CHAPTER 20

INVENTORY MANAGEMENT, JUST-IN-TIME,

AND SIMPLIFIED COSTING METHODS
20-1 Cost of goods sold (in retail organizations) or direct materials costs (in organizations with
a manufacturing function) as a percentage of sales frequently exceeds net income as a percentage
of sales by many orders of magnitude. In the Kroger grocery store example cited in the text, cost
of goods sold to sales is !.", and net income to sales is #.$". %hus, a &#" reduction in the
ratio of cost of goods sold to sales (!. to $$.!") without any other changes can result in a
&'!!" increase in net income to sales (#.$" to (.#").
20-2 )i*e cost categories important in managing goods for sale in a retail organization are the
following+
&. purchasing costs,
'. ordering costs,
!. carrying costs,
-. stoc.out costs, and
/. quality costs
20-3 )i*e assumptions made when using the simplest *ersion of the 012 model are+
&. %he same quantity is ordered at each reorder point.
'. 3emand, ordering costs, carrying costs, and the purchase4order lead time are certain.
!. 5urchasing cost per unit is unaffected by the quantity ordered.
-. 6o stoc.outs occur.
/. Costs of quality are considered only to the extent that these costs affect ordering costs or
carrying costs.
20-4 Costs included in the carrying costs of in*entory are incremental costs for such items as
insurance, rent, obsolescence, spoilage, and brea.age plus the opportunity cost of capital (or
required return on in*estment).
20-5 0xamples of opportunity costs rele*ant to the 012 decision model but typically not
recorded in accounting systems are the following+
&. the return forgone by in*esting capital in in*entory,
'. lost contribution margin on existing sales when a stoc.out occurs, and
!. lost contribution margin on potential future sales that will not be made to disgruntled
customers.
20-6 %he steps in computing the costs of a prediction error when using the 012 decision
model are+
Step 1+ Compute the monetary outcome from the best action that could be ta.en, gi*en
the actual amount of the cost input.
Step 2+ Compute the monetary outcome from the best action based on the incorrect
amount of the predicted cost input.
Step 3+ Compute the difference between the monetary outcomes from 7teps & and '.
'#4&
20-7 8oal congruence issues arise when there is an inconsistency between the 012 decision
model and the model used for e*aluating the performance of the person implementing the model.
)or example, if opportunity costs are ignored in performance e*aluation, the manager may be
induced to purchase in a quantity larger than the 012 model indicates is optimal.
20- 9ust4in4time (9I%) purchasing is the purchase of materials (or goods) so that they are
deli*ered :ust as needed for production (or sales). ;enefits include lower in*entory holdings
(reduced warehouse space required and less money tied up in in*entory) and less ris. of
in*entory obsolescence and spoilage.
20!" )actors causing reductions in the cost to place purchase orders of materials are+
Companies are establishing long4run purchasing agreements that define price and
quality terms o*er an extended period.
Companies are using electronic lin.s, such as the Internet, to place purchase orders.
Companies are increasing the use of purchase4order cards.
20!10 3isagree. Choosing the supplier who offers the lowest price will not necessarily result in
the lowest total purchase cost to the buyer. %his is because the price or purchase cost of the
goods is only one<and perhaps, most ob*ious<element of cost associated with purchasing and
managing in*entories. 1ther rele*ant cost items are ordering costs, carrying costs, stoc.out costs
and quality costs. = low4cost supplier may well impose conditions on the buyer<such as poor
quality, or frequent stoc.outs, or excessi*ely high in*entories<that result in high total costs of
purchase. ;uyers must examine all the elements of costs rele*ant to in*entory management, not
:ust the purchase price.
20!11 7upply4chain analysis describes the flow of goods, ser*ices, and information from the
initial sources of materials and ser*ices to the deli*ery of products to consumers, regardless of
whether those acti*ities occur in the same organization or in other organizations. 7haring of
information across companies enables a reduction in in*entory le*els at all stages, fewer
stoc.outs at the retail le*el, reduced manufacture of product not subsequently demanded by
retailers, and a reduction in expedited manufacturing orders.
20-12 9ust4in4time (9I%) production is a >demand4pull? manufacturing system that has the
following features+
1rganize production in manufacturing cells,
@ire and retain wor.ers who are multi4s.illed,
=ggressi*ely pursue total quality management (%2A) to eliminate defects,
5lace emphasis on reducing both setup time and manufacturing lead time, and
Carefully select suppliers who are capable of deli*ering quality materials in a timely
manner.
20-13 %raditional normal and standard costing systems use sequential trac.ing, in which :ournal
entries are recorded in the same order as actual purchases and progress in production, typically at
four different trigger points in the process.
;ac.flush costing omits recording some of the :ournal entries relating to the cycle from
purchase of direct materials to sale of finished goods, i.e., it has fewer trigger points at which
:ournal entries are made. Bhen :ournal entries for one or more stages in the cycle are omitted,
'#4'
the :ournal entries for a subsequent stage use normal or standard costs to wor. bac.ward to
>flush out? the costs in the cycle for which :ournal entries were not made.
20-14 Cersions of bac.flush costing differ in the number and placement of trigger points at
which :ournal entries are made in the accounting system+
N#$%&' ()
J(#'*+, E*-'.
T'/00&' P(/*-1
L(2+-/(* /* C.2,& 34&'&
J(#'*+, E*-'/&1 M+5&
Cersion & ! 7tage =. 5urchase of direct materials
7tage C. Completion of good finished units of product
7tage 3. 7ale of finished goods
Cersion ' ' 7tage =. 5urchase of direct materials
7tage 3. 7ale of finished goods
Cersion ! ' 7tage C. Completion of good finished units of product
7tage 3. 7ale of finished goods
20-15 %raditional accounting systems cost indi*idual products, and separate product costs from
selling, general, and administrati*e costs. Dean accounting costs the entire *alue stream instead
of indi*idual products. Enused capacity costs and common costs that cannot be reasonably
assigned to *alue streams are excluded from *alue stream costs. In addition, many lean
accounting users expense material costs the period they are purchased, rather than storing them
on the balance sheet until the products using the material are sold.
20-16 ('# min.) E2(*($/2 ('5&' 6#+*-/-. )(' '&-+/,&'!
&. 3 F &#,###, 5 F G'##, C F G

