Production & Operation management

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u will find the basics of POM and forecasting

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PRODUCTION & OPERATION MANAGEMENT:

PRODUCTION & OPERATION MANAGEMENT Author NEELAM YADAV

Production Operation Management:

Production Operation Management POM concerns itself with the conversion of inputs into outputs, using physical resourses, so as to provide the desired utility/ utilities – of form, place, possession or state or a combination thereof – to the customer while meeting the other organisational objectives of effectiveness, efficiency and adaptability. Production and Operations Management – Some Cases Case Input Physical Resource/s used Output Type of Input/ Output Type of utility provided to the customers 1. Inorganic chemicals production Ores Chemical plant & equipment, other chemicals, use of labour, etc. Inorganic chemical Physical input and physical output Form 2. Outpatient ward of a general hospital Unhealthy Patients Doctors, nurses, other staff, equipment, other facilities Healthier patients Physical input and physical output State

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3. Educational institution ‘Raw’ minds Teachers, books, teaching aids, etc. ‘Enlightened’ minds Physical input and physical output State 4. Sales office Data from market Personnel, office equipment and facilities, etc. Processed ‘information’ Non-physical input and Non-physical output State 5. Petrol pump Petrol (in possession of the petrol pump owner) Operators and boys, equipment, etc. Petrol (in possession of the car owner) Physical input and physical output Possession 6. Taxi Service Customer (at railway station) Driver taxi itself, petrol Customer (at his residence) Physical input and physical output Place 7. Maintenance workshop Equipment gone ‘bad’ Mechanics, Engineers, repairs equipment, etc. ‘Good’ Equipment Physical input and physical output State and Form 8. Income Tax office ‘Information’ Officers and other staff, office facility Raid Non-physical input and physical output State (possession?)

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Production and operations management (POM) is defined as the design, operation, and improvement of the transformation process, which converts the various inputs into the desired outputs of products and services. It is now replaced by simply operations management. Operations management is a broad term which includes manufacturing as well as service organizations. Operations management also highlights the increasing importance of service industry in the overall business environment.

Today's Factors Affecting OM:

Today's Factors Affecting OM Global Competition Quality, Customer Service, and Cost Challenges Rapid Expansion of Advanced Technologies Continued Growth of the Service Sector Scarcity of Operations Resources Social-Responsibility Issues

Studying Operations Management:

Studying Operations Management Operations as a System Decision Making in OM

Operations as a System:

Operations as a System Production System Inputs Conversion Subsystem Outputs Control Subsystem

Inputs of an Operations System:

Inputs of an Operations System External Legal, Economic, Social, Technological Market Competition, Customer Desires, Product Info. Primary Resources Materials, Personnel, Capital, Utilities

Conversion Subsystem:

Conversion Subsystem Physical (Manufacturing) Locational Services (Transportation) Exchange Services (Retailing) Storage Services (Warehousing) Other Private Services (Insurance) Government Services (Federal)

Outputs of an Operations System:

Outputs of an Operations System Direct Products Services Indirect Waste Pollution Technological Advances

Transformation Process Transformation process for a hybrid service and manufacturing organization ( a restaurant):

Transformation Process Transformation process for a hybrid service and manufacturing organization ( a restaurant) Inputs Customers Waiters Chef Manager Furniture Building Food Transformation Process Outputs Customer satisfied with Good preparations of the food Pleasant behaviour and personality of the waiters Appropriate prices charged Random Disturbances High turnover of chefs, waiters, etc. Inflation Govt.’s taxation policy Feedback mechanisms Rising revenues Repeat customers Appreciation of customers Quality of inputs monitored Quality of outputs monitored

Decision Making in OM:

Decision Making in OM Strategic Decisions Operating Decisions Control Decisions

Strategic Decisions:

Strategic Decisions These decisions are of strategic importance and have long-term significance for the organization. Examples include deciding: the design for a new product’s production process where to locate a new factory whether to launch a new-product development plan

Operating Decisions:

Operating Decisions These decisions are necessary if the ongoing production of goods and services is to satisfy market demands and provide profits. Examples include deciding: how much finished-goods inventory to carry the amount of overtime to use next week the details for purchasing raw material next month

Control Decisions:

Control Decisions These decisions concern the day-to-day activities of workers, quality of products and services, production and overhead costs, and machine maintenance. Examples include deciding: labor cost standards for a new product frequency of preventive maintenance new quality control acceptance criteria

Production:

Production Production is the process of making products. In this process, different inputs like materials, human, capital and other resources are transformed into higher valued goods and services. “Production is a process by which goods and service are created.”

