAMP*E: A publishing company has five
employees who operate printing presses.
‡ The employees each have annual salaries of
$2·,000 for a total salary cost of $12·,000.
‡ Each employee should be able to print about 10,000
books per year.
‡ The total capacity, therefore is ·0,000 books.
‡ The salary cost per book would be $12·,000 /
·0,000 books = $2.·0 per book.
‡ During the most recent year, the presses produced
så,000 books.

|
 
       

        10Ö of 122

  1 8 #$ !
(($ $# $< $)!!% $ 
‡ EXAMP*E: A publishing company has five
employees who operate printing presses.
‡ The employees‡ 
have
each  annual

 / 
+ 
salaries of 
5salary
$2·,000 for a total
+
  
cost   A 5  
of $12·,000.
  
 + 5  H
,A,
‡ Each employee should
‡ A be 6able
5 H
,AtoI print about 10,000
H
A,
books per year.
‡  
+
   A 5,
‡ The salary cost per book would be $12·,000 /
·0,000 books = H
,A + 5.
‡ During the most recent year, the presses produced
så,000 books.

|
 
       

        10s of 122

  1 8 #$ !
(($ $# $< $)!!% $ 
‡ EXAMP*E: A publishing company has five
employees who operate printing presses.
‡ The employees each have annual salaries of
$2·,000 for a total salary cost of $12·,000.
‡ 
   
 /  "    
‡ Each employee5
should be able

  to print
+"
" about
  10,000
  

books per year.+ 5  H
,A,
‡ :E
‡ The total capacity, 5 6 H
,A
therefore I HEA,
is ·0,000 books.
‡ The salary cost per book would be $12·,000 /
·0,000 books = H
,A + 5.
‡ During the most recent year, the presses produced
så,000 books.

|
 
       

        10· of 122

  1
‡ 8 #$
 " ! .

+
   " 

 
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+  2H
A3 " 
 
(($ $# $< $)!!%
 
 /  " 2HEA3, $ 
‡ H
A - HEA I HEA "
+
,
‡ EXAMP*E: A‡ publishing
   company has five
"
+

 

 "
employees whooperate

 printing presses.
+ 5  H
,A    " 

‡ The employees.
each have 5  salaries
annual
 "  +"
"
of "
 5  . 
  +"
",
$2·,000 for a total salary cost of $12·,000.
‡ H
,A 6 2A +   5 J :E 

‡ Each employee53
should be able
I HEA to print
" about 10,000

+
,
books per year.
‡ The total capacity, therefore is ·0,000 books.
‡ The salary cost per book would be $12·,000 /
·0,000 books = H
,A + 5.
‡ During the most recent year, the presses produced
så,000 books.

|
 
       

        10Î of 122

  1 8 #$ !
(($ $# $< $)!!% $ 
‡ Management may be able to improve
profitability by:
- Applying the unused capacity to other
revenue-generating activities; or
- Eliminating the unused capacity.

|
 
       

        10å of 122

 $%& $# '(! #<$1 $#
#!!%
‡ Two major criticisms have been directed at
traditional cost accounting systems:
± Overhead costs are inappropriately allocated
to products.
± + "  

   
 
 

  ,

|
 
       

        10V of 122

  1
8 !$  %$ #$ & !('
!<(! !<<!  $< & $1 $#

‡ When an organization transitions from a

traditional production system to a lean
manufacturing system, inventory levels are
depleted. Consequently, almost all
production costs of the year are expensed
that year.
‡ Although the effect is temporary,
managers will be concerned if their
performance evaluations are based on the
company¶s reported financial statements.
|
 
       

        10† of 122

  1
8 !$  %$ #$ & !('
!<(! !<<!  $< & $1 $#

‡ Solution to criticism two: Better reports

and measures
± "
 + "   

 
+ 
+ ,
‡ +  
 +"
 
 
" 
"  +"
   " / +


+ " +/ " +-  ++  
+"
,
‡ + /"
  $*,
‡ " 
  / /   
+ 6+ ,

|
 
       

