CHAPTER 16: THE PRODUCTION CYCLE

SUGGESTED ANSWERS TO DISCUSSION QUESTIONS

16.1. When activity-based cost reports indicate that excess capacity exists, management should
either find alternative revenue-enhancing uses for that capacity or eliminate it through
downsizing. What factors influence management’s decision? What are the likely
behavioral side effects of each choice? What implications do those side effects have for
the long-run usefulness of activity-based cost systems?

It will often be easier to identify opportunities to downsize and eliminate jobs than to find
creative value-adding activities for excess capacity. Thus, management may be more likely to
eliminate excess capacity than to redirect it to new tasks. This can have serious negative
effects on both employee morale and the long-run survival of the firm. When employees are
let go, their knowledge and customer relationships go with them. Some consultants argue that
such soft knowledge is a company’s most valuable asset and, therefore, that downsizing is
likely to have negative long-run consequences. If management uses ABC systems to justify
downsizing, there is likely to be a backlash against and distrust of such systems by many
managers.

Instead, managers should seek to find new opportunities to productively make use of excess
capacity. This can involve creating teams to look for ways to improve processes and cut costs.
It is also useful to build-in resources for ongoing maintenance.

Finally, it is critical to focus on “practical” capacity rather than “theoretical” capacity,

recognizing that neither humans nor machines can function productively 100% of the time –
there needs to be “slack” built in to accommodate breaks, maintenance, and unexpected
interruptions.

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Ch. 16: The Production Cycle

16.2. Why should accountants participate in product design? What insights about costs can
accountants contribute that differ from the perspectives of purchasing managers and
engineers?

Product design is concerned with designing a product that meets customer requirements in
terms of quality, durability, and functionality while also minimizing costs. Accountants can
add value to the production team by using their expertise to help properly track and minimize
costs. Accountants can collect past data and use it to project potential warranty and repair
costs. They can also help analyze components used to identify those used in multiple products
and those that are unique. They can then provide cost data about the unique products and ask
engineering whether those parts can be replaced with components used on other products.
Doing so will reduce a number of indirect product costs, especially those related to purchasing
and carrying inventory.

Most important, accountants provide a different perspective and may notice things or question
assumptions that engineers and product designers take for granted.

16.3. Some companies have eliminated the collection and reporting of detailed analyses on
direct labor costs broken down by various activities. Instead, first-line supervisors are
responsible for controlling the total costs of direct labor. The justification for this
argument is that labor costs represent only a small fraction of the total costs of producing
a product and are not worth the time and effort to trace to individual activities. Do you
agree or disagree with this argument? Why?

This question should create some debate. The important issues to keep in mind are:

• How will management use detailed labor data?

• What actions can be taken based on such data?
• How do the potential benefits of collecting and reporting detailed labor costs compare to
the costs of processing that data?

The answers to these questions will determine whether the cost of collecting the data is less
than its value.

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16.4. Typically, McDonald’s produces menu items in advance of customer orders based on
anticipated demand. In contrast, Burger King produces menu items only in response to
customer orders. Which system (MRP-II or lean manufacturing) does each company
use? What are the relative advantages and disadvantages of each system?

McDonald’s uses MRP-II; Burger King uses JIT.

An advantage of MRP-II is that customer orders can be filled with less delay. A disadvantage
is the potential for over-producing items that are not in high demand (in the case of
McDonald’s, this could be either cold or stale food).

An advantage of JIT is that it facilitates customization. A disadvantage is delay in filling

customer orders (i.e., longer wait times) if there is an unanticipated large increase in demand.

The two systems also differ in terms of implications for the supply chain: because MRP-II
systems rely on maintaining a larger supply of raw materials than JIT systems, they are less
vulnerable to short-term interruptions in the supply chain due to strikes or natural disasters that
may disrupt deliveries.

16.5 Some companies have switched from a “management by exception” philosophy to a

“continuous improvement” viewpoint. The change is subtle, but significant. Continuous
improvement focuses on comparing actual performance to the ideal (i.e., perfection).
Consequently, all variances are negative (how can you do better than perfect?). The
largest variances indicate the areas with the greatest amount of “waste,” and,
correspondingly, the greatest opportunity for improving the bottom line. What are the
advantages and disadvantages of this practice?

