Chapter 10 THE PRODUCTION BUSINESS PROCESS TEACHING TIPS I usually gloss over the materials on job costing, for my students have covered job costing in their Cost/Managerial course. I do emphasize the need for good ledger control over property, plant, and equipment. THE PRODUCTION BUSINESS PROCESS Production Planning and Control. A sales order or sales forecast cause the creation of production orders which specify items that should be produced. Materials are requisitioned and production is scheduled. Items are produced, inspected, transferred to finished goods inventory, then transferred to shipping to complete the process. Basic production requirements are provided by the bill of materials and master operations list. Resources available for production are communicated to the production control function through inventory status reports and factor availability reports. The production order serves as authorization for the production departments to make certain products. Materials requisitions are issued for each production order to authorize the inventory department to release materials to the production departments. Production status reports are periodically sent from the production departments to the production control function. Cost Accounting Controls. Job costing is a procedure in which costs are distributed to particular jobs or production orders. In process costing, costs are compiled in process or department accounts by periods (day, week, or month).The cost accounting department is responsible for maintaining a file of WIP cost records. Inventory Control. The control of inventories is accomplished through a series of inventory records and reports that provide such information as inventory use, inventory balances, and minimum and maximum levels of stock. A reorder point is the level of inventory at which it is desirable to order or produce additional items to avoid an out-of-stock condition. The economic order quantity (EOQ) must balance two system costs—total carrying costs and total ordering costs: EOQ = economic order quantity (units) R = requirements for the item this period (units) S = purchasing cost per order P = unit cost I = inventory carrying cost per period, expressed as a percentage of the period inventory value Then ___________ / 2 x R x S \/ P x I

EOQ =

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Lean Production is a term used to describe a production system in which parts are produced only as they are required in subsequent operations. The concept of lean production is based on the concept that inventory is waste. Lean production systems expose the hidden causes of maintaining inventory. Property Accounting Applications Fixed Assets. Every organization, including those on a cash basis, should keep a ledger of fixed assets as an aid to effective control. A fixed asset register is a systematic listing of an organization's fixed assets. There are four objectives of fixed asset or investment accounting applications: 1. Maintain adequate records that identify assets with description, cost, and physical location. 2. Provide for appropriate depreciation and/or amortization calculations for book and tax purposes. 3. Provide for reevaluation for insurance and replacement cost purposes. 4. Provide management with reports for planning and controlling the individual asset items. Investments. The investment register should contain all relevant information, such as certificate numbers and the par value of securities, to facilitate identification and control. QUICK RESPONSE MANUFACTURING SYSTEMS Components of Quick Response Manufacturing Systems The Physical Manufacturing System. Two subsystems directly support the physical manufacturing system. These include the CADD (computer-aided design and drafting) and CAM (computer-aided manufacturing) systems.. Some CAM systems, called flexible manufacturing systems (FMS), incorporate programmable production processes that can be quickly reconfigured to produce different types of products. FMS can significantly contribute to the overall speed in which a system responds, for it can greatly speed up time-consuming retooling. The Manufacturing Resource Planning (MRP II) System. The MRP II system comprises the materials requirements planning (MRP) system and the related systems for sales, billing, and purchasing. But the MRP system is the heart of the MRP II system. Advanced Integration Technologies. Automatic identification enhances integration because electronically tagging products and materials effectively makes them machine-readable and thus physically part of the organization's computer-based information system. Radio Frequency Identification, or RFID, is an automatic identification technology that uses low power radio waves to send and receive data between RFID tags and readers. EDI enhances integration because it effectively integrates the company's system with the systems of its suppliers and customers. Distributed processing enhances integration because it logically and physically combines geographically dispersed information resources into a single system. Transaction Processing in Quick Response Manufacturing Systems Production Planning. Production planning involves the determination of which products to produce and the scheduling of production to make optimal use of production resources. The master production plan is processed against the production-status, bill-of-materials, and master-operations files. This processing generates production order files, materials requisitions, and routings, and also updates the production-status file. The production-status file contains