Objectives of production management:

Objectives of production management 1. Primary objectives Quality Quantity Cost/ price Time

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2. Secondary objectives Men Materials Machines Services Techniques

Functions of production management:

Functions of production management Production design Development of product Purchasing Plan implementation Inventory control

Production vs. Operations vs. Material Management:

Production vs. Operations vs. Material Management These are interrelated but there is a line of difference between three. Production is the transformation of raw materials and other inputs into higher valued outputs. Management of materials as input is known as material management. Management of processes or operations is operations management.

Product Life Cycle:

Product Life Cycle Time Product Develop- ment Introduction Profits Sales Growth Maturity Decline Losses/ Investments ($) Sales and Profits ($) Sales and Profits Over the Product ’ s Life From Introduction to Decline

Introduction Stage of the PLC:

Introduction Stage of the PLC Summary of Characteristics, Objectives, & Strategies Sales Costs Profits Marketing Objectives Product Price Low sales High cost per customer Negative or low Create product awareness and trial Offer a basic product Usually is high; use cost-plus formula Distribution High distribution expenses Advertising Build product awareness among early adopters and dealers

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Growth Stage of the PLC Summary of Characteristics, Objectives, & Strategies Sales Costs Profits Marketing Objectives Product Price Rapidly rising sales Average cost per customer Rising profits Maximize market share Offer new product features, extensions, service, and warranty Price to penetrate market Distribution Increase number of distribution outlets Advertising Build awareness and interest in the mass market

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Maturity Stage of the PLC Summary of Characteristics, Objectives, & Strategies Sales Costs Profits Marketing Objectives Product Price Peak sales Low cost per customer High profits, then lower profits Maximize profits while defending market share Diversify brand and models Price to match or best competitors Distribution Build more intensive distribution Advertising Stress brand differences and benefits

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Decline Stage of the PLC Summary of Characteristics, Objectives, & Strategies Sales Costs Profits Marketing Objectives Product Price Declining sales Low cost per customer Declining profits Reduce expenditure and maintain, reposition, harvest or drop the product Phase out weak items Cut price Distribution Go selective: phase out unprofitable outlets Advertising Reduce to level needed to retain hard-core loyal customers

Classification of Operations:

Classification of Operations The production and operations management function can be broadly divided into the following four areas: Technology selection and management Capacity management Scheduling/Timing/Time allocation System maintenance Technology selection and management This is primarily an aspect pertaining to the long-term decision. It is not immediate connected with the day-to-day short term decisions handled in the plant, it is an important problem to be addressed in an age of spectacular technological advances, so that an appropriate choice is made by a particular organization to suit its objectives, organizational preparedness and its micro-economic perspectives.

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It is a decision that will have a significant bearing on the management of manpower, machinery, and materials capacity of the operations system. A technology decision is closely linked with the capacity and system maintenance areas. Capacity Management The capacity management aspect once framed in a long-term perspective, revolves around matching of available capacity to demand or making certain capacity available to meet the demand variation. This is done on both the intermediate and short time horizons. Capacity management is very important for achieving the organisational objectives of efficiency, customer service and overall effectiveness. While lower than needed capacity results in non-fulfillment of some of the customer services and other objectives of the production/operations system a higher than

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necessary capacity results in lowered utilisation of the resourses or, in other words, lower efficiency of the conversion operations. Scheduling Scheduling is another decision area of operations management which deals with the timing of various activities – time phasing of the filling of the demands or rather, the time phasing of the capacities to meet the demand as it keeps fluctuating. In job-shop (i.e. tailor-made physical output or service) type operations systems, the scheduling decisions are very important which determine the system effectiveness (e.g. customer delivery) as well as the system efficiency (i.e. the productive use of the machinery and labour). Similarly, we can also say that the need for system effectiveness coupled with system efficiencies determine the system structure and the importance of scheduling.

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System Maintenance The fourth area of operations management is regarding safeguards – that only desired outputs will be produced in the ‘normal’ condition of the physical resources, and that the condition will be maintained normal. Technology selection and management has much to contribute towards this problem. A proper selection and management procedure would give rise to few problems. Further, the checks (e.g. quality checks on physical/non-physical output) on the system performance and the corrective action (e.g. repair of an equipment) would enhance the chances of having the desired outputs undiluted by other pollutants.