An advantage of continuous improvement reports is that they combat the tendency for
complacency.

A disadvantage is that they can create too much pressure if expectations for improvement are
unrealistic. Accountants can help avoid this by becoming involved in collecting and analyzing
performance data to ensure that targets are realistic.

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SUGGESTED ANSWERS TO THE PROBLEMS

16.1. Match the terms in the left column with their definitions from the right column:

1. _c__ Bill of materials a. A factor that causes costs to change.

2. _k__ Operations list b. A measure of the number of good units produced
in a period of time.
3. _l__ Master Production c. A list of the raw materials used to create a finished
Schedule product.
4. _m_ Lean manufacturing d. A document used to authorize removal of raw
materials from inventory.
5. _j__ Production order e. A cost-accounting method that assigns costs to
products based on specific processes performed.
6. _d__ Materials requisition f. A cost accounting method that assigns costs to
specific batches or production runs and is used
when the product or service consists of uniquely
identifiable items.
7. _i__ Move ticket g. A cost accounting method that assigns costs to
each step or work center and then calculates the
average cost for all products that passed through
that step or work center.
8. _h__ Job-time ticket h. A document that records labor costs associated
with manufacturing a product.
9. _f__ Job-order costing i. A document that tracks the transfer of inventory
from one work center to another.
10. _a_ Cost driver j. A document that authorizes the manufacture of a
finished good.
11. _b_ Throughput k. A document that lists the steps required to
manufacture a finished good.
12. _o_ Computer-integrated l. A document that specifies how much of a finished
manufacturing good is to be produced during a specific time
period.
m. A production planning technique that is an
extension of the just-in-time inventory control
method.
n. A production planning technique that is an
extension of the Materials Requirement Planning
inventory control method.
o. A term used to refer to the use of robots and other
IT techniques as part of the production process.

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16.2 What internal control procedure(s) would best prevent or detect the following problems?

a. A production order was initiated for a product that was already overstocked in the
company’s warehouse.

Base the master production schedule on

— Current data on product sales
— Product sales forecasts
— Quantities on hand
— Quantity scheduled or under production

Maintain accurate perpetual inventory records.

b. A production employee stole items of work-in-process inventory.

• Ensure good supervision by factory supervisors.

• Implement documentary control over quantities of in-process inventories and their
movement through the factory (e.g., move tickets).
• Count/record quantities at each workstation and have both parties to any transfer
acknowledge the transaction..

c. The “rush-order” tag on a partially completed production job became detached from
the materials and lost, resulting in a costly delay.

— Use rush order tags

— Have production schedules indicate the high priority jobs.
— Configure the ERP system to prepare status reports of production so that failure to
complete portions of the MPS will be detected on a timely basis.
— Use expediters to monitor work on high priority jobs.

d. A production employee entered a materials requisition form into the system in order
to steal $300 worth of parts from the raw materials storeroom.

— Limit authority to prepare or authorize materials requisitions to production planning

personnel and perhaps factory supervisors.
— Have recipient sign a copy of the requisition at the point of issue and send it to the
accounting department for subsequent posting to the work-in-process records.
— Investigate significant unexplained variances between actual and recorded work in
process.

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e. A production worker entering job-time data on an online terminal mistakenly entered

3,000 instead of 300 in the “quantity-completed” field.

— Validate input by comparing the quantity entered with the quantity scheduled during
the elapsed time.
— Flag any amounts that are unreasonably high or low and have the system display a
request that the worker reenter the quantity.

f. A production worker entering job-time data on an online terminal mistakenly posted

the completion of operation 562 to production order 7569 instead of production order
7596.

— Have the system keep track of which order each employee is working on and
o Verify that the production order number properly corresponds to the employee
number.
o Verify that the operation number entered corresponds to the production order
number entered.
— Have any lack of correspondence cause the system to request reentry of the input data.

g. A parts storeroom clerk issued parts in quantities 10% lower than those indicated on
several materials requisitions and stole the excess quantities.

The discrepancy should show up in an unfavorable materials usage variance, since the
shortage will necessitate requesting additional goods. To deter this type of problem:
— Require the recipient of inventories from stores to sign a requisition for the exact
quantities received
— Hold the recipient responsible for shortages to provide an incentive to accurately count
what is received.

h. A production manager stole several expensive machines and covered up the loss by
submitting a form to the accounting department indicating that the missing machines
were obsolete and should be written off as worthless.