'## G ### , &# '

C
35 '
012

= = F //.H! /$ :erseys
'. 6umber of orders per year F
012
3
F
/$
### , &#
F &!.'' &- orders
!.
day wor.ing
each 3emand
F
days wor.ing of 6umber
3
F
!$/
### , &#
F '.-# :erseys per day
5urchase lead time F days
Ieorder point F '.-#
F &H&.(# &H' :erseys
'#4!
20-17 ('# min.) E2(*($/2 ('5&' 6#+*-/-., &))&2- () 7+'+$&-&' 24+*0&1 82(*-/*#+-/(* () 20-169!
&. 3 F &#,###, 5 F G!#, C F G

!# G ### , &# '

C
35 '
012

= = F 'H'. :erseys 'H! :erseys
%he sizable reduction in ordering cost (from G'## to G!# per purchase order) has reduced the
012 from /$ to 'H!.
'. %he =% proposal has both upsides and downsides. %he upside is potentially higher sales.
); customers may purchase more online than if they ha*e to physically *isit a store. ); would
also ha*e lower administrati*e costs and lower in*entory holding costs with the proposal.
%he downside is that =% could capture );Js customers. Iepeat customers to the =% web
site need not be classified as ); customers. ); would ha*e to establish enforceable rules to
ma.e sure it captures ongoing re*enues from customers it directs to the =5 web site.
%here is insufficient information to determine whether ); should accept =%Js proposal.
Auch depends on whether ); *iews =% as a credible, >honest? partner.
20-1 (&/ min.) EO: )(' + '&-+/,&'!
&. 3 F '#,###, 5 F G&$#, C F '#" G( F G&.$#
012 F ; F ',### yards
'. 6umber of orders per year+ F F &# orders
!. 3emand each wor.ing day F
F
; (# yards per day
F -## yards per wee.
5urchasing lead time F ' wee.s
Ieorder point F -## yards per wee. ' wee.s F (## yards
'#4-
20-1" ('# min.) EO: )(' $+*#)+2-#'&'!
&. Iele*ant carrying costs per part per year+
Iequired annual return on in*estment &/" G$# F G H
Iele*ant insurance, materials handling, brea.age, etc.
costs per year $
Iele*ant carrying costs per part per year G&/
Bith 3 F &(,###, 5 F G&/#, C F G&/, 012 for manufacturer is+
F
' &(,### G&/#
G&/

F $## units
'.
%otal rele*ant
ordering costs
F

5
2
3
F

G&/#
$##
### , &(
F G-,/##
where 2 F $## units, the 012.
!. =t the 012, total rele*ant ordering costs and total rele*ant carrying costs will be exactly
equal. %herefore, total rele*ant carrying costs at the 012 F G-,/## (from requirement '). Be
can also confirm this with direct calculation+
costs carrying rele*ant %otal
F

