Chapter 17



Chapter 17

Inventory and Production Management

Questions

1. The three costs are costs of ordering, purchasing, and carrying inventory. These costs are presented in Exhibit 17-1 with examples.

2. A push system is a production control system in which work centers produce inventory in excess of current needs because of lead time or economic production/order quantity requirements.

A pull system of production control is one in which parts are delivered/produced only as needed by the work center for which they are intended. Theoretically, there are no stockrooms where work centers "push" completed parts in excess of the current needs of recipient work centers. JIT is a pull system.

3. Companies must be aware of where their products are in their life cycles, because in addition to the sales effects, the life-cycle stage may have a tremendous impact on costs and profits. Managing production activities and costs requires an understanding of product life cycles in order to effectively and efficiently engage in production planning, controlling, problem solving, and performance evaluation.

4. Target costing is a method of determining what the cost of a product should be by subtracting desired profit from the estimated selling price. Once a product's total life-cycle costs are projected, they can be compared to the target cost to determine whether adjustments to the product design and manufacturing process are necessary before product engineers release the final design and specifications.

5. It is in the development stage that the production components and production processes are determined. Accordingly, most of the costs of producing the product are set for the life of the product line during the development state. Costs are much less subject to influence in later stages of the life cycle.

6. Kaizen costing is an approach to identify ways to incrementally improve the efficiency and reduce the costs of making a product. A major distinction between kaizen costing and target costing is seen in the life-cycle stages in which each is used. Kaizen costing is used to reduce the cost of products in later stages of the product life cycle. Target costing is applied in the product development/design stage.

7. Primary goals of JIT are

* elimination of any process that does not add value to the product;

* continuous improvement of production efficiency; and

* reduction of total cost of production rather than merely the cost of purchasing.

JIT attempts to achieve these goals by working to

* eliminate the acquisition/production of inventories in excess of current needs;

* reduce lead/setup times; and

* minimize product defects.

8. The following changes are needed to effectively implement JIT in a production environment:

* Selection of a vendor should consider the following items in addition to the invoice prices:

consistent quality of materials/parts to minimize product defects; reliable delivery schedules with short lead times to allow for maintaining little or no inventory and for flexibility and speed in setting up production runs; maintaining long-term relationships with fewer vendors to improve communications, ensure quality and service, obtain quantity discounts, and reduce operating costs; obtaining suppliers who are close to the plant to reduce lead times and shipping costs.

* Small quantities should be ordered to minimize inventory carrying costs.

* Product components and tools should be standardized to lower costs and increase production efficiency.

* The number of product components should be minimized to lower costs and increase production efficiency.

* Products should be carefully designed to reduce subsequent change orders.

* Setup times should be shortened to allow for quicker, more flexible production.

* Production workers are used to continually ensure quality control in order to reduce costs and approach zero defects.

* The plant layout should be designed in a manner that is conducive to the flow of goods and organization of workers in order to minimize cycle time from material input to finished product.

* Employee suggestions for improving production should be sought; these individuals often have a wealth of information that goes untapped.

* Utilize multiprocess handling to improve worker flexibility and interest.

9. In an FMS, each employee is charged with operating or overseeing several machines. Although the automation requires fewer workers than traditional production systems, FMS requires its workers to have more training than those in a traditional environment. Also, the employees need to be given the authority and responsibility to make decisions because the environment is too fast paced for people "off the floor" to make certain production decisions.

10. The theory of constraints states that production cannot take place at a rate faster than the slowest machine or person in the process. The theory of constraints can be used in either a manufacturing or service firm to focus management's attention on the elimination of the bottlenecks so that the best use of existing capacity can be made.

11. Total ordering cost declines as order size increases. Carrying costs increase, in total, as order size increases. At some point the two costs are equal and it is at this point that the EOQ point is located. To the right of this point, total carrying costs exceed total ordering costs.

12. Pareto inventory analyses requires that all inventory items be placed into one of three classes: A, B, or C. The three categories are distinguished from one another by their cost-to-volume ratio. High-value, low-volume items are placed in the A category; at the other extreme, low-value, high-volume items are placed in the C category. All other items are placed in category B. A red-line system or a two-bin system is frequently used to control inventory levels of C items.