Responsibilities of Operations Manager:

Responsibilities of Operations Manager Responsibilities Of operations Manager To act as internal quality auditors in certification programmes such as ISO 9000 To take part in strategic decision making of the organization. To implement Total Productive Maintenance (TPM) programme To take part in the implementation and use of ERP software in the organization. To automate processes according to the requirements of the organization To enhance the R & D efforts of the organization for becoming self-reliant in developing new technologies. To take care of issues relating to service operations management Increased attention to timely implementation of projects (such as commissioning of facilities, launching of new products/services, etc.) in view of the increased competition. To implement the environment and pollution norms established by the government from time to time. To take decisions regarding outsourcing/ off-shoing of business processes To act as a member of the concurrent engineering team in new product design. To act as supply chain managers in in forging long-term strategic relationships with suppliers. Increased attention to technology management in view of joint ventures of MNCs with domestic companies.

New-Product Development Process:

New-Product Development Process Idea Generation Idea Screening Concept Development and Testing Marketing Strategy Business Analysis Product Development Test Marketing Commercialization

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Customers Competitors Distributors Suppliers New Product Development Process Step 1. Idea Generation Idea Generation is the Systematic Search for New Product Ideas Obtained Internally From Employees and Also From:

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Process to spot good ideas and drop poor ones as soon as possible. Many companies have systems for rating and screening ideas which estimate: Market Size Product Price Development Time & Costs Manufacturing Costs Rate of Return Then, the idea is evaluated against a set of general company criteria. New Product Development Process Step 2. Idea Screening

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1. Develop New Product Ideas into Alternative Detailed Product Concepts 2. Concept Testing - Test the New Product Concepts with Groups of Target Customers 3. Choose the One That Has the Strongest Appeal to Target Customers New Product Development Process Step 3. Concept Development & Testing

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Part Two Describes Short-Term: Product ’ s Planned Price Distribution Marketing Budget Part Three Describes Long-Term: Sales & Profit Goals Marketing Mix Strategy Marketing Strategy Statement Formulation Part One Describes Overall: Target Market Planned Product Positioning Sales & Profit Goals Market Share New Product Development Process Step 4. Marketing Strategy Development

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New Product Development Process Step 5. Business Analysis Step 6. Product Development Business Analysis Review of Product Sales, Costs, and Profits Projections to See if They Meet Company Objectives If Yes, Move to Product Development If No, Eliminate Product Concept

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New Product Development Process Step 7. Test Marketing Advertising Packaging Product Budget Levels Positioning Strategy Distribution Pricing Branding Elements that May be Test Marketed by a Company Test Marketing is the Stage Where the Product and Marketing Program are Introduced into More Realistic Market Settings.

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When? Where? Commercialization is the Introduction of the New Product into the Marketplace. New Product Development Process Step 8. Commercialization

Facility Location Planning:

Facility Location Planning A factory or a plant is the manufacturing facility of a company. A warehouse is the storage facility of a manufacturing or a distribution company. The offices of a service sector company such as a courier company, a bank, or an insurance company are its facilities. The facility location decision is very important for big business houses as well as new entrepreneurs. Wrong location of the facility may lead to a failure of the complete project.

Factors affecting Facility Location Planning:

Factors affecting Facility Location Planning Facility Location planning Residential Complexes, Schools, Hospitals, Clubs, etc. Availability Of cheap and Skillful labour Proximity to raw material Good transportation facilities Proximity to subcontractors Easy Availability Of cheap land Government policies Basic amenities Environment And community Proximity To markets Low Construction costs Availability Of power supply

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Availability of power supply – Uninterrupted power supply is a basic requirement of most industries. some factories have to set up their own captive power plant if located in areas with power problems. For eg: the factories of HINDALCO (Aditya Birla Group) have their own captive power plant. Basic amenities – The area for location of plant should have water supply lines managed by the local municipal corporation. Roads up to the factory premises are always desireable. These basic amenities are very useful even during the construction period of the plant. Other amenities desired are sanitation facilities such as sewer lines, drainage system, etc. Government Policies – The governments of state such as Maharashtra, Gujarat, and Karnataka have been very successful in inducing big business houses to set up their plants in these states. Local taxation policies and various promotional efforts help in increasing the industrial activity in the region. Pondicherry and Daman and Diu are examples of ‘no sales tax regions’.