C
'
2
F

G&/
'
$##
F G-,/##
where 2 F $## units, the 012.
-. 5urchase order lead time is half a month.
Aonthly demand is &(,### units K &' months F &,/## units per month.
3emand in half a month is &,/## units or /# units.
Da.eland should reorder when the in*entory of rotor blades falls to /# units.
'#4/
20-20 ('# min.) S&*1/-/</-. () EO: -( 24+*0&1 /* '&,&<+*- ('5&'/*0 +*5 2+''./*0 2(1-1!
&. = straightforward approach to the requirement is to construct the following table for
012 at rele*ant carrying and ordering costs. =nnual demand is &#,### units. %he formula for the
012 model is+
012 F
where 3 F demand in units for a specified period of time
5 F rele*ant ordering costs per purchase order
C F rele*ant carrying costs of one unit in stoc. for the time period used for 3 (one year in
this problem.
R&,&<+*-
C+''./*0
C(1-1 7&' U*/- R&,&<+*- O'5&'/*0 C(1-1 7&' P#'24+1& O'5&'
7&' Y&+' =300 =200
G&#
&# G
!## G ### , &# '
; /
&# G
'## G ### , &# '
; $!'
&/
&/ G
!## G ### , &# '
F$!'
&/ G
'## G ### , &# '
F /&$
'#
'# G
!## G ### , &# '
F/-(
'# G
'## G ### , &# '
F --
'. )or a gi*en demand le*el, as rele*ant carrying costs increase, 012 becomes smaller. )or
a gi*en demand le*el, as rele*ant order costs increase, 012 increases.
20-21 (&/ min.) I*<&*-('. $+*+0&$&*- +*5 -4& %+,+*2&5 12('&2+'5!
&. %he incremental increase in operating profits from employee cross4training (ignoring the cost
of the training) is+
Increased re*enue from higher customer satisfaction (G/,###,### L '" L /) G/##,###
Ieduced in*entory4related costs &##,###
Incremental increase in operating profits (ignoring training costs) G$##,###
'. =t a cost of G$##,###, 37C will be indifferent between current expenditures and increasing
employee cross4training by /". Consequently, the most 37C would be willing to pay for this
cross4training is the G$##,### benefit recei*ed.
!. ;esides increasing short4term operating profits, additional employee cross4training can
impro*e employee satisfaction because their :obs can ha*e more *ariety, potentially leading to
unanticipated producti*ity impro*ements and lower employee turno*er. Aulti4s.illed employees
can also understand the production process better and can suggest potential impro*ements. 0ach
of these may lead to additional cost reductions.
'#4$
20-22 ('# min.) JIT 7'(5#2-/(*, '&,&<+*- %&*&)/-1, '&,&<+*- 2(1-1!
&. 7olution 0xhibit '#4'' presents the annual net benefit of G!&/,### to Champion
@ardware Company of implementing a 9I% production system.
'. 1ther nonfinancial and qualitati*e factors that Champion should consider in deciding
whether it should implement a 9I% system include+
a. %he possibility of de*eloping and implementing a detailed system for integrating the
sequential operations of the manufacturing process. 3irect materials must arri*e when
needed for each subassembly so that the production process functions smoothly.
b. %he ability to design products that use standardized parts and reduce manufacturing
time.
c. %he ease of obtaining reliable *endors who can deli*er quality direct materials on
time with minimum lead time.
d. Billingness of suppliers to deli*er smaller and more frequent orders.
e. %he confidence of being able to deli*er quality products on time. )ailure to do so
would result in customer dissatisfaction.
f. %he s.ill le*els of wor.ers to perform multiple tas.s such as minor repairs,
maintenance, quality testing and inspection.
SOLUTION E>HI?IT 20-22
=nnual Iele*ant Costs of Current 5roduction 7ystem and 9I% 5roduction 7ystem
for Champion @ardware Company
R&,&<+*- I-&$1
R&,&<+*-
C(1-1 #*5&'
C#''&*-
P'(5#2-/(*
S.1-&$
R&,&<+*-
C(1-1 #*5&'
JIT
P'(5#2-/(*
S.1-&$
=nnual tooling costs M G&##,###
Iequired return on in*estment+
&/" per year G&,###,### of a*erage in*entory per year G&/#,###
&/" per year G'##,###
a
of a*erage in*entory per year !#,###
Insurance, space, materials handling, and setup costs !##,### ''/,###
b
Iewor. costs '##,### &-#,###
c
Incremental re*enues from higher selling prices M (&$#,###)
d
%otal net incremental costs G$/#,### G!!/,###
=nnual difference in fa*or of 9I% production G!&/,###
a
G&,###,### (& M (#") F G'##,###
b
G!##,### (& M #.'/) F G''/,###
c
G'##,### (& M #.!#) F G&-#,###
d
G- -#,### units F G&$#,###
'#4
!. 5ersonal obser*ation by production line wor.ers and managers is more effecti*e in 9I%
plants than in traditional plants. = 9I% plantJs production process layout is streamlined.
1perations are not obscured by piles of in*entory or rewor.. =s a result, such plants are easier to
e*aluate by personal obser*ation than cluttered plants where the flow of production is not
logically laid out.
;esides personal obser*ation, nonfinancial performance measures are the dominant
methods of control. 6onfinancial performance measures pro*ide most timely and easy to
understand measures of plant performance. 0xamples of nonfinancial performance measures of
time, in*entory, and quality include+
Aanufacturing lead time
Enits produced per hour
Aachine setup time K manufacturing time
6umber of defecti*e units K number of units completed
In addition to personal obser*ation and nonfinancial performance measures, financial
performance measures are also used. 0xamples of financial performance measures include+
Cost of rewor.
1rdering costs
7toc.out costs
In*entory turno*er (cost of goods sold