Exercises

13. a. O

b. O

c. O

d. N/A (Purch.)

e. N

f. O

g. N/A (Purch.)

h. C

i. O

j. O

k. N

l. C

m. N/A (Purch.)

n. C

o. C

p. C

q. N

r. C

14. Storage $0.120

Handling 0.140

Insurance 0.220

Opportunity cost 0.544

Carrying cost $1.024

(Production labor cost is omitted.)

15. Life-cycle revenue:

Year 1 38,000 x $19 $ 722,000

Year 2 48,000 x 18 864,000

Year 3 90,000 x 16 1,440,000

Year 4 40,000 x 12 480,000

Total 216,000 3,506,000

Required profit 216,000 × $4.50 (972,000)

Total target cost $2,534,000

Target cost per unit: $2,534,000 ÷ 216,000 = $11.73

16. a. Life-cycle revenues

Year 1 4,000 x $350 $ 1,400,000

Year 2 3,600 x $350 1,260,000

Year 3 4,700 x $350 1,645,000

Year 4 5,000 x $350 1,750,000

Year 5 1,500 x $275 412,500

Year 6 1,000 x $275 275,000

Totals 19,800 6,742,500

Variable selling costs (19,800 x $80) (1,584,000)

Fixed selling and administrative (1,750,000)

Required profit ($6,742,500 x 0.20) (1,348,500)

Target manufacturing cost $ 2,060,000

Target manufacturing cost per unit $ 104.04

b. Total target manufacturing cost $2,060,000

Year 1 mfg. cost (4,000 x $225) (900,000)

Total target manufacturing cost $1,160,000

Target unit mfg. cost ($1,160,000 ÷ 15,800) $73.42

c. The company’s engineers could redesign the product to make it less costly to produce by reducing both material and conversion costs, or redesign the process to reduce conversion costs. Also, they could use kaizen techniques, which could lower costs after production has started.

17. The student’s memo should address the following issues:

Target cost = $225 - 20 = $205.

1. Given that the target cost is $205 and the anticipated actual first-year production cost is $230, it is apparent that it will be impossible to realize the required profit of $20 per unit unless changes are made.

2. There are two major courses of action. First, management should ask the product engineers to review product design and specifications with the purpose of reducing expected average total life-cycle cost to the required $205 target cost. Failing success in this endeavor, management could consider launching the product with the objective of achieving long-term price reductions through kaizen costing techniques. If management is pessimistic about the company’s ability to achieve the required long-term reductions in cost, the plans for the product should be abandoned.

18. Many fast food restaurants already operate on a JIT basis. Materials or ingredients are delivered fresh to the restaurants on a daily or multi-weekly basis. The customer’s order triggers the production of a meal; meals are not made in anticipation of customer orders. The result is fresher food, less waste, and more satisfied customers.

19. There are situations in which JIT will not readily work. For example, if vendors are unwilling to deliver inputs on a JIT basis, adopting JIT is not possible. Also, some products such as those that are not available from repetitive manufacturing processes are not suitable for JIT. For example, bridges, office buildings and other one-off types of products are not suitable candidates for JIT manufacturing. Other instances in which JIT is not suitable include production environments in which demand is very seasonal. In such environments it may be more economical to produce at a balanced level on a year-around basis rather than produce only seasonally.

20. Manufacturing cells are organized by clustering production machinery so that multiple machines can be operated by a single employee. Such cells are often capable of producing complete products or major product components. The use of such cells reduces set up costs and adds flexibility to a firm’s ability to meet a production schedule.

21. Value engineering is a process, often iterative, applied during the design stage of a product’s life. The intent of the process is to reduce life cycle costs and improve the quality of the product. Many companies have formalized the value engineering process so that it occurs at specific points in the design phase of a product’s life cycle and involves specific teams of individuals.