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both accounting data and operational data pertaining to the status of production orders. This file integrates production-order data pertinent to the stage-of-completion; the production-status file is a major input to the scheduling and cost accounting applications. The bill-of-materials file contains a record for each product manufactured. Each record contains the detailed material requirements and standard material cost of the product identified by the record's key value. The master-operations file contains similar data related to each product's detailed labor and machine operation requirements and their sequencing through the production process. Standard times and costs are also contained in the master-operations file. The production-planning application program integrates data from the master production plan, bill-of-materials file, and master-operations file and generates the necessary production-order documents — detailed production orders, materials-requisition forms, and routings (RTGs) to guide the flow of production. RTGs indicate the sequence of operations required to manufacture a product. RTGs contain information about the work center, length of time, and tooling required to perform each task. Production Scheduling. Routing (RTG) data concerning current production status is collected in the factory departments as work progresses. RTG data may be collected in different ways. RTGs may be output as turnaround documents by the production-planning application. RTGs are filled in by the factory departments as work progresses on specific production orders. Each RTG contains a production-order number and a format for specifying the work completed on an order. The production-loading file is the major input to the production-scheduling application. This file is processed by the scheduling application program to produce production schedules. The scheduling application program may simply accumulate and print reports showing total labor and machine operation requirements for each department/work center. In MRP systems, the scheduling application program would include the use of linear programming or other decisionsupport techniques to relate resource availabilities within each department or work center to overall production requirements to generate a schedule that represents an optimal assignment of available resources to production. Cost Accounting. The central feature of the cost-accounting application is the updating of the production-status (Work-In-Process) file. The outputs of the cost-accounting program include the following items:  an updated production-status file  a completed production-order file  a resource usage file  a summary report Reporting. The completed production-order file lists all cost data for completed production orders. Outputs of processing this file include an updated finished-goods inventory file, a finished-goods stock status report, a completed production-order cost summary, and a summary report that includes batch and application control information as well as the summary journal entry data debiting finished goods and crediting Work-In-Process for the standard cost of goods completed.

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Activity-Based Costing. Traditional cost accounting techniques may be inadequate in a CIM environment. CIM significantly alters a manufacturer's cost-behavior patterns by causing a substitution of capital equipment for direct labor. For a CIM environment, products manufactured with costly automated machinery, which contributes greatly to overhead costs, typically have the lowest number of direct labor hours associated with their production. Activity-based costing (ABC) calculates several overhead rates, one for each manufacturing activity, and uses these rates to build product costs from the costs of the specific activities that are undertaken during production. MRP II versus MRP. Extensions to routings file processing in MRP II might include expanded data concerning work center capacity data, maintenance of machine tooling data, and maintenance of numerical machine control data from the CADD system. Extensions to production order processing in MRP II might include the creation of transaction files and numerical machine control tapes for the plant floor. ERP, ERP II, and EAS. These more advanced systems incorporate all the functionality of MRP and MRP II, but they also integrate all other major business processes into a single system. Implementing Lean Production in a MRP II/CIM Environment. In a batch production environment, manufacture of specific products is sporadic. Batches of similar products are periodically assembled to satisfy present and planned future needs. Setup costs are usually incurred every time a batch is produced, and these costs are typically the same regardless of the proposed size of the batch production run. As the word "planned" indicates, a batch environment fosters a "push" concept of manufacturing efficiency. Economic (i.e., efficient) batch size is derived by using formulas (i.e., economic order quantity models) or is output from a computer simulation or computational model. Special Internal Control Considerations. Quick response manufacturing systems, similar to other totally computerized systems, intensify certain internal control problems. Transactions may be processed without human intervention or approval. This eliminates conventional controls associated with separation of duties in transactions. Thus, a major consideration is to ensure that such controls, or their equivalents, are an integral part of a quick response manufacturing system. Computer processing in general, and EDI in particular, eliminates human-oriented paper documents. There are challenging validation and authenticity problems concerning the operation of paperless processing systems, both within a firm (e.g., electronic production order) and in its exchanges with its trading partners (EDI and EFT). Extensive control and audit trails may be implemented in quick response manufacturing systems, but these features must be included within the design and development of the system. It is neither feasible nor desirable to install controls in a computer-based information system after it has been implemented.