— Limit authority to write off expensive machines to management

— Document all transactions involving the acquisition or disposal of fixed assets.
— Require a dual authorization; that is, two separate members of management must
authorize the disposal of obsolete machinery.
— Have someone not involved in the transaction review it prior to disposing of the
equipment.

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i. The quantity-on-hand balance for a key component shows a negative balance.

— Use sign checks on master file balances after every file update
— Reconcile recorded amounts with a physical count of inventory
— Determine cause of errors and take corrective action to eliminate it.

j. A factory supervisor accessed the operations list file and inflated the standards for
work completed in his department. Consequently, future performance reports show
favorable budget variances for that department.

— Restrict update access to operations list to a limited number of authorized supervisors

of the engineering and product design teams.
— Review all changes to the operations list on a regular and timely basis
— Use variance analysis to determine the difference between standard and actual usage
and investigate any material differences

k. A factory supervisor wrote off a robotic assembly machine as being sold for salvage,
but actually sold the machine and pocketed the proceeds.

• Limit authority to write off machines to management

• Document all transactions involving the acquisition or disposal of fixed assets.
• Require a dual authorization; that is, two separate members of management must
authorize the disposal of obsolete machinery.
• Have someone not involved in the transaction review it prior to disposing of the
equipment.

l. Overproduction of a slow-moving product resulted in excessive inventory that had to

eventually be marked down and sold at a loss.

• Create a Master Production Schedule based on information from sales forecasts and
customer orders, taking into account inventory on hand.

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16.3 Use Table 16-1 to create a questionnaire checklist that can be used to evaluate controls
for each of the basic activities in the production cycle (product design, planning and
scheduling, production operations, and cost accounting).

a. For each control issue, write a Yes/No question such that a “No” answer represents a
control weakness.

A wide variety of questions is possible. Below is a sample list:

Question Yes No
1. Is access to production master data (production orders, inventory, master
production schedule, etc.) restricted?
2. Is the production master data regularly reviewed and all changes
investigated?
3. Is production data encrypted while stored in the database?
4. Does a backup and disaster recovery plan exist?
5. Have backup procedures been tested within the past year?
6. Are appropriate data entry edit controls used?
7. Is a perpetual inventory of raw materials components maintained?
8. Are physical counts of raw materials inventory taken regularly and used to
adjust the perpetual inventory records?
9. Are competitive bids used when ordering fixed assets?
10. Are reports prepared showing the number of unique components for each
finished product?
11. Are warranty and repair costs tracked for each finished product?
12. Is a Master Production Schedule (MPS) created and followed?
13. Are materials requisitions used to authorize and document removal of raw
materials from inventory?
14. Are move tickets used to document transfers of raw materials and work-in-
process in the factory?
15. Are the disposals of fixed assets documented?
16. Is there insurance against losses due to fire, flood, or other disaster?

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b. For each Yes/No question, write a brief explanation of why a “No” answer represents
a control weakness.

Question Reason a “No” answer represents a weakness

1 Unrestricted access to the production master data could result in disclosure of trade
secrets or creation of unauthorized production orders.
2 Failure to investigate all changes to production master data may allow errors to
remain undetected that result in over- or under-production of finished goods.
3 Failure to encrypt production data can result in the unauthorized disclosure of
sensitive information.
4 If a backup and disaster recovery plan does not exist, the organization may lose
important data.
5 If the backup plan is not regularly tested, it may not work.
6 Without proper data entry edit controls, errors may occur in recording production
operations, which may result in inventory valuation errors, over- or under-
production, or poor pricing decisions.
7 Without a perpetual inventory system, shortages and excess inventory is more
likely.
8 Without periodic physical counts and any necessary inventory records adjustments,
the perpetual inventory records are likely to be incorrect.
9 Without competitive bids, purchases may be at higher than necessary prices.
10 Failure to track the number of common and unique components used can result in
poor product design or excessive costs of production and inventory.
11 Failure to trace warranty and repair costs to specific finished products precludes
correcting poor product designs.
12 Without a Master Production Schedule, unauthorized production orders could
result in over-production of finished goods. There could also be underproduction
of finished goods.
13 Failure to document transfer of raw materials from inventory stores can lead to
theft.
14 Not documenting the transfer of raw materials and work-in-process can prevent
discovery of theft and make it difficult to identify the perpetrator.
15 Not documenting the disposal of fixed assets can cover up theft and make it
difficult to identify the perpetrator.
16 Lack of adequate insurance exposes the organization to the risk of substantial
monetary loss in the event of an insurable incident.