22. a. Material usage variance:

Actual cost of materials this month:

(A) 11,000 lbs. x $2.25 per lb. = $24,750

(B) 10,000 lbs. x $3.40 per lb. = 34,000 $58,750

Current materials standard:

(A) 3,000 x 2 x $2.25 per lb. = $13,500

(B) 3,000 x 5 x $3.40 per lb. = 51,000 64,500

Material usage variance $ 5,750 F

Annual materials standard:

(A) 3,000 x 3 x $2.25 per lb. = $20,250

(B) 3,000 x 4 x $3.40 per lb. = 40,800 $61,050

Current standard 64,500

ENC variance $ 3,450 U

b. The effect of the engineering change was to change the mix of material inputs by decreasing the proportion of the less expensive material, A. For July, this engineering change generated extra costs of $3,450.

23. a. SP x AQ SP x SQ

$0.01 x 184,000 = $1,840 $0.01 x 176,000 = $1,760

$0.05 x 31,000 = 1,550 $0.05 x 32,000 = 1,600

$3,390 $3,360

$30 U

Material Usage Variance

(Material X, $80 U; Material Y, $50 F)

b. Current SP x SQ Annual SP x SQ

$0.01 x 176,000 = $1,760 $0.01 x 256,000 = $2,560

$0.05 x 32,000 = 1,600 $0.05 x 16,000 = 800

$3,360 $3,360

$ 0

ENC Variance

(Material X, $800 F; Material Y, $800 U)

c. The company was fairly effective in managing costs. The engineering change variance had no effect on costs, but relative to the current standard, actual usage slightly exceeded the standard.

d. The company would make a change that was cost neutral, if the quality of the product would be improved. Thus, for no increase in cost, a higher quality product is obtained, which could result in greater revenues.

24. a. 1. Direct Materials 16,000

Accounts Payable 16,000

2. Conversion Costs 32,000

Various Accounts 32,000

3. Work in Process 48,000

Direct Materials 16,000

Conversion Costs 32,000

Finished Goods Inventory 48,000

Work in Process 48,000

4. Accounts Receivable 79,000

Sales 79,000

Cost of Goods Sold 47,400

Finished Goods 47,400

b. 1. Cost of Goods Sold 48,000

Various accounts 48,000

2. no entry

3. Finished Goods Inventory 600

Cost of Goods Sold 600

25. a. Raw and In Process Inventory 322,000

Accounts payable 322,000

Conversion costs 648,000

Various accounts 648,000

Raw and In Process Inventory 640,000

Conversion costs 640,000

Finished Goods Inventory 960,000

Raw and In Process Inventory 960,000

Cost of Goods Sold 954,000

Finished Goods Inventory 954,000

Cost of Goods Sold 8,000

Conversion costs 8,000

Accounts receivable 1,590,000

Sales 1,590,000

Alternatively, the following journal entries could be used:

Raw and In Process Inventory 2,000

Finished Goods Inventory 6,000

Cost of Goods Sold 962,000

Accounts payable 322,000

Conversion costs 648,000

Accounts receivable 1,590,000

Sales 1,590,000

b. Raw and In Process Finished Goods

322,000 960,000 960,000 954,000

640,000

Bal 2,000 Bal 6,000

Cost of Goods Sold Conversion Costs

954,000 648,000 640,000

8,000 8,000

Bal 962,000 Bal 0

Accounts payable Various accounts

322,000 648,000

Sales Accounts receivable

1,590,000 1,590,000

c. The remaining balance in Raw and In Process Material Inventory =

$322,000 - $320,000 = $2,000.

The remaining balance in finished goods = ($2 + 4) x 1,000 = $6,000

26. The first consideration would be to keep the two remaining polishing machines operating at peak efficiency. To do so would require that all flatware entering the polishing operation be defect free. Thus, one would want to be certain that there is a quality inspection that immediately precedes the polishing operation. Further, one would want to recommend that the two remaining machines be properly maintained so that no additional breakdowns will occur while the third machine is being repaired.

To gain additional capacity, one could rent a machine from a vendor, or outsource some of the polishing to an outside firm.

27. No, Office Provisions did not complete the 180 units by 5:00 PM.

Time of Afternoon Output

1-2 2-3 3-4 4-5 Total

Dept. 1 44 40 49 47 180

Dept. 2 44 40 45 45 174

Dept. 2

Backlog 0 0 4 2

Cumulative

Dept. 2

Backlog 0 0 4 6 6*

* The robot can be counted on to finish 45 units per hour.

