CHAPTER20InventoryManagement,Just-in-Time,andSimplifiedCostingMethodsChapter20learningobjectivesIdentifysixcategoriesofcostsassociatedwithgoodsforsaleBalanceorderingcostswithcarryingcostsusingtheeconomic-order-quantity(EOQ)decisionmodelIdentifytheeffectoferrorsthatcanarisewhenusingtheEOQdecisionmodelandwaystoreduceconflictsbetweentheEOQmodelandmodelsusedforperformanceevaluation20-2Chapter20learningobjectives,cont’dDescribewhycompaniesareusingjust-in-time(JIT)purchasingDistinguishmaterialsrequirementsplanning(MRP)systemsfromjust-in-time(JIT)systemsformanufacturingIdentifythefeaturesandbenefitsofajust-in-timeproductionsystem20-3Chapter20learningobjectives,concludedDescribedifferentwaysbackflushcostingcansimplifytraditionalinventory-costingsystemsUnderstandtheprinciplesofleanaccounting20-4InventoryManagementin

OrganizationsInventorymanagementincludesplanning,coordinating,andcontrollingactivitiesrelatedtotheflowofinventoryinto,through,andoutofanorganization.20-5CostsAssociatedwith

GoodsforSale,overviewManaginginventoriestoincreasenetincomerequireseffectivelymanagingcoststhatfallintothesesixcategories:Purchasingcosts.Orderingcosts.Carryingcosts.Stockoutcosts.Qualitycosts.Shrinkagecosts.20-6CostsAssociatedwith

GoodsforSale,detailsPurchasingcosts—thecostofgoodsacquiredfromsuppliers,includingincomingfreightcosts.Usuallythisisthelargestcostcategoryofgoodsininventory.Orderingcosts—thecostsofpreparingandissuingpurchaseorders,receivingandinspectingtheitemsincludedintheorders,andmatchinginvoicesreceived,purchaseorders,anddeliveryrecordstomakepayments.20-7CostsAssociatedwith

GoodsforSale,details,cont’dCarryingcosts—thecoststhatarisewhilegoodsarebeingheldininventory.Thesecostsincludetheopportunitycostoftheinvestmenttiedupininventory,andcostsassociatedwithstorage.Stockoutcosts—thecoststhatarisewhenacompanyrunsoutofaparticularitemforwhichthereiscustomerdemand(stockout).Thecompanymustactquicklytomeetthedemandorsufferthecostsofnotmeetingit.20-8CostsAssociatedwithGoodsforSale,details,concludedCostsofQuality–thecostsincurredtopreventandappraise,orthecostsarisingasaresultof,qualityissues.Recallfromchapter19,therearefourcategoriesofqualitycosts:Prevention.Appraisal.Internalfailure.Externalfailure.Shrinkagecosts—coststhatresultfromtheftbyoutsiders,embezzlementbyemployees,misclassificationsandclericalerrors.Shrinkageismeasuredbythedifferencebetweenthecostofinventoryonthebooksvsthecostofthephysicalcount.20-9TheFirstStepinManaging

