Chapter 3
Operating
Processes:
Planning and
Control
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
Operating Processes
• Revenue Process
 Activities that involve CUSTOMERS
• Expenditure Process
 Activities that involve SUPPLIERS
• Conversion Process
 Activities of the production process
What are the Goals of the Revenue
Process?
• Provide customers with products/services
they want at a price they are willing to pay
• Receive payment from customers in a
timely manner
• Provide customer support before and after
the sale to ensure future sales
3-3
What are the 5 Primary Activities in
the Revenue Process?
1. Determine marketing and distribution
channels
2. Receive and accept orders
 Sales Discount
3. Deliver goods/services
 FOB shipping versus FOB destination
4. Receive payment from customers
5. Provide customer support
 Sales returns and allowances
3-4
Generate Sales
• Marketing a product begins before it is
developed.
 Market Analysis
• Customer buying habits, survey preferences
 Distribution
• How to sell product, how to get good to customer
Receive and Accept Orders
• Determine the credit and payment
 Obtain credit approval for customer if initial
sale
 Sales Discount
• To encourage customers to pay credit balance
early
• Pay less than full invoice if paid early
• Determine if the goods are available
 Inventory available?
 How quickly can it be obtained?
Cash vs. Credit Sales
• Cash Sales
 Simplest sales transaction
 Direct exchange
• Cash for product or service
 Outside credit card = cash sale
• Card company assumes risk of collection
• Credit Sales
 Complexity depends on business’ policy
 Business’ charge card = credit sale
• Business bears the risk of nonpayment
Deliver Goods / Services
• Bill of Lading
 Shipping agreement between the business
and carrier
• Rates, responsibilities, tracking
• Free on Board (FOB) Destination
 Legal title to the goods does not pass until the
customer receives the goods
• Seller responsible for freight charges
• FOB Shipping Point
 Goods belong to customer when picked up
• Buyer responsible for charges
Receive Payment
• The company must bill the customer and
then record the receipt from the customer
• Sales Invoice
 Sent to the customer as a bill
 Includes
•
•
•
•
•
Quantity
Type of Good
Price
Sales Agreement
Purchase Order Number
Provide Customer Support
• Often free to customer with purchase
 Support customers after the sale by providing
customer training, etc.
 Service provided and costs must be recorded
• Sales Return
 Customer may return defective or unwanted
product
• Sales Allowance
• Reduction in the selling price as compensation for
unhappiness with product or service
What are the Goals of the
Expenditure Process?
• Receive the highest quality goods/services
at the lowest cost when needed
• Pay for goods/services in a timely manner
• Develop good relationships with suppliers
of goods/services
3-11
What are the 4 Primary Activities in
the Expenditure Process?
1. Determine the need for goods/services
2. Select suppliers and order goods/services
3. Receive the goods
 Purchase returns and allowances
4. Pay for goods/services
 Purchase discounts
3-12
Determine the Need
• Have a person(s) authorized to order
goods for other areas of the business
• Purchase Requisition
 Document used as an internal control used to
list type and quantity of item(s) needed
Select Suppliers and Order
• Determine where to buy the items it needs
 Quality
• Goods exactly as specified, free of defects
 Availability/Service
• Timing and Quantity
 Price
• Sometimes must pay to meet other demands
• Purchase Order
 Quantity and description, plus other terms
Receive Goods
• Inspect to ensure goods meet agreed upon
terms
• Store and secure the items once accepted
• Purchase Return
 Send back item(s) to supplier
• Purchase Allowance
 Reduction in purchase price because
unsatisfied with product/service
Pay Suppliers
• Pay only for goods ordered and received
• Pay in time to receive any available
purchase discounts
• Purchase Discounts
 Offered to encourage paying bills in timely
fashion
 Delay until latest possible time in discount
period
What are the Goals of the
Conversion Process?
• Manufacture the highest quality products
• Utilize labor and other manufacturing
resources in an efficient and effective
manner
3-17
What are the 4 Primary Activities in
the Conversion Process?
1. Schedule production
2. Obtain raw materials
3. Use labor and other manufacturing
resources
 Manufacturing overhead
4. Store finished goods until sold
3-18
Schedule Production
• Must decide
 What product(s)?