The Production Business Process 10 REVIEW QUESTIONS

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1. Job costing is a procedure in which costs are distributed to particular jobs or production orders. In process costing, costs are compiled in process or department accounts by periods (day, week, or month). At the end of each period, the cost of each process is divided by the units produced to determine the average cost per unit. 2. WIP is increased for production costs and decreased when production is completed. Production cost entries debit WIP and credit stores (material), payroll, and manufacturing overhead. Completed production is evidenced by a debit to finished goods inventory and a credit to WIP. 3. A bill of material lists the raw materials that are necessary to produce a product. A reorder point is the level of inventory at which it is desirable to order or produce additional items to avoid an out-ofstock condition. The reorder quantity must balance two system costs—total carrying costs and total ordering costs. A master operations list identifies and specifies the sequencing of all labor operations and/or machine operations that are necessary to produce a product. 4. Internal control over inventories and production is based on separation of functions and basic records and documentation, such as production orders, material requisition forms, and labor time cards. Protection of inventories from physical theft involves security and access provisions as well as periodic physical counts and tests against independent records. 5. The production order serves as authorization for the production departments to make certain products. A copy of the production order is sent to the cost accounting function to establish a WIP record for each job. 6. JIT systems differ from conventional production systems in that inventories of work-in-process, raw materials, and finished goods are minimized or totally eliminated. 7. There are four objectives of fixed asset or investment accounting applications: 1. Maintain adequate records that identify assets with description, cost, and physical location. 2. Provide for appropriate depreciation and/or amortization calculations for book and tax purposes. 3. Provide for reevaluation for insurance and replacement cost purposes. 4. Provide management with reports for planning and controlling the individual asset items. 8. Fixed assets and investments should be recorded in a ledger as an aid to effective control. Assets themselves should be labeled with identifiers linked to the fixed asset register. 9. Several entries must be made when an asset is disposed of. The first records the date of disposal. The second entry removes the original cost of the asset in the current period. A third entry removes the accumulated depreciation taken to date. 10. 11. 12. CIM integrates the physical manufacturing system with the MRP II (resource planning) systems. MRP II includes MRP plus the related systems for sales, billing, and purchasing. CADD can provide many support functions such as simulation and testing.

13. CAM can control robots used to automatically generate products, and also to automatically scan cost data and generate reports.

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14. Automatic identification could be used (for example) to scan work orders at the stores department and to physically track products as they flow through production. 15. MRP II systems involve production planning, scheduling, cost accounting, and reporting. They must also interface with other systems such as sales and billing. 16. ABC costing involves breaking the production process down into a series of operations and assigning overhead and other costs to each operation. CIM operations typically involve many operations, so ABC costing often helps provide better cost collection and control in CIM environments. ANSWERS TO DISCUSSION QUESTIONS AND PROBLEMS 17. - 32. Multiple-Choice Varies 17. A 18. A 19. D 20. D 21. B 22. B 23. B 24. C

25. A 26. D 27. B 28. C 29. A 30. D 31. D 32. B

33. EOQ - 20 minutes Easy CMA Examination, Unofficial Answer In order to compare the two alternatives, the carrying costs and the production initiation costs must be calculated for each alternative. These two amounts are calculated as follows: Carrying costs = annual carrying cost (20%) x standard manufacturing cost ($50) x average inventory Production initiation costs = number of runs x cost to initiate a run ($300) Current Situation 2 production runs of 3,000 units per run Average inventory = 3,000 / 2 = 1,500 units Present costs: Carrying costs (.20 x $50 x 1,500) Production initiation costs (2 x $300) Total cost

$15,000 600 $15,600

The Production Business Process 10 Proposed situation The EOQ formula as it applies to inventories can be used to determine production run quantities by substituting "cost per order" with "production initiation costs." ______________ / 2 x 6,000 x $300 = \/ 50 x .2 ______ = \/ 360,000 =

169

Production quantity

600 units

Average inventory 600/2 = 300 units Number of runs 6,000 / 600 = 10 runs Proposed costs: Carrying costs (.20 x 50 x 300) Production initiation costs (10 x 300) Total cost Expected annual cost savings