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Environmental and community considerations- Many state governments have strict environmental policies in place, which have to be followed by the industries operating there. The people residing in the area should not be against the idea of having a plant in their region as the effluents from a factory spoil the natural environment of the region. Proximity to subcontractors- The presence of small ancillary units manufacturing small components/sub-assemblies is important for any new factory. If a new auto plant is set up in Gurgaon, where the Maruti Suzuki plant is already located, it will get the advantage of the subcontractors existing there. These subcontractors can immediately start supplying the components required by the new plant for starting its production process. Easy availability of cheap land- Land is the basic necessity for the construction of a new plant. Regions such as UP, Bihar, and Orissa may be suitable because of this. Still, because of many other factors, companies prefer costly land near Mumbai, Pune, Ahmedabad, etc.

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Less Construction costs- Construction costs of a plant may be low at a particular place due to cheap labour available there. The construction material may also be cheaper at another place. Such places are obviously preffered for locating a plant. Availability of cheap, skillful and efficient labour- India and other developing nations appear to have cheap labour. However, the reality is that labour turns to be expensive here because it is not efficient when compared to the labour in developed countries. Multinational companies prefer China over India to set up their global sourcing bases because the labour in china has become more skillful and efficient as a result of increased industrial activity in the past few decades. Residential complexes, schools, hospitals, clubs, etc. – Usually new factories are given land in remote villages by the state governments. Proper facilities such as residential complexes, schools, hospitals, clubs, etc. are not available for the managers of these plants and their families at such places. Under such situations, companies have to create these facilities on their own.

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Proximity to customers (markets)- When the customers/markets are located near the plant, products can be easily supplied to them. This reduces the cost of the product as the transportation cost is not added to it. Proximity to raw material- Most textile units are located in Gujarat and Maharashtra because these are the largest cotton-growing areas in the country. Iron and steel plants are located in Bihar and Orissa because of the large presence of iron ore mines in these regions. Good transportation facilities- Regions near metro cities have the advantage of good transportation facilities, as they have good rail, air, water and road transportation networks.

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The Production Cycle

INTRODUCTION:

INTRODUCTION The production cycle is a recurring set of business activities and related data processing operations associated with the manufacture of products.

INTRODUCTION:

INTRODUCTION Questions to be addressed in this topic include: What are the basic business activities and data processing operations that are performed in the production cycle? What decisions need to be made in the production cycle, and what information is needed to make these decisions? How can the company’s cost accounting system help in achieving the entity’s objectives? What are the major threats in the production cycle and the controls that can mitigate those threats?

INTRODUCTION:

INTRODUCTION Information flows to the production cycle from other cycles, e.g.: The revenue cycle provides information on customer orders and sales forecasts for use in planning production and inventory levels. The expenditure cycle provides information about raw materials acquisitions and overhead costs. The human resources/payroll cycle provides information about labor costs and availability.

INTRODUCTION:

INTRODUCTION Information also flows from the production cycle: The revenue cycle receives information from the production cycle about finished goods available for sale. The expenditure cycle receives information about raw materials needs. The human resources/payroll cycle receives information about labor needs. The general ledger and reporting system receives information about cost of goods manufactured.

INTRODUCTION:

INTRODUCTION Decisions that must be made in the production cycle include: What mix of products should be produced? How should products be priced? How should resources be allocated? How should costs be managed and performance evaluated? These decisions require cost data well beyond that required for external financial statements.

PRODUCTION CYCLE ACTIVITIES:

PRODUCTION CYCLE ACTIVITIES The four basic activities in the production cycle are: Product design Planning and scheduling Production operations Cost accounting Accountants are primarily involved in the fourth activity (cost accounting) but must understand the other processes well enough to design an AIS that provides needed information and supports these activities.

PRODUCT DESIGN:

PRODUCT DESIGN The objective of product design is to design a product that strikes the optimal balance of: Meeting customer requirements for quality, durability, and functionality; and Minimizing production costs.

PRODUCT DESIGN:

PRODUCT DESIGN Key documents and forms in product design: Bill of Materials: Lists the components that are required to build each product, including part numbers, descriptions,and quantity. Operations List : Lists the sequence of steps required to produce each product, including the equipment needed and the amount of time required.

PRODUCT DESIGN:

PRODUCT DESIGN Role of the accountant in product design: Participate in the design, because 65 − 80% of product cost is determined at this stage. Add value by: Designing an AIS that measures and collects the needed data. Information about current component usage. Information about machine set-up and materials-handling costs. Data on repair and warranty costs to aid in future modification and design.