Although Dept. 1 averaged 45 units per hour, it was late getting 6 units to Dept. 2 in the last two hours. Since the robot was constrained to 45 units per hour, it could not handle the extra 4 units given it between 3:00 and 4:00 and the extra 2 units given it between 4:00 and 5:00.

28. $6,700; at the EOQ, the total annual carrying costs will equal the total annual ordering costs.

29. EOQ (Face Cream) = SQRT (2QO ÷ C)

= SQRT [(2 x 2,000 x 2.25) ÷ 2.00]

= SQRT (4,500)

= 67*

EOQ (Lotion) = SQRT [2 x 1,000 x 3.25) ÷ 1.45]

= SQRT (4,482)

= 67*

EOQ (Powder) = SQRT [(2 × 900 × 1.70) ÷ 1.25]

= SQRT (2,448)

= 50*

*rounded

30. EOQ = SQRT (2QO ÷ C)

(EOQ)2 = 2QO ÷ C

(C × EOQ2) ÷ (2 × O) = Q

Q = (0.35 x (800)2) ÷ (2 x 140)

= 224,000 ÷ 280

= 800 units

31. EPR = SQRT (2QS ÷ C)

= SQRT [(2 x 1,600 x 400) ÷ 2]

= SQRT (640,000)

= 800 units

32. a. EPR = SQRT [(2 x 7,500 x 400) ÷ 2.50]

= SQRT (2,400,000)

= 1,549 units (rounded)

Avg. Inventory = 1,549 ÷ 2 = 774.5 units

Carrying cost (774.5 x $2.50) $1936.25

Setup cost 400.00

Total cost $2336.25

b. EPR = SQRT [(2 x 7,500 x 100) ÷ 10]

= SQRT (150,000)

= 387 units (rounded)

Avg. Inventory = 387 ÷ 2 = 193.5 units

Carrying cost (193.5 x $10) $ 1935.00

Setup cost 100.00

Total cost $2,035.00

c. Number of runs = 7,500 ÷ 1,549 units = 4.84 or 5 runs

d. Setup costs = 5 x $400 = $2,000

Problems

33. a. The controller would want to isolate just the variable costs - those costs that vary with the number of orders processed. In this case, the relevant costs would include the $0.30 of department supplies, and $3.02 for phone expense.

b. Similar to the ordering costs, the controller would only want to include those costs that vary with the number of units stored. The variable costs include the $0.05 for inventory insurance and $0.07 for obsolescence.

34. a. Revenues

Year 1 100,000 x $2.50 $ 250,000

Year 2 250,000 x $2.40 600,000

Year 3 350,000 x $2.30 805,000

Year 4 500,000 x $2.10 1,050,000

Year 5 600,000 x $2.00 1,200,000

Year 6 450,000 x $2.00 900,000

Year 7 200,000 x $1.90 380,000

Year 8 130,000 x $1.90 247,000

Totals 2,580,000 5,432,000

Profit margin 1,086,400

Target cost $4,345,600

Unit target cost $4,345,600 ÷ 2,580,000 = $1.68

b. Total production cost estimate:

Fixed costs $100,000 x 8 $ 800,000

Variable costs $1.30 x 2,580,000 3,354,000

Total $4,154,000

The comparison of the estimated production costs to the target production cost is favorable. Over the life cycle of the product, the target cost is $191,600 larger than the estimated actual costs of production. This information suggests that the company can achieve its targeted gross margin without redesigning the product. Thus, the company might choose to use kaizen methods to improve cost efficiency, but to not delay the start of production given the highly profitable projections for the product.

c. Yes, the company should begin production of the product because the

targeted level of profitability is achievable.

35. Using the data given, the target cost of production can be computed:

Estimated sales price $430

Projected profit per unit (70)

Projected selling & administrative costs (80)

Target cost of production $280

Estimated cost of production:

Direct materials $140.00

Direct labor 80.00

Variable overhead 30.00

Fixed costs (($10,000 x 5) ÷ 180,000) 0.28

Total estimated actual cost $250.28

After integrating the marketing and engineering information, it is clear that the prospects are favorable for launching a product that will generate more than the expected level of profit. The expected cost of production is well below the target cost of production. The gap between the two numbers should represent additional profit.