$3,000 3,000 $6,000 $9,600

34. EOQ - 25 minutes Medium CIA Examination, Unofficial Answer a. (1) The increase in demand for an inventory stock item means that quantities on hand will be exhausted more quickly. With no change in lead time, the reorder level would have to be increased to assure stock being on hand until an order that was placed can be filled. (2) The economic order quantity would also increase because the increased usage would force an increase in total ordering costs, making it more economical to order in larger quantities. In the EOQ equation ____ / 2AS \/ R where S = the total annual usage in dollars, an increase in S will result in an increase in EOQ. b. (1) A decrease in the cost of capital would have no effect on the reorder point, but would make it economical to carry larger average inventory amounts, which, in turn, would be the result of placing larger orders. (2) EOQ would increase. In the equation, ____ / 2AS \/ R R is the carrying cost expressed as a percentage of the dollars invested in inventory. A decrease in cost of capital would cause a decrease in R. c. (1) The salary increase of purchasing and receiving personnel would have no effect on the reorder point; but the increased ordering costs that would result would, in part, be compensated by placing fewer orders for larger quantities.

170 (2)

10 The Production Business Process Again, the result is indicated by the EOQ equation ___ / 2AS \/ R where A is the cost of ordering and where an increase in A will cause an increase in EOQ.

35. Work Order Application - 1 Hour Medium CMA Examination, Unofficial Answer a. (1) Data items, which should be included on a Repair/Maintenance work order document, are as follows: . Job Identification - department (or plant) in which work is to be done, machine or work station, and general description of job. . Starting and completion dates - both estimated and actual. . Materials and supplies data - estimated and actual quantities and costs. . Labor data - estimated and actual hours and cost and employee number for each job or person completing the work. . Applied overhead. (2) At least four copies of the work order would be required with a possible fifth copy needed if a work order summary is not prepared. The work order would be prepared in the R & M Department and given to the supervisor for review and scheduling. The work order would then be used by the person responsible for the work for the recording of actual hours spent on the job and actual materials and supplies required to complete the job. After the job is completed, the work order would be forwarded to accounting for costing and charging. The distribution of each copy of the work order would be as follows: . Original (Copy l) - Once the job is completed and all data has been recorded on the work order, this copy is forwarded to the Accounting Department for costing and then filed in the Accounting Department. . Copy 2 - This copy is also fully completed and is filed in the R & M Department in a completed work order file. . Copy 3 - This copy would be kept by the R & M Department in a file of scheduled jobs until the work is complete. A reference file is needed for all work orders while the job is in process. Once this job is completed, Copy 3 would be attached to Copy 2 and filed with Copy 2. . Copy 4 - This copy would be sent to the production department where the work is being done to acknowledge the actual scheduling of the job. An evaluation of the performance of the R & M Department would probably be done in three departments as explained below. . The production department which requests the work should compare the estimated charges indicated on the Work Order Request with the actual charges and the timelines on the work (i.e., the estimated and actual starting and completion times on the Work Order). If the work is not timely or if the actual charges vary considerably from the estimate, the management of the production department would contact the supervisor of the R & M Department for an explanation. The supervisor of the R & M Department would conduct a self-evaluation by comparing the Work Order Request and the completed Work Order. The supervisor would want to be sure the actual times and charges were close to the original estimates. Such a comparison would be important for evaluating the staff in the department, and also for

.

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.

preparing future estimates. The Accounting Department (or some other appropriate department) would probably conduct a review of the R & M Department's work. The estimates and actual results shown on the Work Order would be compared. Types of repair and maintenance jobs, which have standard times for completion, could be compared with actual times required for the work in order to evaluate the department's performance.

b.

Flowchart. See following page.

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36. Systems Development - 45 minutes Hard a. There are many variations possible in preparing the standard journal entries that Fred Beam, the controller of the Wadswad Corporation, could use to document how the expected outputs of the new system for work-in-process accounting will impact on the general ledger. There should be two basic standard journal entries, one to debit work-in-process for manufacturing costs and the second to credit work-in-process for the cost of completed production. Standard Journal Entry (1) Manufacturing Costs Debit: Work-in-process Inventory Credit: Raw Materials Inventory Credit: Accrued Payroll (direct labor) Credit: Applied Overhead Control While the debit to work-in-process is straightforward, there are many possible variations in the credits. The credit to Raw Materials Inventory might be made to Stores, or even possibly to Purchases. The credit to Accrued Payroll for direct labor cost has several variations, a common one being to credit a Payroll Clearing or Payroll Summary account. The credit to Applied Overhead Control might be made instead to either Factory (or Manufacturing or Production) Overhead Control (i.e., actual). Of course one might make three separate entries, one each for materials, labor, and overhead, rather than use a single compound entry as shown above. Standard Journal Entry (2) Cost of Completed Production Debit: Finished Goods Inventory Credit: Work-in-process Inventory While both the basic debit and the basic credit are straightforward in this case, there is a major complication which the instructor (or students) might raise concerning the accounting for spoilage. The indicated entry would account for spoilage by the method of omission. That is, any spoilage is simply omitted in calculations. If one wishes to include an accounting for both normal and abnormal spoilage, then the basic entry might appear as follows: Standard Journal Entry (2-a) Cost of Completed Production (with spoilage) Debit: Finished Goods Inventory Debit: Cost of Abnormal Spoilage Credit: Work-in-process Inventory