PLANNING AND SCHEDULING:

PLANNING AND SCHEDULING The objective of the planning and scheduling activity is to develop a production plan that is efficient enough to meet existing orders and anticipated shorter-term demand while minimizing inventories of both raw materials and finished goods.

PLANNING AND SCHEDULING:

PLANNING AND SCHEDULING Key documents and forms: Master production schedule Specifies how much of each product is to be produced during the period and when. Uses information about customer orders, sales forecasts, and finished goods inventory levels to determine production levels. Although plans can be modified, production plans must be frozen a few weeks in advance to provide time to procure needed materials and labor. Scheduling becomes significantly more complex as the number of factories increases. Raw materials needs are determined by exploding the bill of materials to determine amount needed for current production. These amounts are compared to available levels to determine amounts to be purchased.

PLANNING AND SCHEDULING:

PLANNING AND SCHEDULING Key documents and forms: Master production schedule Production order Authorizes production of a specified quantity of a product. It lists: Operations to be performed Quantity to be produced Location for delivery Also collects data about these activities,

PLANNING AND SCHEDULING:

PLANNING AND SCHEDULING Key documents and forms: Master production schedule Production order Materials requisition Authorizes movement of the needed materials from the storeroom to the factory floor. This document indicates: Production order number Date of issue Part numbers and quantities of raw materials needed (based on data in bill of materials)

PLANNING AND SCHEDULING:

PLANNING AND SCHEDULING Key documents and forms: Master production schedule Production order Materials requisition Move ticket Documents the transfer of parts and materials throughout the factory.

COST ACCOUNTING:

COST ACCOUNTING The objectives of cost accounting are: To provide information for planning, controlling, and evaluating the performance of production operations; To provide accurate cost data about products for use in pricing and product mix decisions; and To collect and process information used to calculate inventory and COGS values for the financial statements.

COST ACCOUNTING:

COST ACCOUNTING Types of cost accounting systems: Job order costing Assigns costs to a specific production batch or job. Used when the product or service consists of discretely identifiable items.

CONTROL & THREATS:

CONTROL & THREATS In the production cycle (or any cycle), a well-designed AIS should provide adequate controls to ensure that the following objectives are met: All transactions are properly authorized. All recorded transactions are valid. All valid and authorized transactions are recorded. All transactions are recorded accurately. Assets are safeguarded from loss or theft. Business activities are performed efficiently and effectively. The company is in compliance with all applicable laws and regulations. All disclosures are full and fair.

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There are several actions a company can take with respect to any cycle to reduce threats of errors or irregularities. These include: Using simple, easy-to-complete documents with clear instructions (enhances accuracy and reliability). Providing space on forms to record who completed and who reviewed the form (encourages proper authorizations and accountability).

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Pre-numbering documents (encourages recording of valid and only valid transactions). Restricting access to blank documents (reduces risk of unauthorized transaction). In the following sections, we’ll discuss the threats that may arise in the four major steps of the production cycle, as well as general threats

THREATS IN PRODUCT DESIGN:

THREATS IN PRODUCT DESIGN THREAT NO. 1—Poor product design Why is this a problem? Higher materials purchasing and carrying costs. Costs for inefficient production. Higher repair and warranty costs. Controls: Accurate data about the relationship between components and finished goods. Analysis of warranty and repair costs to identify primary causes of product failure to be used in re-designing product.

THREATS IN PLANNING AND SCHEDULING:

THREATS IN PLANNING AND SCHEDULING THREAT NO. 2—Over- or under-production Why is this a problem? Over-production may result in: Excess goods for short-run demand and potential cash flow problems. Obsolete inventory. Under-production may result in: Lost sales. Customer dissatisfaction.

THREATS IN PLANNING AND SCHEDULING:

THREATS IN PLANNING AND SCHEDULING Controls: More accurate production planning, including accurate and current: Sales forecasts Inventory data Investments in production planning. Regular collection of data on production performance to adjust production schedule. Proper authorization of production orders. Restriction of access to production scheduling program.

THREATS IN PLANNING AND SCHEDULING:

THREATS IN PLANNING AND SCHEDULING THREAT NO. 3—Suboptimal investment in fixed assets Why is this a problem? Over-investment causes excess costs. Under-investment impairs productivity. Controls: Proper authorization of fixed asset transactions:

THREATS IN PRODUCTION OPERATIONS:

THREATS IN PRODUCTION OPERATIONS THREAT NO. 4—Theft of inventories and fixed assets Why is this a problem? Loss of assets. Misstated financial data. Controls: All internal movement of inventory should be documented. Materials requisitions should be used to authorize release of raw materials. Should be signed by both inventory control clerk and production employee to establish accountability. Requests in excess of the bill of materials should be documented and have supervisory authorization.

