The Conversion Cycle

The Conversion Cycle is a recurring set of business activities and related information processing
operations associated with the manufacture of products. It is also known as production cycle, which is
used by accounting systems that records one economic event – the consumption of labor, material and
overhead to produce a product or service.

Transactions in the conversion process:

 acquisition of materials
 acquisition of labor
 transfer of materials, labor and overheads into production
 transfer of finished goods to inventory
 sale of inventory

Four Basic Steps in Conversion Cycle

Product
D esign
Design

Plann ing
Planning
Co st
Cost and
Accounting Scheduling
Conversion
Cycle

Productio
Productionn
O perations
Operations

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

Process:
Bill of materials – specifies the part number, description, and quantity
Operation list – specifies steps in making the product

Threat: Poor product design resulting in excess cost

Planning and Scheduling

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

Methods:
Manufacturing Resource Planning (MRP) – seeks to balance existing production capacity and
raw materials needs to meet forecasted sales demands. MRP is often referred to as push
manufacturing, because goods are produced in expectation of customer demand.

Lean manufacturing – seeks to minimize or eliminate the inventories of raw materials, work in
process, and finished goods. This is often referred to as pull manufacturing, because goods are
produced in response of customer demand.

Threat: Overproduction and underproduction

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

Computer-Integrated Manufacturing (CIM) – using various forms of information technology in the

production process.

Threat: Theft of inventory and poor performance

Cost Accounting
The final step in the conversion cycle is the cost accounting. The three principal objectives of the cost
accounting are (1) to provide information for planning, controlling, and evaluating the performance of
production operations; (2) to provide accurate cost data about products for use in pricing and product
mix decisions; and (3) to collect and process the information used to calculate the inventory and cost of
goods sold values that appear in the company’s financial statements.

Methods:
Job-order costing – assigns costs to specific production batches, or jobs, and is used when the
product or service being sold consists of discretely identifiable items.

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

Threat: Inaccurate cost data, inappropriate allocation of overhead costs, and misleading reports

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