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10 The Production Business Process In this case the cost of normal spoilage is calculated and added to the cost transferred to Finished Goods Inventory. In some cases, the cost of normal spoilage is debited to Overhead Control (and the overhead rate includes a charge for anticipated normal spoilage) and in some cases, the net disposal value of spoilage is calculated and debited to the Stores (or Materials Inventory account). With these factors, the standard journal entry might appear as follows: Standard Journal Entry (2-b) Cost of Completed Production (with spoilage, part 2) Debit: Finished Goods Inventory Debit: Cost of Abnormal Spoilage (net) Debit: Overhead Control (normal spoilage (net)) Debit: Stores (disposal value of spoilage) Credit: Work-in-process Inventory Other entries are possible, but this should suffice as a reasonably complete discussion of the topic. One should note that the basic file structure includes data concerning spoilage, but the accountant would have to determine several other statistics (i.e., data concerning percent complete) to develop the data for the standard journal entry.

b.

In addition to accounting-related data, the system will output several other types of information, which should be useful to management. This is a major advantage of computer processing of accounting data: the ability to produce other types of useful data as a byproduct of preparing the accounting records. Spoiled production reports are to be prepared by the system. Units spoiled in production for each job will be posted to the master work-in-process file and accumulated for each job. Special messages will be printed during processing if the spoilage rate exceeds management's expectations. Management's expectation (such as a rate of 15 percent) is included as a parameter in the work-in-process program. This type of processing is a good illustration of the concept of management by exception. When a job is complete, the computer system will report the total cost of the job and also the per unit cost. The date of completion will be compared to the expected date of completion, field 7 in the master work-in-process file. Special messages will be printed during processing if a job is completed late. This type of processing is another example of the concept of management by exception.

37. Property Accounting System - 30 minutes Medium CMA Examination, Unofficial Answer a. Four major objectives the automated property system should possess include: Completeness. Records for all fixed assets owned by Deake Corporation need to be included in the system. Completeness is important because the users of the information derived from the system will assume the data in the system are complete and all fixed assets are recorded. If all fixed assets are recorded in the system, a reconciliation of the physical inventory of all fixed assets with the records will reveal any disappearances or losses. In order to assure complete records, controls must be established so that all fixed assets are updated, and records cannot be deleted without proper authorization. Accuracy. Accuracy in establishing records and updating them based upon current transactions

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(improvements, maintenance, depreciation, additions, disposal) are very important if users are going to rely on the information generated from the system for decisions. Timeliness. Transactions affecting the fixed assets records should be processed as quickly as possible. Users of the information will assume that all events pertaining to the fixed asset records are reflected in the records. In addition, requests for information from the system should be handled as expeditiously as possible. Information has to be provided on a timely basis to users if the information is to be useful for decision-making purposes. Flexibility. The property account system should be designed to permit additions, revisions, and changes to be made without the system needing to be redesigned and redeveloped completely. This flexibility is needed should the company's needs change in the future. b. The data items, which should be included in the computer record for each fixed asset owned by Deake, include: Descriptive data Name of asset Manufacturer Model and serial number Asset class code Company assigned asset number General ledger account number Location data (plant, department, building) Acquisition date Original cost Data for book depreciation Data for tax depreciation Maintenance record Cycle Date Amount

38. Systems Implementation - 20 minutes Easy a. The problem which Yard Company has experienced in implementing the use of numerically-controlled machines in its production operations stems from errors in the programming and subsequent operation of the numerically-controlled machines, which have created conflicts between the programmers and the artisans. Total production costs have increased rather than decreased, and management is aware that both the programmer and the artisans are blaming each other for the company's problems. Machine programmers and artisans are segregated not only by physical location and operational function, but also by educational and vocational background as well as age. Programming the numerically-controlled machines requires skills, which are most readily obtained by studying computer science in college or a trade school. As none of the artisans employed by the Yard Company had the necessary background, it was necessary to hire recent college graduates to program the machines. The programmers are much younger than most of the artisans and very different in terms of their backgrounds and career objectives. It was thus very difficult for the two groups to communicate. Since effective communication between system designers (i.e., the programmers) and the users (i.e., the artisans) is required to successfully implement an information system, Yard Company has experienced problems.