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Ch. 16: The Production Cycle

16.4 You have recently been hired as the controller for a small manufacturing firm that makes
high-definition televisions. One of your first tasks is to develop a report measuring
throughput.

Describe the data required to measure throughput and the most efficient and accurate
method of collecting that data.

Throughput = A x B x C where
A = total production (units) / processing time
B = processing time / total elapsed real time
C = good units / total production (units)

A x B x C reduces down to good units/total elapsed real time

The key data needed are:

• total production in units
• good units produced (i.e., those without defects)
• time spent performing production tasks
• total time

The AIS can calculate total time by recording 1) the time when the production order was
released and 2) the time when it was completed and the products were placed into finished
goods inventory.

Total time spent in operations (processing time) can be collected by measuring the time spent
on each operation. This can be most accurately done with badge or card readers at each
station.

Total production can be recorded by counting (with bar-code scanners or using RFID tags , if
possible) all units produced at each step of the manufacturing process.

Subtracting defective units from total production yields good production.

Production in multi-stage processes is probably the most difficult to measure accurately,

especially if defects are identified continuously because then it is necessary to track all such
partially completed work to obtain a more accurate measure of throughput.

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16.5 The Joseph Brant Manufacturing Company makes athletic footwear. Processing of
production orders is as follows: At the end of each week, the production planning
department prepares a master production schedule (MPS) that lists which shoe styles and
quantities are to be produced during the next week. A production order preparation
program accesses the MPS and the operations list (stored on a permanent disk file) to
prepare a production order for each shoe style that is to be manufactured. Each new
production order is added to the open production order master file stored on disk.

Each day, parts department clerks review the open production orders and the MPS to
determine which materials need to be released to production. All materials are bar-
coded. Factory workers work individually at specially designed U-shaped work areas
equipped with several machines to assist them in completely making a pair of shoes.
Factory workers scan the bar-codes as they use materials. To operate a machine, the
factory workers swipe their ID badge through a reader. This results in the system
automatically collecting data identifying who produced each pair of shoes and how much
time it took to make them.

Once a pair of shoes is finished, it is placed in a box. The last machine in each work cell
prints a bar-code label that the worker affixes to the box. The completed shoes are then
sent to the warehouse.

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a. Prepare a data flow diagram of all operations described.

QOH inventory

1.0
Plan
Production sales forecasts

Scheduled
MPS Production

operations list open

production
orders
2.0
Prepare
Production Production
bill of materials Order Orders

Production Operations
Order Card

Work
3.0 Activity
Perform
Production
Operation

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b. What control procedures should be included in the system?

A large number of controls are possible, including the following:

• Access Control - User ID and Password

• Compatibility Test - Password
• Preformatting or Prompting -All Data Entered
• Record Count - # of Transactions
• Validity Check - Product Code Number
• Limit Check - Production Quantity
• Field Check - Production Date
• Field Check - Quantity
• Completeness Test - Each Record
• File Library - Log Master Files
• External Labels - Master Files
• Header Labels - Master Files
• Backup Copy - Operations List and Bill of Materials
• Backup Copy - Production Orders
• Record Count - # of Operations
• Sequentially Numbered Product Orders
• Reasonableness Check - Date Completed versus date started
• Validity Check - Employee Number
• Reasonableness Test - Elapsed Time

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16.6 The XYZ Manufacturing Company is evaluating options for spending on product quality
and wants to find the optimal amount to spend on changing its processes to improve prevention
of defects. Its engineers have developed the following estimates:

• The current defect rate is 10%. If it invests an additional $10 per unit in prevention costs,
the defect rate will drop to 6%; spending $20 per unit on prevention drops the defect rate
to 3%; spending $30 per unit drops the defect rate to 1.5%; and investing $40 per unit on
prevention reduces the defect rate to 1%.
• Inspection costs are $5 per unit. Inspection is successful at detecting 98% of defective
units; the remaining 2% of defective products are sold and eventually returned for
warranty repairs or replacement at no cost to the customer.
• Internal failure costs are $400 per defective unit that is detected.
• External failure costs are $1000 per unit returned.
• Current production level is 1 million units.

