9-1

Chapter 9

Production Cycle

“There is one rule for industrialists and that is: Make the best quality of goods possible at the lowest cost possible, paying the highest wages possible.”—Henry Ford

9-2

Presentation Outline

I. Files and Reports in a Production System

II. Production Control Application System

III. Control Risk Assessment

IV. Substantive Procedures

9-3

I. Files and Reports in a Production System

A. Production Order

B. Bill of Materials

C. Master Operations List

D. Materials Requisitions

E. Job Time Cards

F. Resource Availability Reports

G. Production Status Reports

9-4A. Production Order

Production control issues production orders to authorize production departments to make

certain products.

We are ready to begin this

order.

9-5

B. Bill of Materials

A bill of materials is a listing of the

ingredients that go into making a product.

It lists of all the required parts and their descriptions.

What materials do we need to make this product?

9-6

C. Master Operations List

A master operations list specifies the

sequencing of all labor and/or machine

operations that are necessary to produce a

product.

9-7

D. Materials Requisitions

Production control prepares materials

requisitions to authorize the release of raw materials from inventory for use in

production.

9-8

E. Job Time Cards

Job time cards are used to document the

amount of labor time that is spent on each production order or

job.

9-9F. Resource Availability Reports

Inventory status reports detail the material

resources available in inventory for production.

Factor availability reports communicate the

availability of labor and machine resources for

production.

We have the materials, but may have to schedule some

overtime for this job.

9-10G. Production Status Reports

Production status reports detail the work completed on individual production

orders as they move through production.

Open production orders are monitored and

departmental production schedules are revised as

necessary.

9-11II. Production Control Application System

A. The Role of Production Control

B. Accounting for the Factors of Production

C. Completion of the Production Order

D. Overview of Production Cycle Control Procedures

9-12A. The Role of Production Control

1Production

Order 3

2

Production Departments

Production Control

Inventory Control

Cost Accounting

General Ledger

1Production

Order

2Production

Order

N

InventoryStatusReport

Finished Goods Raw Materials

InventoryStatusReport

FactorAvailability

Report

FactorAvailability

Report

2 1ProductionSchedule

D

1ProductionSchedule

9-13B. Accounting for the Factors of ProductionProduction

DepartmentsProduction

ControlInventory Control

Cost Accounting

General Ledger

3 2

1Materials

Requisition

N

2 1

MaterialsRequisition

1Materials

Requisition

NPost to WIP

Records

JournalVoucher

JournalVoucher

Materials Placed in Production

ProductionStatus

ProductionStatus

Job Time Cards Job Time Cards

Post to WIP Records

JournalVoucher

JournalVoucher

Conversion Costs

9-14C. Completion of the Production Order

3 2

Production Departments

Production Control

Inventory Control

Cost Accounting

General Ledger

1Production

Order

1Production

Order 2Production

Order

N Completed 2

ProductionOrder

Post to Inventory Records

Completed 2Production

Order

Summarize Production

JournalVoucher

JournalVoucher

Cost of Goods Manufactured Completed

ProductionCost Report

To Management

9-15D. Overview of Production Cycle Control Procedures

• Physical Controls– Production Order and Materials Requisition.– Physical inventories reconciled to perpetual inventory

records.– Restrict access to inventories

• Segregation of Duties– Authorization– Recording– Custody– Reconciliation

• Performance Reviews– Scrap reports– Variance analysis

9-16III. Control Risk Assessment

In the event that control risk is deemed to be high, an auditor could lower detection risk by:

Sampling more inventory production reports for valuation calculations

Scheduling inventory observation closer to year end

Making a larger number of test counts

9-17

IV. Substantive Procedures

A. Analytical Procedures

B. Physical Inventory Observation

C. Pricing and Compilation

D. Purchase Cutoffs

E. Accounting Firm Tips

9-18

A. Analytical Procedures

• Verify REASONABLENESS of COGS– Gross Profit Margin

– Compare to prior year, industry averages

• Verify REASONABLENESS of ending inventory– Days Sales in Inventory

– Inventory Turnover

9-19

B. Physical Inventory Observation

1. A Required Procedure

2. Client Count Instructions

3. Inventory Count and Measurement Challenges

4. Audit Program for Inventory Count

5. Inventory Count Sheet

9-20

1. A Required Procedure

• “…it will always be necessary for the auditor to make, or observe, some physical counts of the inventory and apply appropriate tests of intervening transactions" (AU 331.12).

• May make test counts at a time other than year-end. – test roll-forward.

9-21

2. Client Count Instructions

• Names of client personnel and dates and times of count• Instructions for recording inventory descriptions and

counts (measuring physical quantities)• Noting obsolete or worn items• Tag control—compilation of counts• Shutting down production to avoid double counting• Controlling movement• Making changes and corrections to counts• Review and approval of supervisory personnel

9-22

Examples Challenges/ Special procedures.

Lumber Problem identifying quality or grade. /Employ a specialist

Piles of sugar, coal, scrap steel Geometric computations, aerial photos./ Employ a specialist

Items weighed on scales Accuracy of scales./Examine certification.

Bulk materials (oil, grain, liquids in storage tanks)

Measuring volume, ensuring composition of content/Climb the tanks Dip measuring rods. Sample for assay or chemical analysis.

Diamonds, jewelry Identification and quality determination problems/ Hire a specialist.

Pulp wood Quantity measurement estimation/Examine aerial photos.

Livestock Movement not controllable/Use chutes to control animals.

3. Inventory Count and Measurement Challenges

9-23

4. Audit Program for Inventory Count

9-24

5. Inventory Count Sheet – Exhibit 9.6

9-256. Observation Considerations

• Control tags or count sheets• Be wary of "hollow squares" and "empty boxes”

• Tour shipping and receiving areas• Watch for OBSOLETE and SLOW-MOVING

inventory • CONFIRM inventory on CONSIGNMENT and

at other locations• Consider the use of SPECIALISTS

• Confirm inventory in transit.

9-26

C. Pricing and Compilation Tests

• Valuation (Price Tests) – VENDOR INVOICES– COST FLOW ASSUMPTION (FIFO, LIFO,

average, specific identification)– LOWER OF COST OR MARKET for

inventory

• Check Extensions and Footings. • Agree to G/L

9-27

D. Purchase Cutoffs

• Verify CUT-OFFs for purchases and sales– Examine Receiving Reports and Vendor Sales

Invoices occurring around year-end.– Examine bills of lading and sales invoices– Agree to inclusion/exclusion from inventory

9-28

E. Accounting Firm Tips

• Focus test counts on high value items.• Advise client as late as possible about locations for inventory observation and do

not be predictable about approach.• Be skeptical of large test count differences.• Beware of client interest in procedures and

test counts.• Be alert for slow moving or obsolete

inventory.

9-29

Summary

• Documents in Production Cycle

• Segregation of Duties in Production Cycle

• Control Risk Assessment

• Substantive Procedures including Observation of Physical Inventory