36. a. D

b. U

c. T

d. D, T

e. T

f. T

g. D

h. T

i. T

j. D, T

37. a. Conversion costs 20,000

Various Accounts 20,000

Finished Goods Inventory 32,000

Accounts Payable 12,000

Conversion Costs 20,000

Cost of Goods Sold 31,000

Finished Goods Inventory 31,000

Accounts Receivable 58,000

Sales 58,000

b. Raw and In Process Inventory 12,000

Accounts Payable 12,000

Conversion costs 20,000

Various Accounts 20,000

Cost of Goods Sold 31,000

Finished Goods Inventory 1,000

Raw and In Process Inventory 12,000

Conversion Costs 20,000

Accounts Receivable 58,000

Sales 58,000

c. Cost of Goods Sold 31,000

Finished Goods Inventory 1,000

Accounts Payable 12,000

Various Accounts 20,000

Accounts Receivable 58,000

Sales 58,000

d. Conversion costs 20,000

Various Accounts 20,000

Cost of Goods Sold 32,000

Accounts Payable 12,000

Conversion Costs 20,000

Finished Goods Inventory 1,000

Cost of Goods Sold 1,000

Accounts Receivable 58,000

Sales 58,000

38. a. (1) Raw and In Process 24,904,000

Material Price variance 480

Accounts Payable 24,904,480

(2) Conversion costs 3,000,000

Accum. depreciation 600,000

Cash 2,200,000

Accounts Payable 200,000

(3) Raw and In Process 2,912,000

Conversion cost 2,912,000

(20,800 x $140)

(4) No entry

(5) Conversion costs 14,442,000

Accum. Depreciation 4,000,000

Cash 9,325,000

Accounts payable 1,117,000

(6) Raw and In Process 14,448,000

Conversion costs 14,448,000

(103,200 x $140)

b. 103,200 rolls x 0.4 = 41,280 yd.; 41,280 x $2 = $82,560 increase

c. Material Quantity Engineering

Change Variance 82,560

Raw and In Process 82,560

d. 103,200 x (5 ÷ 240) x $140 = $301,000 saved

e. Conversion costs 301,000

Machine Hrs. Eng. Change Variance 301,000

f. Actual conversion costs ($3,000,000 + $14,442,000) $17,442,000

Machine hours engineering change 301,000

Revised conversion costs 17,743,000

Applied conversion costs ($2,912,000 + $14,448,000) 17,360,000

Underapplied $ 383,000

g. Increase in material cost per roll (0.4 x $2.00) $ 0.80

Decrease in conv. cost per roll [(5 ÷ 60) x $35)] (2.92)

Net decrease in cost per roll $(2.12)

Yes, the changes are cost beneficial.

39. a. A key consideration would be to minimize the probability of having obsolete products and product components on hand. With the rapid rate of product obsolescence, the firm would only want to produce to satisfy immediate demand; no stockpiling would occur. Also, the firm would want to have a production system that could be quickly adapted from the production of one product to another.

b. The firm would want to use a pull-based inventory control system. Such a system would avoid the accumulation of materials and components that might be rendered obsolete or unusable due to technical innovations within the firm and by competitors.

c. It would have the effect of reducing the EPR. The EPR would be reduced because of the high carrying cost of inventory. Inventory carrying costs would be high because included in the inventory carrying costs would be a component to account for the cost of product obsolescence.

(CMA adapted)

40. The president should ask for a formal analysis of the situation. This analysis should address the costs and benefits of each alternative. Costs should include purchase prices, warehousing costs (including insurance), personnel to operate the warehouse and intake any necessary inventories during the period, the cost of capital on the funds tied up in the parts, and penalties for canceling. The supply director should comply with the president's request by preparing and presenting an objective report.