REQUIRED:
a. Create and submit a spreadsheet that calculates total quality costs for the existing process and
for each of the four options for investing in additional prevention.
b. Use conditional formatting to highlight the cell with minimum total quality costs. Important:
If you change the prevention costs, your conditional formatting should automatically switch to
the cell that has the new minimum total costs.

Spreadsheet solution provided on instructor website. Key points in grading:

• Appropriate use of formulas and cell references (may want to deduct points if student hard-
wire formulas)
• For conditional formatting of the cell with the minimum total costs:
o Highlight the cell range for total quality costs
o Select conditional formatting
o Choose “color scales” and then choose “more rules”
o Choose the “classic” type
o Choose “bottom 1”
o Create some highlight style that makes that cell stand out

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16.7 EXCEL PROBLEM

REQUIRED:
a. Create a spreadsheet that calculates throughput for the following combinations:
• Productive capacity = 1,000 units per hour
• Productive processing time ranges from 90% to 98%, increasing in increments of
2%
• Yield ranges from 91% to 99% increasing in increments of 2%
• Costs of productive processing time:
o 90% = $100
o 92% = $150
o 94% = $250
o 96% = $400
o 98% = $600
• Costs of yield rates:
o 91% = $10
o 93% = $20
o 95% = $35
o 97% = $60
o 99% = $100
o
b. Create a formula that displays in a labeled cell the maximum throughput.

c. Create a cell range that displays the total costs for the various combinations of yield
and productive processing time.

d. Below the cell range created in step 3 write a statement explaining whether the
company should focus on changing productive processing time or yield in order to
minimize total costs for the same amount of throughput.

Solution on next page

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Ch. 16: The Production Cycle

Management should focus on productive processing time because increasing it while holding yield
constant results in same throughput at less total cost than the reverse. Cells above in same color have
same throughput – note that higher levels of productive processing time results in lower total costs
(e.g., 92% productive processing time and 91% yield rate has lower costs for throughput of 837 than
does 90% productive processing time and 93% yield rate).

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16.8 EXCEL PROBLEM

Acme Manufacturing currently employs 13 people in its receiving department. Each receiving
dock clerk earns $50,000 per year. Each employee can unload up to 200 pallets of inventory per
day. It currently receives on average 2450 pallets per day.

Acme is considering two options to improve productivity of its receiving dock employees. Option
1 (Automation) involves investing $200,000 in automation equipment that would enable each
employee to unload up to 350 pallets of inventory per day. Option 2 (RFID) involves investing
$50,000 in RFID equipment that would enable each employee to unload up to 275 pallets per
day.

For both options, Acme plans to keep total costs of the receiving function the same as they
currently are by eliminating some workers. 4 workers would be eliminated if Acme chooses
option 1 (automation) and 1 worker would be eliminated if it chooses option 2 (RFID).

REQUIRED
a. Download the spreadsheet from the course website and complete it by creating formulas
to calculate
i. Receiving capacity
ii. Cost per pallet received (Note: standard cost equals total costs divided by
maximum capacity)
iii. Cost of receiving capability used
iv. Cost of unused receiving capability
b. Acme now wishes to further downsize its operations under options 1 and 2, but without
impairing its ability to receive and process incoming shipments. Thus, it desires to keep
enough employees to be able to process at least 2600 pallets per day. Management
realizes that it cannot employ a fraction of a worker, thus there will continue to be some
excess capacity with both options.