THREATS IN PRODUCTION OPERATIONS:

THREATS IN PRODUCTION OPERATIONS Managers should be held accountable for assets under their control. Fixed assets should be physically secured. Disposal of assets should be authorized and documented. Periodic reports of fixed asset transactions should be reviewed by the controller.

THREATS IN PRODUCTION OPERATIONS:

THREATS IN PRODUCTION OPERATIONS THREAT NO. 5—Disruption of operations Why is this a problem? Disasters can disrupt functioning and destroy assets Controls: Backup power sources, such as generators and uninterruptible power supplies. Investigate disaster preparedness of key suppliers and identify alternative sources for critical components.

THREATS IN COST ACCOUNTING:

THREATS IN COST ACCOUNTING THREAT 6 — Inaccurate recording and processing of production activity data Why is this a problem? Diminishes effectiveness of production scheduling. Undermines management’s ability to monitor and control operations. Controls: Automate data collection with RFID technology, bar code scanners, and badge readers to ensure accurate data entry.

THREATS IN COST ACCOUNTING:

THREATS IN COST ACCOUNTING Use online terminals for data entry. Restrict access with passwords, user IDs, and access control matrices to prevent unauthorized changes to data. Do periodic physical counts of inventory and compare to records. Do periodic inspections and counts of fixed assets .

GENERAL THREATS:

GENERAL THREATS THREAT NO. 7: Loss, alteration, or unauthorized disclosure of data Why is this a problem? Loss or alteration of data could cause: Errors in external or internal reporting. Unauthorized disclosure of confidential information can cause: Unfair competition Loss of business

GENERAL THREATS:

GENERAL THREATS Controls: All data files and key master files should be backed up regularly. All disks and tapes should have external and internal file labels to reduce chance of accidentally erasing important data. Promptly, remove all access rights of employees who quit or are fired

UNIT-2:

UNIT-2

Demand Forecasting:

Demand Forecasting Demand Forecasting is predicting the future demand of the products or services of an organization. To forecast is to estimate or calculate in advance. Planning is a fundamental activity of management. Forecasting forms the basis of planning. Be it planning for sales and marketing, or production planning or manpower planning, forecasts are extremely important. Forecasting is a scientifically calculated guess. It is basic to all planning activity – Whether it is national, regional, organisational, or functional planning; and Whether it is a long range plan or a short-range plan.

Reasons for Demand Forecastiong:

Reasons for Demand Forecastiong Reasons for demand forecasting To offset the actions of competitor organizations. To minimize losses associated with uncontrollable events external to the organization To maximize gains from events which are the results Of actions taken by the organization. To maximize gains From events external To the organization (from the external Environment). To develop policies That apply to people Who are not part of The organization. To develop administrative Plans and policies internal To an organization (e.g., personnel or budget). To provide adequate Staff to support production requirements. As an input to aggregate production Planning and/or materials requirement Planning (MRP). In decision-making For facility capacity planning and for capital budgeting

Methods of Demand Forecasting:

Demand Forecasting Methods of Demand Forecasting Qualitative analysis Quantitative analysis Customer survey Sales force composition Executive opinion Delphi method Past analogy Time Series analysis Casual analysis Trend analysis Simple moving average Simple exponential smoothing Holt’s double- Exponential smoothing Winters’ triple- Exponential smoothing Forecast by linear Regression analysis

Qualitative Methods of Forecasting:

Qualitative Methods of Forecasting There are certain situations in which forecasts have to be prepared quickly without using historical data. At other times, historical data may not be available, resulting in qualitative analysis as the only available forecasting method. For example, in the launch of a new innovative product, there is no data available from past experience on the sales of the product. Thereare five qualitative methods of forecasting. Customer Surveys It is the customers who determines the demand for a product or service. It is practically not possible to identify all the potential customers or to contact all the existing customers, sampling of customers are resorted to. While designing customer survey questionnaires, care has to be taken to frame questions such that the true responses of the customers are solicited. Similarly, the implementation and analysis stages of the survey have to be carefully handled to ensure that the conclusions drawn from the survey reflect the exact pulse of the customers.

