Chapter 11 Controlling Inventory and Production Costs.
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Transcript of Chapter 11 Controlling Inventory and Production Costs.
Chapter 11
Controlling Inventory and Production Costs
1. Why do managers use ABC inventory control
systems?
2. How does a company determine from whom,
how much, and when to order?
C11
Learning Objectives
3. What are the differences between the economic order
quantity model and materials requirements
planning?
4. What is the JIT philosophy and how does it affect
production?
C11
Continuing . . . Learning Objectives
5. What is the impact of flexible manufacturing systems on
production and on satisfying customers?
6. How would the traditional accounting system change if a
JIT inventory system were adopted? (Appendices 1 and
2)
C11
Continuing . . . Learning Objectives
7. How does the product life cycle influence sales
and costs? (Appendix 3)
C11
Continuing . . . Learning Objectives
Costs Associated with Inventory:
Purchasing or Production
Purchasing Production
$$$
Quoted price Direct material
- Discounts allowed + Direct labor
+ Shipping charges +Traceable overhead
+ Insurance charges +Allocated fixed overhead
while items are
in transit
Costs Associated with Inventory:
Ordering or Setup
Ordering SetupInvoice preparation Labor time
receipt & inspection Machine downtime
Payment
Forms
Clerical processing
12
3
6
9
Costs Associated with Inventory:
Carrying or Not Carrying (Stockout)
Carrying Not Carrying
(Stockout)Storage Lost customer goodwillHandling Lost contribution marginInsurance charges Ordering & shipping Property taxes charges from filling Losses from obsolescence, special orders damage, and theft Setup costs for rescheduledOpportunity cost of production invested capital
Decisions in Purchasing Inventory
In purchasing inventory, a purchasing manager needs to make three primary decisions.
– What supplier?
– What quantity?
– When to order?
Traditional Supplier Relationship
Decision based primarily on price!
$
Partnership View
of New Buyer-Supplier Relations
Views cost in relationto quality and reliability
Changes in
Buyer-Supplier Relationship• Number of vendors reduced to limited group
– Selected based on quality, reliability, price
– Quality certification
• Long-term contracts
• Develop better communications– Site visits
• Assure quality and service
• Obtain quantity discounts– Order size reduced
– Frequency of delivery increased
• Reduce operating costs
Economic Order Quantity
Estimate of number of units per order that
would provide the optimal balance between
ordering and carrying costs
AFTER
the supplier
is selected EOQ = 2 Q O
C
Example
Quantity needed per year (Q) = 4,200 tons
Cost of ordering (O) = $30 per order
Cost of carrying (C) = $10 per ton
Uses 15 tons of pulp wood per day
Supplier can deliver in 3 days
Maximum quantity used per day is 19 tons
Economic Order Quantity
EOQ =2 Q O
C
EOQ =
EOQ =
2 (4,200) $30
$10
159 (rounded)
Total Inventory Costs
Carrying Costs:
(159 2) x $10 = $ 795
Ordering Costs:
(4,200 159) x $30 792
Total Inventory Costs $1,587=====
Questions to Ask Before Ordering
• Is storage space a limited resource?• How critical is the item to production?• How critical is cash flow?• Can units be ordered in the quantity indicated?
When to Order
Safety Stock = (Maximum Usage - Normal Usage) x Lead Time
= ( 19 - 15) x 3 = 12 tons
Order Point = (Daily Usage x Lead Time) + Safety Stock
= ( 15 x 3) + 12 = 57 tons
Problems with EOQ Model
• Is difficult to identify all relevant inventory costs
• Does not provide any direction for managers attempting to control individual types of purchasing and carrying costs
• Ignores relationships among inventory items
Materials Requirements Planning
• What items are needed?• How many of them are needed?• When are they needed?
Answers the questions:
Steps in an MRP System
• Sales forecast used to develop a master production schedule (MPS)
• Computer MRP model generates a time-sequenced schedule for purchases and production component needs using
– Product bill of materials and operations flow document
– Inventory balances
– Lead time
Continuing . . . Steps in
an MRP System
Work load compared with capacity; bottlenecks identified
– MRP program run again until all bottlenecks accounted for
MRP II
Manufacturing Resource Planning
Plans production jobs using MRP AND
calculates resource needssuch as labor and machine hours
Involves manufacturing, marketing, and finance
Push System
MaterialsStorage
WIPStorage
FGStorage
Purchases
Sales
WIPStorage
Work
Center
Work
Center
Work
Center
Just-In-Time Systems
• Eliminating any production process or operation that does not add value to the product/service
• Continuously improving production/performance efficiency
• Reducing the total cost of production/performance while increasing quality
Three primary goals
Elements of JIT Philosophy
• Eliminate as much inventory and storage space as possible
• Keep lead time short by using frequent deliveries
• Use creative thinking to find ways to reduce costs
• Work to eliminate defects and scrap
Continuing . . . Elements of
JIT Philosophy
• Establish good relationships with suppliers • Listen to employees• Train employees to be multiskilled and increase
productivity• Constantly look for ways to improve operations
Pull System
Purchases
Sales
WorkCenter
WorkCenter
WorkCenter
Product Processing
• Reduce machine setup time– New equipment
– Training
• Implement highest quality standards and focus on goal of zero defects
– Quality determined on continuous basis
– Vendor product quality
– Quality in conversion process
– Modern production equipment
Traditional
Manufacturing Plant Layout
WIP
WIPWIPWIP
WIPWIP
Finished
Goods
aterials
M
Just-In-Time
Manufacturing Plant Layout
Finished
Goods
aterials
M
Employee Empowerment• Put the right people in the right jobs
• Make training an ongoing process
• Provide employees with necessary tools
– Equipment
– Information
– Authority
– Training
• Push decision-making authority and responsibility down to lowest reasonable level