Often, when confronted by situations such as this one, the only costs that are considered are the direct costs (purchase price and penalties). Decision making of this nature should be careful to reflect not only the directly visible costs but also the "hidden costs" of purchase arrangements.

41. a. As technology changes, the relative costs of ordering and carrying inventory change. The changes mentioned in this scenario would appear to lower the costs of ordering inventory. Consequently, assuming the costs of carrying inventory remain at their original level, the reduction in ordering costs would drive the EOQ quantity down.

b. The memo should make the points listed in part (a).

42. JIT requires close relations and communications with suppliers. Preferably, there should be a few, well-cultivated suppliers who are "trained" to know precisely your inventory needs and who understand the critical requirement of meeting your just-in-time operation schedule. Further, they should be made aware that they will be dismissed for defective or inappropriate products or service or for failure to meet delivery schedules. All of the above requires continual close communications between the vendor and the JIT producer.

In this case, William Manufacturing needs to consider whether some or all of the responsibility rests with the company itself. Have the vendors been properly "trained" and made precisely aware of product and timing needs? Have the vendors been chosen with the expertise, facilities and delivery capability to service Johnson's requirements? Do William's personnel know exactly what the needs are, and are those needs fairly stable? If, for example, William has frequent engineering changes because of inadequate product development, supplier compliance is hampered.

Finally, JIT systems cannot be fully and effectively implemented in a few months. It usually takes considerably longer to make the system work well. Expectations that JIT can have immediate perfect results are likely to lead to disappointment.

43. a. EOQ = SQRT [(2 x 14,000 x 16.00) ÷ 0.50]

= SQRT (896,000)

= 946.57 or 947 pounds

b. Average daily usage = 14,000 ÷ 365 = 38.36 lbs.

Order point = [38.36 x (12 + 7)] = 728.84 lbs.

44. a. EPR = SQRT (2QS ÷ C)

= SQRT [(2 x 30,000 x $50) ÷ $0.25]

= SQRT (12,000,000)

= 3,464.10 or 3,464 pounds

b. Number of runs = 30,000 ÷ 3,464 = 8.66 or 9 runs

c. EOQ (seed) = SQRT (2QO ÷ C)

= SQRT [(2 x 30,000 x 2 x 2 x $4.25) ÷ $0.01]

= SQRT (102,000,000)

= 10,099.51 or 10,100 seeds

EOQ (fertilizer) = SQRT[ (2 x 30,000 x 0.25 x $8.80) ÷ $0.05]

= SQRT (2,640,000)

= 1,624.81 or 1,625 pounds of fertilizer

d. Seed orders = (30,000 x 2 x 2) ÷ 10,100 = 11.88 or 12 orders

Fertilizer orders = (30,000 x 0.25) ÷ 1,625 = 4.62 or 5 orders

e. Total cost:

Average inventory:

Onions: 3,464 ÷ 2 = 1,732 lbs.

Seeds: 10,100 ÷ 2 = 5,050 seeds

Fertilizer: 1,625 ÷ 2 = 812.5 lbs.

Carrying costs:

Onions: 1,732 x $0.25 $433.00

Seeds: 5,050 x $0.01 50.50

Fertilizer: 812.50 x $0.05 40.63 $ 524.13

Ordering costs:

Seeds: 12 x $4.25 $ 51.00

Fertilizer: 5 x $8.80 44.00 95.00

Setup costs:

Onions: 9 x $50.00 450.00

Total cost $1,069.13

f. The growing of onions is very similar in most respects to a factory production setting. However, the length of time from the beginning of the process to the end of the process is likely to be much longer and therefore require more careful planning. An incorrect estimate of demand cannot be remedied in any time shorter than the growing cycle of the onion plant. Also, weather and local growing conditions may be additional constraints on the production decision. Further, the yield is likely to vary much more for onions than other production processes because some of the critical inputs are beyond the control of managers (sunshine and rain, for example).

g. Yes, there are some inconsistencies. Because the growing of onions is a cyclical event, as opposed to a continuous event, there should be a very close relationship between the required quantities of onions, fertilizer, and seeds. Inventories should be minimal and be ordered in quantities that match input requirements for each growing cycle. The EOQ quantities differ from the cycle quantities.

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