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Sales Force composite This approach to forecasting is much less expensive compared to customer surveys. The sales force of a company is in direct contact with the customers. Thus, they may be advised to give their estimates about the likely sales of the product in their region. The marketing manager may compile these estimates for different regions to arrive at the overall estimate of the demand forecast for the product. This approach to forecasting has its disadvantages. The sales person’s estimates may not be as accurate as customer surveys. Executive opinion A jury of top executives of the company from different functional areas such as marketing, finance, human resources, production, etc. are brought together to give their opinion about the forecast of a new product to be launched. This approach to forecasting is particularly suitable for new products, which do not have any past history of sales. In such situations, there is no other option except to depend upon the vast experience of these senior executives in providing the forecast for the new product.

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Delphi method This method is named after an ancient Greek astrologer Delphi. In this method, a questionnaire email is sent to experts from various diversified streams, seeking their opinion on the forecast of a (usually highly advanced technology) product. This method is different from executive opinion, as here the experts may not necessarily be top executives. The experts may be technology forecasters, sales persons with varied experiences in promoting path-breaking high-tech products, etc. The opinions expressed by these experts as responses to the questionnaire are kept anonymous. Thus, even experts on the lower rung of the hierarchy feel free to express their opinions. The responses of the experts are compiled and summarized. Past analogy For forecasting the sales of a new product, an analogy of the sales growth trends of other existing products may be taken. These products may be substitutes of the new product, complementary products, or products related to the consumers belonging to income groups similar to that being targeted by the new product. For example, a watch manufacturing company launching a designer range of watches may study the buying patterns of customers who patronize fashionable sunglasses or clothes designed by high-profile fashion designers.

Quantitaive Methods of Forecasting:

Quantitaive Methods of Forecasting Time Series Analysis In this method, we require a time series of historical demand data with respect to time intervals (periods) in the past to make predictions for future demand. Five popular methods are used in time series analysis: Simple moving average Simple exponential smoothing Holt’s double-exponential smoothing Winters’ triple-exponential smoothing Forecasting by linear regression analysis Simple moving average The simple moving average method of forecasting is suitable under situations where there is neither a growth nor a decline trend, i.e., there is a horizontal trend shown by the actual past data used for forecasting. There can also be seasonal variations in this past data. This method involves finding the simple average of the past data used for forecasting.

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In mathematical terms, moving average forecast can be expresses as F t = A t-1 +A t-2 +….+A t-n n Example 1 Kids Toys (P) Ltd is a toy marketing company at Mumbai. The sales figures (in units) of a particular toy during the past 20 weeks are given. Calculate the four-week and eight-week moving average forecasts for the given 20 weeks. Week Actual demand (units) Week Actual demand (units) 1 1,643 11 2,395 2 1,821 12 2,683 3 2,069 13 1,936 4 1,952 14 2,076 5 2,178 15 2,103 6 1,597 16 1,699 7 1,834 17 2,387 8 1,852 18 1,854 9 1,771 19 1,521 10 2,014 20 1,726

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Week No. Actual Demand (in units) Four Week Moving Average Eight Week Moving Average 1 1634 2 1821 #N/A #N/A 3 2069 #N/A #N/A 4 1952 #N/A #N/A 5 2178 1869 #N/A 6 1597 2005 #N/A 7 1834 1949 #N/A 8 1852 1890.25 #N/A 9 1771 1865.25 1867.125 10 2014 1763.5 1884.25 11 2395 1867.75 1908.375 12 2683 2008 1949.125 13 1936 2215.75 2040.5 14 2076 2257 2010.25 15 2103 2272.5 2070.125 16 1699 2199.5 2103.75 17 2387 1953.5 2084.625 18 1854 2066.25 2161.625 19 1521 2010.75 2141.625 20 1726 1865.25 2032.375 21 1872 1912.75

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Weighted moving average In calculating the simple moving average, actual demand data in all the past periods considered are given equal importance. Sometimes it is felt that while finding the moving average, the data in the recent past periods should be given more weight or importance compared to the data in the periods far off the current time. For example , let us suppose that for a product the actual demand in months 1, 2, and 3 is 20, 30, and 10 units, respectively. For calculating a three-month moving average forecast for month 4, the company may decide to give 50% importance (weight 0.5) to the data in week 3, 30% importance (weight 0.3) to the data in week 2, and 20% importance (weight 0.2) to the data in week 1. Thus, the weighted three-month moving average forecast for week 4 will be given by F 4 = 0.2 x 20 + 0.3 x 30 + 0.5 x 10 = 4 + 9 + 5 = 18 0.2 + 0.3 + 0.5