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10 The Production Business Process A solution to Yard Company's problem depends on improving the relationship between the artisans and the programmers. These two groups must be able to communicate effectively if the new system is to operate profitably. This task in improving human relations in the workplace may not be easy as the two groups are so different. The inherent problem stems from the nature of computer system analysis and design. Special skills are required to perform these functions, but they also require an in-depth understanding of the user's problem. This problem is particularly acute in the implementation of a man-machine system such as the numerically-controlled machines because the interfaces between the system design and the user are so tight. The artisans immediately experience the slightest error by the programmers. Programming the numerically-controlled machines requires a degree of education which none of the artisans possess. And the programmers themselves do not have the skills of the artisans. The ideal candidate to design and implement (i.e., program) the system in Yard Company's situation would be either an artisan who had the required programming skill or a programmer who had the required artisan skill. Neither of these two types of person is, unfortunately, likely to be readily obtainable. Thus, communication between these two groups must improve to overcome this inherent problem in the implementation of computer systems.

39. Activity-based Costing - 20 minutes Medium a.
Overhead Base Rate Material Handling $200,000 40000 $5

Robotic Assembly $400,000 5000 $80

All Other $400,000 20000 $20

Product X Y Z -----------------------------------------------------------# of Parts 10 15 20 Robot Hours 3 0 1 Labor Hours 0 4 2 ABC Costs Material Labor ($30/hour) Overhead: # of Parts Robot Hours Labor Hours Total $200 $0 $50 $240 $0 $490 $200 $120 $75 $0 $80 $475 $200 $60 $100 $80 $40 $480

b.

Allocation bases for activity costs should be identified informally through a cause and effect (i.e., cost incurrence) or benefits received analysis, or more formally through the use of statistical regression techniques.

40. Document Flowchart - 15 minutes Easy A. Inventory status reports B. Production authorizations C. Production orders D. Material requisitions

The Production Business Process 10 41. Asset Retirement Scenarios – 30 Minutes Hard

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Scenario Summary
Current Values: A B C

Changing Cells: $B$5 $B$6 Result Cells: $B$8

$2,000 12% $540,585

$1,000 4% $58,328

$1,500 6% $125,703

$2,000 12% $540,585

WEB RESEARCH ASSIGNMENTS 42. Lean accounting is consistent with lean manufacturing, which focuses on cutting waste, eliminating inventories, controlling processes, and allocating only direct costs or costs organized by value stream. ABC accounting, on the other hand, tends to focus on allocating full costs based on activities. See the July 2004 article published in Journal of Accountancy (www.journalofaccountancy.com) by Karen M. Kroll. In a given application, the two approaches can have much in common, as ―activities‖ and the value stream can coincide. 43. E-Z-MRP™ as targeted towards small manufacturers. The main issue with this product is the effort to integrate with one’s existing accounting system. On the other hand, ERP systems such as SAP One come with financial accounting and ERP fully integrated. 44. Toyota is well known for using all the latest technologies, including robotics (FMS). A lot has been written about Toyota’s manufacturing and accounting systems. A Web search reveals a wealth of materials. 45. A virtual enterprise is a partnership between multiple companies. The ability for companies to quickly set up virtual enterprises depends on their ability to interface and integrate their operations and information systems. EDI-type technologies (e.g., ebXML) can be a big help. Whereas the extended supply chain focuses on vertical integration, the virtual enterprise may also focus on horizontal integration. The SAP application suite is built on a service-oriented architecture. Obviously, two companies both using SAP would find it relatively easy to collaborate. However, SAP has interfaces to communicate with other companies using a wide variety of protocols, so it’s not necessary that all collaborating companies use SAP. Oracle software provides another viable alternative.

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