OVERVIEW OF THE CONVERSION PROCESS



OVERVIEW OF THE CONVERSION PROCESS

THE CONVERSION PROCESS

IS CONCERNED WITH :

- the conversion of input resources into products

-the provision of services to customers

-the costing of goods and services

-the management of inventories.

ALSO CALLED THE MANUFACTURING,

The PRODUCTION,

or the INVENTORY CYCLE.

supply push vs. demand pull

-balance between production and demand is maintained in ?

just-in-time inventory

-driven by lead time required for raw material procurement and production time

ACTIVITY BASED COSTING - ABC COSTING

direct materials are traced directly to the product or service

but conversion costs are traceable to activities

advantage lies in the information it provides to production managers

ABC focuses attention on the cost drivers - the activities that give rise to costs - and facilitates cost control by control of these drivers.

It draws attention to activities that may be expensive but add no value to the product.

FILE STRUCTURE

1. in a MERCHANDISING organization:

MASTER FILE -

MERCHANDISE INVENTORY file

TRANSACTION FILES -

RECEIVING TRANSACTION FILE

SALES TRANSACTION FILE

INTERFACE with PURCHASING and REVENUE

CYCLES

2. in a MANUFACTURING organization:

WE NEED 3 MASTER FILES FOR INVENTORY:

RAW MATERIALS

WORK IN PROCESS

FINISHED GOODS

PLUS

OPEN JOB FILE - in job costing system replaces

WORK IN PROCESS FILE

MANUFACTURING OVERHEAD or

ACTIVITY COST FILE

STANDARD COST FILE

TRANSACTION FILES:

RECEIVING TRANSACTION FILE -

(INTERFACE WITH PURCHASING CYCLE)

MATERIALS ISSUANCE TRANSACTION FILE

PRODUCTION LABOR TRANSACTION FILE -

(may be merged into PRODUCTION COST

TRANSACTION FILE)

COMPLETED PRODUCT TRANSACTION FILE

SALES or SHIPMENT TRANSACTION FILE

INVENTORY ADJUSTMENT file

INPUT DOCUMENTS for a manufacturing organization

1. MATERIALS REQUISITION

materials are issued to production through this form

which is authorized by a production supervisor

lists quantity of each material needed

2. PRODUCTION ORDER

internal to the CONVERSION PROCESS

issued in response to sales orders or may be issued

routinely

authorizes production of goods

3. WORK ORDER

used to document manual operations

authorizes the expenditure of labor resources for the

production of goods

list type of personnel needed, skill level, expected number

of hours required

4. TIME CARD or LABOR TICKET

capture labor hours

direct labor or indirect labor

job costing of hours

electronic time clock may be used to replace paper time card

labor variances

Use of input documents - particularly in CONVERSION PROCESS - is being replaced by electronic data capture.

REPORTS

INVENTORY AND PRODUCTION STATUS REPORTS:

1. INVENTORY STATUS REPORTS

(raw materials and finished goods)

2. INVENTORY REORDER REPORTS

(raw materials and finished goods)

3. MATERIALS REQUIREMENTS REPORT

4. PRODUCTION OR JOB STATUS REPORT

ACTIVITY REPORTS OR JOURNALS:

1. MATERIALS RECEIPTS AND ISSUANCES JOURNAL

2. MATERIALS AND LABOR USAGE REPORT

3. SCRAP AND LOST TIME REPORT

4. COMPLETED PRODUCTION REPORT

5. INVENTORY ADJUSTMENT JOURNALS

6. COST WORK SHEET

7. STANDARD COST VARIANCE REPORTS

MAJOR RISKS IN THE CONVERSION PROCESS

1. Risks concerning the management of inventories

.misstatement of inventory valuation

.costs determined or classified improperly

.errors made in cost allocations

.cost flow models - LIFO, FIFO - not applied as authorized

.total inventory is correct but misstatements exist among components - RM, WIP, FGS

.errors in perpetual inventory records

shortages, overstocking, obsolescence

.excessive inventory inflating carrying costs

.overstatement of inventory value due to obsolete, slow

movers, or overstocking

.loss of market value not reflected properly by write down of

inventory costs - LCM

2. Risks concerning the control of production

.production plan and initiation without management approval

.production is not regulated according to plan

excessive production and inventory

underutilization and inventory shortage

.unauthorized goods produced

not up to customer standards of quality

intent to sell without authorization (theft)