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Simple exponential smoothing Simple exponential smoothing is the most popular forecasting method. It is very simple in application and, in addition, the past data required is limited to just the last period’s actual demand and its forecast. The forecast using simple exponential smoothing is given by the following equation: F t +1 = ά D t + (1 - ά ) F t where: F t +1 = forecast for next period D t = actual demand for present period F t = previously determined forecast for present period ά = weighting factor, smoothing constant having a value between 0 & 1

Effect of Smoothing Constant:

Effect of Smoothing Constant 0.0   ά   1.0 If  ά = 0.20, then F t +1 = 0.20 D t + 0.80 F t If  ά = 0, then F t +1 = 0 D t + 1 F t 0 = F t Forecast does not reflect recent data If ά = 1, then F t +1 = 1 D t + 0 F t = D t Forecast based only on most recent data

Selection of smoothing constant:

Selection of smoothing constant α can make the difference between an accurate forecast and an inaccurate forecast. forecast error = (actual demand)- (forecast demand)

Exponential Smoothing (α=0.30):

Exponential Smoothing ( α =0.30) F 2 = ά D 1 + (1 - ά ) F 1 = (0.30)(37) + (0.70)(37) = 37 PERIOD MONTH DEMAND 1 Jan 37 2 Feb 40 3 Mar 41 4 Apr 37 5 May 45 6 Jun 50 7 Jul 43 8 Aug 47 9 Sep 56 10 Oct 52 11 Nov 55 12 Dec 54 F 3 = ά D 2 + (1 - ά ) F 2 = (0.30)(40) + (0.70)(37) = 37.9

Exponential Smoothing:

Exponential Smoothing FORECAST, F t + 1 PERIOD MONTH DEMAND (  = 0.3) (  = 0.5) 1 Jan 37 – – 2 Feb 40 37.00 37.00 3 Mar 41 37.90 38.50 4 Apr 37 38.83 39.75 5 May 45 38.28 38.37 6 Jun 50 40.29 41.68 7 Jul 43 43.20 45.84 8 Aug 47 43.14 44.42 9 Sep 56 44.30 45.71 10 Oct 52 47.81 50.85 11 Nov 55 49.06 51.42 12 Dec 54 50.84 53.21 13 Jan – 51.79 53.61

PowerPoint Presentation:

Holt’s double-exponential smoothing Holt’s double-exponential smoothing is suitable when the actual demand follows either a increasing or a decreasing trend. In Holt’s double-exponential smoothing, we use two smoothing constants. One is smoothing constant α , and other is γ , which is used to adjust the trend effect. Forecasting by linear regression analysis Linear regression analysis is applied in situations where two variables are linearly correlated to each other. In time series analysis, the independent variable is time, while the dependent variable is the actual demand in the past. The best-fit line is represented by the straight line equation y = a + bx y = forecast for period x b= slope of the straight line x = specified number of time period

Monitoring and controlling forecasts:

Monitoring and controlling forecasts Once a forecast has been completed, it needs to be monitored and corrected periodically by determining why actual demand differed significantly from that projected. This can be done by setting upper and lower limits on how much the performance characteristic of a forecasting model can deteriorate before we change the parameters of the model. One way to monitor forecasts to ensure that they are performing well is to use a tracking signal. A tracking signal is a measurement of how well the forecast is predicting actual values. tracking signal = running sum of forecast errors (RSFE) /mean absolute deviation(MAD) (OR) tracking signal = forecasting errors/ n

PowerPoint Presentation:

RSFE = (actual demand in period i) – ( forecast demand in period i) MAD = (actual demand in period i – forecast demand in period i)/n n= number of years

Implication of tracking signal:

Implication of tracking signal + tracking signals indicate that demand is greater than forecast. - tracking signals mean that demand is less than forecast. Once tracking signals are evaluated, they are compared with predetermined control limits. When a tracking signal exceeds an upper or lower limit, there is some problem with the forecasting method and hence, the forecasting method must be reevaluted.

Factors to be considered in the selection of a forecasting method are:

Factors to be considered in the selection of a forecasting method are Cost and accuracy Data available Time span Nature of product and services Impulse response

Reasons for ineffective forecasting:

Reasons for ineffective forecasting Not involving a broad cross section in forecasting Not recognizing that forecast will never be correct or accurate Not recognizing the fact the forecasting is integral to business planning Not forecasting the right things Not selecting an appropriate forecasting method Not tracking the performance of the forecasting models models so that forecast accuracy can be improved.

PowerPoint Presentation:

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