GoodsforSale:theeconomicorderquantityThefirstdecisioninmanaginggoodsforsaleishowmuchtoorderofagivenproduct.Economicorderquality(EOQ)isadecisionmodelthatcalculatestheoptimalquantityofinventorytoorderunderagivensetofassumptions.20-10BasicEOQAssumptionsThereareonlyorderingandcarryingcosts.Thesamequantityisorderedateachreorderpoint.Demand,purchase-orderleadtime,orderingcosts,andcarryingcostsareknownwithcertainty.Purchasingcostsperunitareunaffectedbythequantityordered.(Therefore,purchasingcostsareirrelevant.)Nostockoutsoccur.Managersconsiderthecostsofqualityandshrinkagecostsonlytotheextentthatthesecostsaffectorderingorcarryingcosts.20-11EOQFormula-resultsinthequantitythatminimizesannualrelevanttotalcostsD=DemandinunitsforspecifiedperiodP=RelevantorderingcostsperpurchaseorderC=RelevantcarryingcostsofoneunitinstockforthetimeperiodusedforD20-12OrderingandCarryingCostsIllustrated20-13Whentoorder(assumescertaintyofdemandandleadtime)Theseconddecisioninmanaginggoodsforsaleiswhentoorderagivenproduct.Reorderpoint—thequantitylevelofinventoryonhandthattriggersanewpurchaseorder.20-14OrderingPointsIllustrated20-15SafetyStock(demandandleadtimeuncertain)SafetystockisinventoryheldatalltimesregardlessofthequantityofinventoryorderedusingtheEOQmodel.Safetystockisabufferagainstunexpectedincreasesindemand,uncertaintyaboutleadtime,andunavailabilityofstockfromsuppliers.Managersuseafrequencydistributionbasedonpriordailyorweeklylevelsofdemandtocomputesafety-stocklevels.20-16EstimatingInventory-RelatedRelevantCostsandtheireffectsTherelevantcostsarecategorizedasfollows:Carryingcosts–seenextslideStockoutcosts–thecostofexpeditinganorderfromasupplierOrderingcosts–thoseorderingcoststhatchangewiththenumberofordersplaced20-17CarryingCostsRelevantinventorycarryingcostsconsistofrelevantincrementalcostsandtherelevantopportunitycostofcapital.Relevantincrementalcosts—thosecostsofthepurchasingfirmthatchangewiththequantityofinventoryheld.20-18OpportunityCostsRelevantopportunitycostofcapital—thereturnforegonebyinvestingcapitalininventoryratherthanelsewhere.Itiscalculatedastherequiredrateofreturnmultipliedbytheper-unitcostsofacquiringinventory,suchasthepurchasepriceofunits,incomingfreight,andincominginspection.Opportunitycostsarealsocomputedoninvestmentsiftheseinvestmentsareaffectedbychangesininventorylevels.20-19CostofaPredictionErrorThreestepsindeterminingthecostofapredictionerror:Computethemonetaryoutcomefromthebestactionthatcouldbetaken,giventheactualamountofthecostperpurchaseorder.Computethemonetaryoutcomefromthebestactionbasedontheincorrectamountofthepredictedcostperpurchaseorder.Computethedifferencebetweensteps1and2.20-20Just-in-TimePurchasingJust-in-time(JIT)purchasing,amethodofmanagingpurchasessothematerialsorgoodsaredeliveredjustasneededforproductionorsales.JITpurchasingisnotguidedsolelybytheEOQmodelbecausethatmodelonlyemphasizesthetradeoffbetweenrelevantcarryingandorderingcosts.20-21JITPurchasing,concludedJITreducesthecostofplacingapurchaseorderbecause:Long-termpurchasingagreementsdefinepriceandqualityterms.Individualpurchaseorderscoveredbythoseagreementsrequirenoadditionalnegotiationregardingpriceorquality.Companiesareusingelectroniclinkstoplacepurchaseordersatasmallfractionoftraditionalmethods(phoneormail).Companiesareusingpurchase-ordercards(similartoconsumercreditcards).20-22RelevantCostsinJITPurchasingRelevantcostsfortheEOQmodelarethecarryingandorderingcosts.Inventorymanagementincludespurchasingcosts,stockoutcosts,costsofqualityandshrinkagecosts.JITrelevantcostsinclude:PurchasingcostsOrderingcostsOpportunitycostsCarryingcostsStockoutcostsQualitycosts20-23JITPurchasingand

Supply-ChainAnalysisSupplychaindescribestheflowofgoods,services,andinformationfromtheinitialsourcesofmaterialsandservicestothedeliveryofproductstoconsumers.Supplychainmembersshareinformationandplan/coordinateactivities.SupplierevaluationsarecriticaltoJITpurchasingimplementation.20-24InventoryManagement,MaterialsRequirementsPlanning(mrp)&jitproductionMaterialsrequirementsplanning(MRP)—a“push-through”systemthatmanufacturesfinishedgoodsforinventoryonthebasisofdemandforecasts.JITproductionisa“demand-pull”approachandisalsocalledleanproduction.Eachcomponentinaproductionlineisproducedassoonas,andonlywhen,neededbythenextstepintheproductionline.20-25MRPInformationInputsTodetermineoutputsateachstageofproduction,MRPuses:Thedemandforecastsforfinalproducts.Abillofmaterialsdetailingthematerials,components,andsubassembliesforeachfinalproduct.Informationaboutacompany’sinventoriesofmaterials,components,andproducts.20-26MRP,processTakingintoaccounttheleadtimerequiredtopurchasematerialsandtomanufacturecomponentsandfinishedproducts,amasterproductionschedulespecifiesthequantityandtimingofeachitemtobeproduced.Onceproductionstartsasscheduled,theoutputofeachdepartmentispushedthroughtheproductionline.MaintainingaccurateinventoryrecordsandcostsiscriticalinanMRPsystem.20-27InventoryManagement,MRPandJITProductionJIT(lean)productionisa“demand-pull”manufacturingsystemthatmanufactureseachcomponentinaproductionlineassoonas,andonlywhen,neededbythenextstepintheproductionline.Demandtriggerseachstepoftheproductionprocess,startingwithcustomerdemandforafinishedproductandworkingallthewaybacktothedemandfordirectmaterialsatthebeginningoftheprocess.20-28JITProductionGoalsJITproductionsystemsresultinclosecoordinationamongwork-stations.Smoothstheflowofgoods.Achieveslowquantitiesofinventory.