a*erage in*entory)
%he success of a 9I% system depends on the speed of information flows from customers to
manufacturers to suppliers. %he 0nterprise Iesource 5lanning (0I5) system has a single
database, and gi*es lower4le*el managers, wor.ers, customers, and suppliers access to operating
information. %his benefit, accompanied by tight coordination across business functions, enables
the 0I5 system to rapidly transmit information in response to changes in supply and demand so
that manufacturing and distribution plans may be re*ised accordingly.
'#4(
20-23 (!# min.) ?+2@),#14 2(1-/*0 +*5 JIT 7'(5#2-/(*!
&.
(a) 5urchases of direct materials In*entory+ Aaterials and In45rocess
Control ',/-,###
=ccounts 5ayable Control ',/-,###
(b) Incur con*ersion costs Con*ersion Costs Control '!,$##
Carious =ccounts '!,$##
(c) Completion of finished goods )inished 8oods Control
a
!,-(-,###
In*entory+ Aaterials and In45rocess
Control ',!!,$##
Con*ersion Costs =llocated /#,-##
(d) 7ale of finished goods Cost of 8oods 7old
b
!,-!',###
)inished 8oods Control !,-!',###
a
'$,(## L (G&#' N G'() F G!,-(-,###
b
'$,-## L (G&#' N G'() F G!,-!',###
'.
In*entory+

!. Ender an ideal 9I% production system, there could be zero in*entories at the end of each
day. 0ntry (c) would be G!,-!',### finished goods production, not G!,-(-,###. =lso, there
would be no in*entory of direct materials instead of G',/-,### M G',!!,$## F G'#,-##.
'#4H
)inished 8oods Control
Cost of 8oods 7old
Aaterials and In45rocess Control
(b) '!,$##
Con*ersion Costs Control
(c) /#,-##
Con*ersion Costs =llocated
(d) !,-!',### (d) !,-!',### (c) !,-(-,###
;al. '#,-##
(a) ',/-,###
(c) ',!!,$##
;al. /',###
Con*ersion
Costs
3irect
Aaterials
20-24 ('# min.) ?+2@),#14 2(1-/*0, -A( -'/00&' 7(/*-1, $+-&'/+,1 7#'24+1& +*5
1+,& 82(*-/*#+-/(* () 20-239!
&.
(a) 5urchases of direct materials In*entory Control ',/-,###
=ccounts 5ayable Control ',/-,###
(b) Incur con*ersion costs Con*ersion Costs Control '!,$##
Carious =ccounts '!,$##
(c) Completion of finished goods 6o entry
(d) 7ale of finished goods Cost of 8oods 7old !,-!',###
In*entory Control ',$H',(##
Con*ersion Costs =llocated !H,'##
(e) Enderallocated or Con*ersion Costs =llocated !H,'##
o*erallocated con*ersion Costs of 8oods 7old &/,$##
costs Con*ersion Costs Control '!,$##
'.