 What quantity?
 When?
Obtain Direct Materials
• Direct materials requisitioned from the
secured-storage location by an authorized
person(s)
 Direct Material
• Material that is directly traceable to the final product
• Car – Steel, Gasoline – Crude Oil, Furniture - Glue
Use Labor and Other Manufacturing
Resources
• Labor and other resources (machines,
electricity, etc.) convert direct materials
into finished products
• Manufacturing Overhead
 Cost of all indirect manufacturing resources
• Machines, electricity, etc.
Store Finished Goods Until Sold
• Try to minimize the time that finished
goods are stored
• Just In Time
 Products are manufactured only as customers
order them
 Eliminate finished good inventory
• Reduce cost
Cost and Revenue Behavior
• Cost Behavior
 How a cost reacts to changes in the level of
operating activity
• Revenue Behavior
 How a revenue reacts to changes in the level
of operating activity
• To predict cost and revenue in the future,
must understand how they change in
response to changes in operating activity
What are the Basic Concepts in
Determining Cost/Revenue Behavior?
• Behavior pattern
 Relationship between X (activity) and Y (cost
or revenue)
 Y=a+b*X
• a = intercept – where the line begins on y axis
• b = slope – rise/run
• Relevant range
 Normal range of activity
 Can only consider operating activity in this
span
• Can only solve for activity that falls within the range
3-24
Basic Concepts in Determining
Cost/Revenue, Cont.
• Activity driver
 Way of measuring the consumption or
provision of resources
 Activity that is assumed to cause
changes in revenues or costs
What is a Fixed Cost or Revenue?
• Does not change in total as the amount of
activity driver changes throughout the
relevant range (constant)
• On a per “unit” of activity over the relevant
range, it does not change
$
Activity
3-26
What is a Variable Cost or
Revenue?
• Changes in total (proportionately) in the
amount of activity driver throughout the
relevant range
• Constant per “unit” of activity over the
relevant range
$
Activity
3-27
What is a Mixed Cost or Revenue?
• Changes in total (but not proportionately)
to a change in activity driver over the
relevant range
• Changes per “unit” over the relevant range
• Includes a fixed and a variable component
$
Activity
3-28
High/Low Method
• Use past data about costs (revenues) and
the associated drivers to determine a total
cost formula which then is used to predict
costs in the future.
• Cost Formula:
 total cost = fixed cost + (variable cost x activity
level)
How can we Use the High/Low Method
to Determine the Components of a
Mixed Cost/Revenue?
• Uses only 2 data points from the available
data
 Highest level of ACTIVITY DRIVER
 Lowest level of ACTIVITY DRIVER
• Determine the cost (revenue) associated
with the highest and lowest activity levels
• Do not use any of the other activity or cost
(revenue) data
3-30
High/Low Method Continued
• Determine the variable component by
dividing the change in cost (revenue) by
the change in activity driver (rise over run)
• Determine the fixed component by using
the variable component, (activity driver),
and the cost (revenue) in the equation and
solving for the unknown amount, fixed
component
3-31
Lecture Example
1.What type of cost/revenue is represented by each of the following data sets?
Fixed, Variable, or Mixed?
Data Points
Activity Level
Dollars
1
2
3
4
5
6
35,000
40,000
37,500
45,000
42,000
32,500
$50,000
$50,000
$50,000
$50,000
$50,000
$50,000
Data Points
Activity Level
Dollars
1
2
3
4
5
6
10,000
12,000
15,000
11,000
13,500
16,500
$20,000
$24,000
$30,000
$22,000
$27,000
$33,000
Data Points
Activity Level
Dollars
1
2
3
4
5
6
5,000
6,000
5,500
7,500
8,000
6,500
$17,000
$20,000
$18,500
$24,500
$26,000
$21,500
Lecture Example
2.
A company experienced the following activity levels and associated revenues:
Use the high/low method to determine the total revenue equation.
Data Points
Activity Level
Dollars
1
12,700
$13,000
2
8,300
$8,500
3
10,500
$10,700
4
15,600
$15,800
5
9,200
$9,700
6
11,700
$12,000