3. Risks in the accumulation of production costs

.computed production costs are erroneous

.materials, labor, overhead expensed when should be capitalized (or the opposite)

.period costs included in manufacturing overhead

.incorrect allocation of overhead

.overhead rates or standards are inappropriate

resulting in misstatement of product cost

misapplication of overhead

.completed production not recorded correctly or at all

lost sales

repeated production

.errors made in transfer of cost data from WIP to FGS inventory

.standard costs charged without management authorization

concealing unfavorable variances

.flow of costs into FGS inventory falsified to conceal shortages or theft

.issuance of materials to production incorrectly recorded

mismatch between raw materials and WIP

.scrap. spoilage, waste not recorded properly

sale of scrap not reported

.scrap stolen

INTERNAL CONTROLS FOR CONVERSION PROCESS

much of the control of safeguarding inventories lies with physical security measures--general controls

securely locked warehouse, storeroom, electronic sensing and monitoring devices, etc.

Access to storerooms should be limited to those with authorized access-photo id cards

magnetic key, locks changed periodically

insurance coverage

use of standard cost systems and perpetual inventory recordkeeping systems are also important means of control

comparing inventory per count (or floor) to inventory per books

1. ORGANIZATIONAL CONTROLS

segregation of duties--established through the organization chart and related job descriptions

some types of segregation can be enforced through the use of passwords and by selective read-update privileges

restrict access to key data and processes to designated terminals

responsibility for custody of inventory should be separated from responsibility for maintaining perpetual inventory records

physical custody or issuance of inventory items should be separated from preparation of receiving documents, materials requisitions or shipping documents

responsibility for reviewing inventory valuations and approving write-down or write-off of inventory should be separated from maintenance of perpetual inventory records and from the authority to dispose of obsolete, unsalable items.

2. Data Access Controls

special attention should be given to the security of interactive systems, particularly those in real time mode--which is particularly prone to error contamination.

Access to interactive terminals should be controlled by physical controls over terminals as well as passwords.

Access logs determine the origin of transaction data.

Transaction entry should be accepted only upon submittal and verification of user identification codes.

3. Authorization Controls

to ensure that input data are authorized

authority to accept raw materials lies with receiving dept

authority to transport finished goods lies with the shipping dept

authorization of production orders should be made in accordance with clearly stated management policies

any deviation from these policies should be approved in writing by management

production orders for custom goods should be coordinated with sales orders and contract specifications

authorization for materials requisitions for the issuance of raw materials and parts lies with factory dept

requisitions should be coordinated with bills of materials and engineering specifications

woork orders authorized by production supervisors, who also authorize time cards or labor tickets related to the work

labor and machine assignments should be made in accordance with engineering specifications, production schedules, standard allowances

overhead application rates and cost standards approved by upper management and remain in force for 12 month budget periods

any deviations should be approved in writing

written authorization must be received to remove any equipment, materials, goods or scrap from the plant facilities

written procedures should be established for the accumulation of materials, labor and overhead costs

periodic checks should be made to ensure that computer programs are working as established

computer programs should routinely analyze inventory status to identify slow moving, overstocked, or obsolete items

actual levels should be compared with reorder points

4. Data Verification Controls

ie. Input controls--ensure that input data are accurate before processing begins

Verification can be performed by batch edit program or by point-of-entry editing

Real Time inventory systems demand point-of-entry controls because of the immediate update of master records.

All inventory part or product numbers should be validated by check digits or table look up.

Retrieval of the inventory description allows data entry clerk to make comparisons between the number typed in and the description.

Limit and reasonableness tests should be done on inventory quantity and dollar amounts.

Entry of redundant data, such as inventory number and description, provides high rejection rate for invalid entries.

5. Processing Controls

a. batch controls / batch balancing

record counts

control totals / control logs

cross footings

hash totals

b. prenumbered documents - all processing is complete

production orders, work orders, materials requisitions issued in sequence

deviations from sequence reported to exception report

control of unused form supply

form used to approve inventory adjustments and disposal of assets

c. independent comparisons

between production records and production orders

outstanding production orders on open job file and

number of jobs being worked in the factory

reports of spoiled jobs with spoilage reports

6. File Controls

currency of data in inventory master files

file maintenance

edit logs - adjustments to inventory approved in writing

data security for back up concerns

7. Output Controls

output may be generated automatically

may generated purchase order by programmed criteria

control over proper distribution / usefulness of

reports to management

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