'#4&#
(e) &/,$## (d) !,-!',###
Cost of 8oods 7old In*entory Control
(d) ',$H',(## (a) ',/-,###
;al. $&,'##
(d) !H,'##
Con*ersion Costs =llocated
(e) !H,'##
Con*ersion Costs Control
(b) '!,$## (e) '!,$##
Con*ersion
Costs
3irect
Aaterials
20-25 ('# min.) ?+2@),#14 2(1-/*0, -A( -'/00&' 7(/*-1, 2($7,&-/(* () 7'(5#2-/(* +*5 1+,&
82(*-/*#+-/(* () 20-239!
&.
(a) 5urchases of direct materials 6o 0ntry
(b) Incur con*ersion costs Con*ersion Costs Control '!,$##
Carious =ccounts '!,$##
(c) Completion of finished goods )inished 8oods Control !,-(-,###
=ccounts 5ayable Control ',!!,$##
Con*ersion Costs =llocated /#,-##
(d) 7ale of finished goods Cost of 8oods 7old !,-!',###
)inished 8oods Control !,-!',###
(e) Enderallocated or Con*ersion Costs =llocated /#,-##
1*erallocated con*ersion Costs of 8oods 7old '$,(##
Costs Con*ersion Costs Control '!,$##
'.

{

{
'#4&&
(c) /#,-##
Con*ersion Costs =llocated
(e) /#,-##
(b) '!,$##
Con*ersion Costs Control
(e) '!,$##
(d) !,-!',### (e) '$,(##
Cost of 8oods 7old
(c) !,-(-,###
)inished 8oods Control
(d) !,-!',###
;al. /',###
Con*ersion
Costs
3irect
Aaterials
20-26 (!# min.) E))&2- () 5/))&'&*- ('5&' 6#+*-/-/&1 (* ('5&'/*0 2(1-1 +*5 2+''./*0 2(1-1, EO:!
&.
S2&*+'/(
1 2 3 4 5
3emand (units) (3)
'!-,##
# '!-,### '!-,### '!-,### '!-,###
Cost per purchase order (5)
G
(&.## G (&.## G (&.## G (&.## G (&.##
=nnual carrying cost per pac.age (C)
G
&&.# G &&.# G &&.# G &&.# G &&.#
1rder quantity per purchase order (units) (2) H## &,/## &,(## ',&## ',##
6umber of purchase orders per year (3 2) '$#.## &/$.## &!#.## &&&.-! ($.$
=nnual ordering costs (3

2)

5
G'&,#$
# G&',$!$ G&#,/!# G H,#'$ G ,#'#
=nnual carrying costs (2C ')
G
/,'$/ G (,/ G&#,/!# G&','(/ G&/,H/
%otal rele*ant costs of ordering and carrying in*entory
G'$,!'
/ G'&,-&& G'&,#$# G'&,!&& G'',(&/
%he economic order quantity is &,(## pac.ages. It is the order quantity at which carrying costs
equal ordering costs and total rele*ant ordering and carrying costs are minimized.
Be can also confirm this from direct calculation. Esing 3 F '!-,###, 5 F G(& and C F G&&.#
012 F
# . && G
(& G ### , '!- '
F &,(## pac.ages
It is interesting to note that Koala ;lue faces a situation where total rele*ant ordering and
carrying costs do not *ary *ery much when order quantity ranges from &,/## pac.ages to ',##
pac.ages.
'. Bhen the ordering cost per purchase order is reduced to G-H+
012 F
# . && G
-H G ### , '!- '
F &,-## pac.ages
%he 012 drops from &,(## pac.ages to &,-## pac.ages when Koala ;lueJs ordering cost per
purchase order decreases from G(& to G-H.
=nd the new rele*ant costs of ordering in*entory F

5
2
3
F

G-H
-## , &
### , '!-
F G(,&H#
and the new rele*ant costs or carrying in*entory F

C
'
2
F

G&&.#
'
-## , &
F
G(,&H#
%he total new costs of ordering and carrying in*entory F G(,&H#

' F G&$,!(#
!. =s summarized below, the new Aona Disa web4based ordering system, by lowering the
012 to &,-## pac.ages, will lower the carrying and ordering costs by G-,$(#. Koala ;lue will
spend G',### to train its purchasing assistants on the new system. 1*erall, Koala ;lue will still
sa*e G',$(# in the first year alone.
'#4&'
%otal rele*ant costs at 012 (from Iequirement ') G&$,!(#
=nnual cost benefit o*er old system (G'&,#$# M G&$,!(#) G -,$(#
%raining costs ',###
6et benefit in first year alone G ',$(#
'#4&!
20-27 (!# min.) EO:, #*2&'-+/*-., 1+)&-. 1-(2@, '&('5&' 7(/*-.
&.
' 35 ' &'#, ### G'/#
012
C G'.-#