JITaimstosimultaneously:Meetcustomerdemandinatimelymanner.Producehighqualityproducts.Generatethelowestpossiblecosts.20-29FeaturesofJITProductionsystemsProductionisorganizedinmanufacturingcells,whichareworkareaswithdifferenttypesofequipmentgroupedtogethertomakerelatedproducts.Workersarehiredandtrainedtobemulti-skilled(cross-trained).Defectsareaggressivelyeliminated.Setuptimeandmanufacturingcycletimearereduced.Suppliersareselectedonthebasisoftheirabilitytodeliverqualitymaterialsinatimelymanner.20-30CostsandBenefitsofJITProductionLoweroverheadcostsLowerinventorylevels,lowercarryingcostsHeightenedemphasisonimprovingqualitybyeliminatingthespecificcausesofrework,scrap,andwasteLowermanufacturingcycletimes20-31EnterpriseResourcePlanning(ERP)SystemsERPsystemsarefrequentlyusedinconjunctionwithJITproduction.AnERPsystemisanintegratedsetofsoftwaremodulescoveringacompany’saccounting,distribution,manufacturing,purchasing,humanresourcesandotherfunctions.Real-timeinformationiscollectedinasingledatabaseandsimultaneouslyfedintoallofthesoftwareapplications,givingpersonnelgreatervisibilityintothecompany’send-to-endbusinessprocesses.CompaniesbelievethatanERPsystemisessentialtosupportJITinitiativesbecauseoftheeffectithasonleadtime.20-32EnterpriseResourcePlanning(ERP)Systems,concludedThechallenge,whenimplementingERPsystems,istostriketheproperbalancebetweenthelowercostandreliabilityofstandardizedsystemsandthestrategicbenefitsthataccruefromcustomization.20-33PerformanceMeasuresand

ControlinJITFinancialperformancemeasuressuchasinventoryturnoverratio,whichisexpectedtoincrease.Nonfinancialperformancemeasuresoftime,inventory,andqualitysuchas:Numberofdaysofinventoryonhand:expectedtodecrease.Unitsproducedperhour:expectedtoincrease%ofscrapped/reworkovertotalunitsstarted:expectedtodecrease.Manufacturingcycletime:expectedtodecrease.Setuptime:expectedtodecrease.20-34BackflushCostingTraditionalnormalorstandard-costingsystemsusesequentialtrackinginwhichtherecordingofthejournalentriesoccursinthesameorderasactualpurchasesandprogressinproduction.Asareminder,the4stagesare:

PurchaseofDirectMaterials&IncurringofConversioncosts*

ProductionresultinginWIP

CompletionofGoodfinishedunitsofproduct*

Salesoffinishedgoods**Indicatesatriggerpointforjournalentries20-35BackflushCosting,cont’dBackflushcostingomitsrecordingsomeofthejournalentriesrelatingtothestagesfromthepurchaseofdirectmaterialstothesaleoffinishedgoods.Becausesomestagesareomitted,thejournalentriesforasubsequentstageusenormalorstandardcoststoworkbackwardto“flushout”thecostsinthecycleforwhichjournalentrieswerenotmade.20-36BackflushCosting,concludedBackflushcostingdoesnotnecessarilycomplywithGAAP.However,inventorylevelsmaybeimmaterial,negatingthenecessityforcompliance.Backflushcostingdoesnotleaveagoodaudittrail—theabilityoftheaccountingsystemtopinpointtheusesofresourcesateachstepoftheproductionprocess.20-37LeanAccounting AnothersimplifiedproductcostingsystemthatcanbeusedwithJITsystemsisleanaccounting.WhenacompanyutilizesJITproduction,ithastofocusontheentirevaluechainofbusinessfunctionsinordertoreduceinventories,leadtimesandwaste.TheimprovementsthatresulthaveledsomecompanieswithJITsystemstodeveloporganizationsstructuresandcostingsystemsthatfocusonvaluestreams.20-38LeanaccountingandValuestreamsValuestreamsareallthevalue-addedactivitiesneededtodesign,manufacture,anddeliveragivenproductorproductlinetocustomers.Leanaccountingisacostingmethodthatfocusesonvaluestreams,asdistinguishedfromindividualproductsordepartments,therebyeliminatingwasteintheaccounti