• Establish atmosphere of trust among all employees at all levels
Seven Steps to Implement
a JIT System
1. Determine how well products, materials, or services are delivered now.
2. Determine how customers define superior service, and set priorities accordingly.
3. Establish specific priorities for distribution (and possibly purchasing) functions to meet customer needs.
4. Collaborate with and educate managers and employees to refine objectives and to prepare for implementation of JIT.
Continuing . . . Seven Steps to
Implement a JIT System
5.Execute a pilot implementation project and evaluate its results.
6.Refine the JIT delivery program and execute it company wide.
7.Monitor progress, adjust objectives over time, and always strive for excellence.
Important Relationships
Every company has a set of upstream suppliers and a set of downstream customers. In a one-on-one context, these parties can be depicted in the following model:
UpstreamSupplier
The CompanyDownstream
Customer
Continuing . . .
Important Relationships
Consider the following opportunities for improvement between entities:
• improved communication of requirements and specifications
• greater clarity in requests for products or services
• improved feedback regarding unsatisfactory products or services
• improvements in planning, controlling, and problem solving
• shared managerial and technical expertise, supervision, and training
Flexible Manufacturing Systems
A flexible manufacturing system (FMS) is a network of robots and material conveyance devices monitored and controlled by computers.
Two or more FMSs connected by a host computer and an information networking system are generally referred to as computer integrated manufacturing (CIM).
Comparison of Traditional
Manufacturing and FMS
Information requirements Batch-based On-line, real-time
Product variety Low Basically unlimited
Response time to market needs Slow Rapid
Worker tasks Specialized Diverse
Production runs Long Short
Lot sizes Massive Small
FACTOR MANUFACTURING FMS TRADITIONAL
Continuing . . . Comparison of
Traditional Manufacturing and FMS
Basis of performance rewards Individual Team
Setups Slow and expensive Fast and inexpensive
Product life cycle expectation Long Short
Work area control Centralized Decentralized
Technology Labor-intensive Technology- intensive
Worker knowledge of technology Low to medium Highly trained
FACTOR MANUFACTURING FMS TRADITIONAL
Accounting Implications of JIT
• End-of-period variance reporting and analysis essentially disappears– Variances recognized on the spot
• Two comparison standards: annual and current• Use conversion costs rather than labor and
overhead• Inventory accounting
– Raw and In Process (RIP) Inventory account
Backflush Costing
• Streamlined cost accounting method that speeds up, simplifies, and reduces accounting effort
• During period, records purchases of materials and accumulates conversion costs
• At completion or sale, total costs incurred recorded to cost of goods sold and finished goods inventory using standard production costs
Continuing . . . Backflush Costing
Bernard Company’s standard production cost per unit:
Direct material $ 75
Conversion 184
Total costs $259====
No beginning inventories exist.
Continuing . . . Backflush Costing
(1):
Raw and In Process Inventory 1,530,000
Accounts Payable 1,530,000
Purchased $1,530,000 of direct materials in June.
Continuing . . . Backflush Costing
(2):
Conversion Costs 3,687,000
Various accounts 3,687,000
Incurred $3,687,000 of conversion costs in June.
Continuing . . . Backflush Costing
(3):
Finished Goods Inventory 5,180,000
Raw and In Process Inventory 1,500,000
Conversion Costs 3,680,000
Completed 20,000 units of production in June.
Continuing . . . Backflush Costing
(4):
Cost of Goods Sold 5,128,200
Finished Goods Inventory 5,128,200
Accounts Receivable 8,316,000
Sales 8,316,000
Sold 19,800 units having a cost of $259 per unit on account in June for $420.
Continuing . . . Backflush Costing
Ending Inventories:
Raw and In Process ($1,530,000 - $1,500,000) $30,000
Finished Goods ($5,180,000 - $5,128,200) 51,800
In addition, there are underapplied conversion costs of $7,000 ($3,687,000 - $3,680,000).