= =
F /,### pairs of shoes
'. Bee.ly demand F Aonthly demand K -
F &#,### K - F ',/## pairs of shoes per wee.
5urchasing lead time F & wee.
Ieorder point F ',/## pairs of shoes per wee. L & wee. F ',/## pairs of shoes
!. 7afety stoc. F '#" L&#,### F ',### pairs of shoes
Ieorder point F Bee.ly demand N 7afety stoc.
F ',/## N ',### F -,/## pairs of shoes
012 F /,### pairs of shoes (since neither annual demand, ordering cost, nor carrying
cost ha*e changed, the 012 will not change).
-.
3/-4(#- S+)&-. S-(2@ 3/-4 S+)&-. S-(2@
%otal rele*ant
a. F
ordering costs
3
5
2




&'#, ###
G'/# F G$,###
/, ###




&'#, ###
G'/# F G$,###
/, ###




%otal rele*ant
b. F
ordering costs
2
( 7afety 7toc.) C
'
+



/, ###
G'.-#
'




F G$,###
/, ###
( ',###) G'.-#
'
+



FG&#,(##
c. %otal Iele*ant Cost (a N b) G&',### G&$,(##
'#4&-
'#.'( ('/ min.) MRP, EO:, +*5 JIT!
&. Ender a AI5 system+
=nnual cost of producing and carrying 945ods in in*entory
F Cariable production cost N 7etup cost N Carrying cost
F G/# L -(,### N (G/#,### L &' months) N OG'# L (-,### K ')P
F G',-##,### N $##,### N -#,### F G!,#-#,###
'. Esing an 012 model to determine batch size+
' 35 ' -(, ### G/#, ###
012
C G'#

= =
F &/,-H' 945ods per batch
5roduction of -(,### per year di*ided by a batch size of &/,-H' would imply 945ods
would be produce !.& batches per year. Iounding this up to the nearest whole number
yields - batches per year.
=nnual Cost of producing and carrying 945ods in in*entory
F Cariable production cost N 7etup cost N Carrying cost
F G/# L -(,### N (G/#,### L -) N OG'# L (&/,-H' K ')P
F G',-##,### N '##,### N &/-,H'# F G',/-,H'#
!. Ender a 9I% system
=nnual Cost of producing and carrying 945ods in in*entory
F Cariable production cost N 7etup cost N Carrying cost
F G/# L -(,### N (G/,### L H$
a
) N OG'# L (/## K ')P
F G',-##,### N -(#,### N /,### F G',((/,###
a
production of -(,### per year di*ided by a batch size of /## would imply H$ setups per
year.
-. %he 012 system resulted in the lowest costs, despite the fact that carrying costs were
lower for the 9I% model. @owe*er, the 012 model, in this case, limits production to only
once e*ery four months. %his would not allow managers to react quic.ly to changing mar.et
demand or economic conditions. %he 9I% model pro*ides management with much more
flexibility. 9I% systems might also lead managers to impro*e processes, reduce costs and
increase quality.
'#4&/
20-2" (!# min.) E))&2- () $+*+0&$&*- &<+,#+-/(* 2'/-&'/+ (* EO: $(5&,!
&.
' 35 ' /##, ### G(##
012
C G/#

= =
F -,### computers
'. 6umber of orders per year F
3 /##, ###
012 -, ###
=
F &'/ orders
%otal rele*ant
F
ordering costs

3
5
2

F
/##, ###
G(##
-, ###

F G&##,###

%otal rele*ant
F
carrying costs

2
C
'

F
-, ###
G/#
'

F G&##,###
%otal rele*ant cost F G&##,### N G&##,### F G'##,###
!.
' 35 ' /##, ### G(##
012
C G!#

= =
F /,&$- computers
%otal rele*ant
F
ordering costs
3
5
2

F
/##, ###
G(##
/,&$-

F G,-/H

%otal rele*ant
F
carrying costs
2
C
'

F
/,&$-
G/#
'