        110 of 122

  1
8 !$  %$ #$ & !('
!<(! !<<!  $< & $1 $#

‡ Solution to criticism two: Better reports

and measures
± Produce reports based on lean accounting
principles.
± %/ + 
  
  
+  +"
 

 ,
‡ !6+ 8
± &  + +"
" +   + ",
± 1    +"
 7 ,

|
 
       

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 $&*& 8  1!&! $<
$%& $# !<<! )!#!
‡ Throughput = Productive Capacity x
Productive Processing Time x Yield
± "
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 I  & 
"
"  
  
‡   +/" 8
± +/  
    

,
± +/  
 ,
±  +   +"
 "  +

 ,

|
 
       

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 $&*& 8  1!&! $<
$%& $# !<<! )!#!
‡ Throughput = Productive Capacity x
Productive Processing Time x Yield
± Productive Capacity = Total Units Produced /
Processing Time
± "
 / 
   I 
 
   
‡  ++   ". ,
‡   +/" 8
±   
  "
 
  ". ,
±  
"   " /   "
 .   ,

|
 
       

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$%& $# !<<! )!#!
‡ Throughput = Productive Capacity x
Productive Processing Time x Yield
± Productive Capacity = Total Units Produced /
Processing Time
± Productive Processing Time = Processing
Time / Total Time
± '  " I *" &    & 
‡   +/" 8
± &   .   ,
± +/  .5 5 ,

|
 
       

        11s of 122

 $&*& 8  1!&! $<
$%& $# !<<! )!#!
‡ Throughput = Productive Capacity x Productive
Processing Time x Yield
± Productive Capacity = Total Units Produced / Processing Time
± Productive Processing Time = Processing Time / Total Time
± Yield = Good Units / Total Units
‡ !F1(!8 1 , +"
"     K .
  - + ", %    + "  .    
  
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""     . "
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± $%& )!  ' I     L +"
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,    ,
± $%& )! $!#* 1! I L +"
 /    
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± '!(% I L "        I ,L
± $&*& I , 6 ,L 6 ,L I L
|
 
       

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 9&( ' $# $(

‡    7 

±Quality control costs can be divided
into four categories:
‡ / 

‡  
"  "
 +"
 "
 ,

|
 
       

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 9&( ' $# $(

‡    7 

±Quality control costs can be divided
into four categories:
‡ Prevention costs
‡ +
 

‡  
"   +"
  7 
"",

|
 
       

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 9&( ' $# $(

‡    7 

±Quality control costs can be divided
into four categories:
‡ Prevention costs
‡ Inspection costs
‡   

‡   .5 " 
+ . +"
 
"  "  "
 / +    ,

|
 
       

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 9&( ' $# $(

‡    7 

±Quality control costs can be divided
into four categories:
‡  . "
 / +"
   " 
‡ Prevention costs

 ,, . " + 

‡ Inspection costs

 

+"
  
"  
 
‡ Internal " "  + ,
failure costs
‡ !6  


|
 
       

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 9&( ' $# $(
‡    7 

±Quality control costs can be divided
into four categories:
‡ Prevention costs / "   
‡ 
+ 
‡ +costs
Inspection  "
  / /
‡ . 
 
Internal 
failure  "   M 
costs
6
+ M + +   M
 
‡ External failure costs
+/M / .+ ,  
±  +/
0
 /  7 


 


+   
+

   4   
  " 2 ,, +
 3,
 
,

|
 
       

        120 of 122

 &11'
‡ You¶ve learned about the basic business
activities and data processing operations that
are performed in the production cycle, including:
± Product design
± Production planning and scheduling
± Production operations
± Cost accounting
‡ You¶ve learned how IT can improve the
efficiency and effectiveness of these processes.

|
 
       

        121 of 122

 &11'
‡ You¶ve learned about decisions that need to be
made in the production cycle and the information
required to make these decisions.
‡ You¶ve also learned about the major threats that
present themselves in the production cycle and
the controls that can mitigate those threats.
‡ Finally, you¶ve learned how the company¶s cost
accounting system can help in achieving the
entity¶s objectives.

|
 
       

        122 of 122