Complete the remainder of the spreadsheet to show

i. Number of employees required under all 3 options
ii. Actual receiving capability under all 3 options
iii. Cost per pallet received (Note: standard cost equals total costs divided by
maximum capacity)
iv. Cost of receiving capability used
v. Cost of unused receiving capability

Solution on following page and spreadsheet available to instructors

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 Accounting Information Systems

16.9 EXCEL PROBLEM*

REQUIRED
Download the spreadsheet for problem 16.9 from the website for this textbook. Write
formulas to calculate the total depreciation expense and to display the correct values in
the following three columns: Age, Depreciation Rate, and Depreciation Expense. (Hint:
You will need to use the VLOOKUP and MATCH functions to do this. You may also
want to read the article “Double-Teaming In Excel,” by Judith K. Welch, Lois S.
Mahoney, and Daniel R. Brickner, in the November 2005 issue of the Journal of
Accountancy, from which this problem was adapted).

Solution:

Depreciation expense formula: =VLOOKUP(J5,$A$4:$D$14,MATCH(H5,$A$4:$D$4,0))

- explanation of formula:
• The age column subtracts the year the asset was purchased from the reference year in cell H3.
It then adds one to that value because the year the asset is purchased is its first year of
depreciation.
• The VLOOKUP function extracts tax rate from the tax table. The first argument to the
VLOOKUP function is the asset’s age. The second argument is the location of the vlookup
table (cells A14 to D14, using absolute references so that the formula can be correctly copied).
The third argument is the row in which to find the answer. In this case, the row is given by the
result of the MATCH function.
• The first argument of the MATCH function is the cell which contains the asset class (column
H). The second argument indicates where the column headings are for the different classes
(A4:D4). The third argument (0) indicates the match type where 0 means an exact match.

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16.10 Answer all of the following multiple-choice problems:

1. In terms of quality control measures, scrap and rework costs are part of
a. Prevention costs
b. Inspection costs
c. Internal failure costs
d. External failure costs

Correct answer: c.

2. Which part of the throughput formula provides information about the

impact of equipment downtime on overall productivity?
a. Productive capacity
b. Productive processing time
c. Yield
d. None of the above

Correct answer: b.

3. Which of the following is most likely the cost driver for accounts payable
expenses associated with processing supplier invoices?
a. Number of different parts purchased
b. Total price of purchases
c. Number of suppliers used
d. Number of purchases made
e. All of the metrics listed above

Correct answer: d. Each purchase results in a supplier invoice that must be processed and paid.

4. Move tickets are a control procedure designed to reduce the risk of

a. Loss or destruction of production data
b. Theft of inventory
c. Disruption of operations
d. Inappropriate allocation of overhead costs

Correct answer: b.

5. At which stage of the production process can accountants contribute to

significantly reducing the cost of goods sold?
a. Product design
b. Planning and scheduling
c. Production operations
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d. None of the above

Correct answer: a.

6. MRP-II would most likely be used by a company that produces

a. Different grades of milk (e.g., whole, 2% and skim)
b. Toner cartridges for laser printers
c. Toys based on a new movie
d. All of the above are equally amenable to MRP-II systems
e. None of the above

Correct answer: a. Future demand for consumer staples, such as milk, is much more predictable than
demand for toner cartridges or toys. Toys are a “fad” item for which it is extremely difficult to predict
future demand. Toner cartridges are not purchased regularly because individual consumers and
businesses have markedly different patterns of use.

7. In terms of quality control measures, the costs associated with issuing

credit memos to customers who return defective products is part of
a. Prevention costs
b. Inspection costs
c. Internal failure costs
d. External failure costs
e. None of the above

Correct answer: d.

8. Which control procedure would be most effective in reducing the risk of

over- or under-production?
a. Reviewing all changes to master data
b. Activity-based costing
c. Production planning systems
d. Computer-integrated manufacturing
e. Reports that highlight the components of throughput

Correct answer: c.

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SUGGESTED ANSWERS TO THE CASES

CASE 16-1 The Accountant and CIM

Examine issues of the Journal of Accountancy, Strategic Finance, and other business
magazines for the past three years to find stories about current developments in factory
automation. Write a brief report that discusses the accounting implications of one
development: how it affects the efficiency and accuracy of data collection and any new
opportunities for improving the quality of performance reports. Also discuss how the
development affects the risks of various production cycle threats and the control
procedures used to mitigate those risks.

There is no one correct answer. In addition to grading on writing quality, be sure that students
fulfill task requirements (i.e., describe the development, the controller’s role, and the effect on
production cycle threats). The logical reasoning used to support any analysis should also be
evaluated.

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