F G&'H,&##
%otal rele*ant cost F G,-/H N &'H,&## F G'#$,//H
%hus, the 012 quantity and total rele*ant costs are higher if the company ignores holding costs
when e*aluating managers, but only by about !". %he square root in the 012 model reduces
the sensiti*ity of the ordering decision to errors in parameter estimates.
-. 7ince managers will choose to order /,&$- computers instead of -,###, the cost to the
company will be G$, //H (G'#$,//H 4 G'##,###) higher than it would be if managers were
e*aluated based upon all carrying costs. Computers - E probably does not include the
opportunity costs of carrying in*entory because it is not trac.ed by the financial accounting
system. %he company could change the e*aluation model to include a cost of in*estment in
in*entory. 0*en though this would in*ol*e an additional calculation, it would encourage
managers to ma.e optimal decisions.
'#4&$
20-30 ('/ min.) E))&2- () EO: ('5&'/*0 (* 1#77,/&' 2(1-1
82(*-/*#+-/(* () P'(%,&$ 20-2"9!
&.
i) 7et up cost F Cost per setup L annual setups
=lternati*e =+ G&,### L/# setups F G/#,###
=lternati*e ;+ G&,### L '/# setups F G'/#,###
ii) Carrying Cost F =*erage in*entory le*el L carrying cost
=lternati*e =+ &#,### K ' L G/# F G'/#,###
=lternati*e ;+ =ssumed to be G# (because computers are shipped on the day they are
produced)
iii) %otal rele*ant cost
=lternati*e =+ G/#,### N G'/#,### F G!##,###
=lternati*e ;+ G'/#,### N G# F G'/#,###
Costs would be lower if IA;est produced computers e*ery day.
'. Det C F carrying costs per unit
=lternati*e =+ %otal cost F G/#,### N (&#,### K ') L C
=lternati*e ;+ %otal cost F G'/#,### N G#
0quating these costs, G/#,### N G/,###C F G'/#,###
G/,###C F G'##,###
C F G-#
If carrying costs fall below G-# per unit, IA;est would be better off producing the
computers once a wee..
'#4&
20-31 (!# min.) JIT 7#'24+1/*0, '&,&<+*- %&*&)/-1, '&,&<+*- 2(1-1!
&. 7olution 0xhibit '#4!& presents the G!,/## cash sa*ings that would result if Aargro
Corporation adopted the :ust4in4time in*entory system in '##(.
'. Conditions that should exist in order for a company to successfully adopt :ust4in4time
purchasing include the following+
Q %op management must be committed and pro*ide the necessary leadership support to
ensure a company4wide, coordinated effort.
Q = detailed system for integrating the sequential operations of the manufacturing
process needs to be de*eloped and implemented. 3irect materials must arri*e when
needed for each subassembly so that the production process functions smoothly.
Q =ccurate sales forecasts must be a*ailable for effecti*e finished goods planning and
production scheduling.
Q 5roducts should be designed to maximize use of standardized parts to reduce
manufacturing time and costs.
Q Ieliable *endors who can deli*er quality direct materials on time with minimum lead
time must be obtained.
'#4&(
SOLUTION E>HI?IT 20-31
=nnual Iele*ant Costs of Current 5urchasing 5olicy and 9I% 5urchasing 5olicy
for Aargro Corporation
R&,&<+*-
C(1-1 #*5&'
C#''&*-
P#'24+1/*0
P(,/2.
R&,&<+*-
C(1-1 #*5&'
JIT
P#'24+1/*0
P(,/2.
Iequired return on in*estment
'#" per year

G$##,### of a*erage in*entory per year G&'#,###

'#" per year

G# in*entory per year G #

=nnual insurance and property tax costs &-,### #
Barehouse rent $#,### (&!,/##)
a
1*ertime costs
6o o*ertime #
1*ertime premium -#,###
7toc.out costs
6o stoc.outs #
G$./#
b
contribution margin per unit

'#,### units &!#,###

%otal incremental costs G&H-,### G&/$,/##
3ifference in fa*or of 9I% purchasing G!,/##
a
G(&!,/##) F Barehouse rental re*enues, O(/"

&',###)

G&./#P.
b
Calculation of unit contribution margin
7elling price
(G&#,(##,### K H##,### units) G&'.##
Cariable costs per unit +
Cariable manufacturing cost per unit
(G-,#/#,### K H##,### units) G-./#
Cariable mar.eting and distribution cost per unit
(GH##,### K H##,### units) &.##
%otal *ariable costs per unit /./#
Contribution margin per unit G $./#
6ote that the incremental costs of G-#,### in o*ertime premiums to ma.e the additional &/,###
units are less than the contribution margin from losing these sales equal to GH,/## (G$./#

&/,###). Aargro would rather incur o*ertime than lose &/,### units of sales.
'#4&H
20-32 ('/ min.) S#77,. 24+/* &))&2-1 (* -(-+, '&,&<+*- /*<&*-('. 2(1-1!
&. %he rele*ant costs of purchasing from Aa:i and Indu. are+

