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.

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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

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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.

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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
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 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

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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
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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

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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

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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
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.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

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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

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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

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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.
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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
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 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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