C(1- C+-&0('. M+B/ I*5#@
5urchase costs
&#,### boards L GH! per board
&#,### boards L GH# per board
GH!#,###
H##,###
1rdering costs
/# orders L G&# per order
/# orders L G( per order
/##
-##
Inspection costs
&#,### boards L /" L G/ per board
&#,### boards L '/" L G/ per board
',/##
&',/##
Iequired annual return on in*estment
&## boards L GH! per board L &#"
&## boards L GH# per board L &#"
H!#
H##
7toc.out costs
&## boards L G/ per board
!## boards L G( per board
/##
',-##
Ieturn costs
/# boards L G'/ per board
/## boards L G'/ per board
&,'/#
&',/##
1ther carrying costs
&## boards L G'./# per board per year
&## boards L G'./# per board per year
'/#
RRRRRRRR '/#
%otal Cost GH!/,H!# GH'(,H/#
'. Bhile Indu. will sa*e Cow 7pot G$,H(# (GH!/,H!# S GH'(,H/#), Cow 7pot may still choose
to use Aa:i for the following reasons+
a. %he sa*ings are less than &" of the total cost of the mother boards.
b. Bith ten times the number of returns, Indu. will probably ha*e a negati*e effect
on Cow 7potJs reputation.
c. Bith Indu.Js higher stoc.outs, Cow 7potJs reputation for a*ailability and on time
deli*ery will be effected.
d. %he increased number of inspections may necessitate the hiring of additional
personnel and the need for additional factory space and equipment.
'#4'#
20-33 ('# min.) ?,+2@),#14 2(1-/*0 +*5 JIT 7'(5#2-/(*!
&.
(a) 5urchases of direct materials
In*entory+ Aaterials and In45rocess Control //#,###
=ccounts 5ayable Control //#,###
(b) Incur con*ersion costs Con*ersion Costs Control --#,###
Carious =ccounts --#,###
(c) Completion of finished goods
)inished 8oods Control
a
H-/,###
In*entory+ Aaterials T In45rocess Control /'/,###
Con*ersion Costs =llocated -'#,###
(d) 7ale of finished goods Cost of 8oods 7old
b
H##,###
)inished 8oods Control H##,###
a
'&,### L G-/ (G'/ N G'#) F GH-/,###
b
'#,### L G-/ F GH##,###
'.

( b )

- - # , # # #


( a

)

/ / # , # # # ( c )

/ ' / , # # # ( c )

H - / , # # #
; a l .

' / , # # #
( c )

- ' # , # # #
( d )

H # # , # # #
; a l .

- / , # # #
( d )

H # # , # # #
In*entory
Aaterials and In45rocess Control )inished 8oods Control Cost of 8oods 7old
Con*ersion Costs =llocated
Con*ersion Costs Control
Con*ersion
Costs
3irect
Aaterials
'#4'&
20-34 ('# min.) ?+2@),#14, -A( -'/00&' 7(/*-1, $+-&'/+,1 7#'24+1& +*5 1+,&
82(*-/*#+-/(* () 20-339!
&.
(a) 5urchases of direct materials In*entory Control //#,###
=ccounts 5ayable Control //#,###
(b) Incur con*ersion costs Con*ersion Costs Control --#,###
Carious =ccounts
(such as =ccounts 5ayable
Control and Bages 5ayable Control) --#,###
(c) Completion of finished goods 6o entry
(d) 7ale of finished goods Cost of 8oods 7old H##,###
In*entory Control /##,###
Con*ersion Costs =llocated -##,###
(e) Enderallocated Con*ersion Costs =llocated -##,###
or o*erallocated Cost of 8oods 7old -#,###
con*ersion costs Con*ersion Costs Control --#,###
'.
'#4''
(d) H##,###
(b) --#,### (e) --#,###
Con*ersion
Costs
In*entory Control
Con*ersion Costs =llocated
Con*ersion Costs Control
Cost of 8oods 7old
(a) //#,### (d) /##,###
(e) -##,### (d) -##,###
;al./#,###
(e) -#,###
3irect
Aaterials
20-35 ('# min.) ?+2@),#14, -A( -'/00&' 7(/*-1, 2($7,&-/(* () 7'(5#2-/(* +*5 1+,&
82(*-/*#+-/(* () 20-339!
&.
(a) 5urchase of direct materials 6o entry
(b) Incur con*ersion costs Con*ersion Costs Control --#,###
Carious =ccounts
(such as =ccounts 5ayable
Control and Bages 5ayable Control) --#,###

(c) Completion of finished )inished 8oods Control H-/,###
goods =ccounts 5ayable Control /'/,###
Con*ersion Costs =llocated -'#,###

(d) 7ale of finished goods Cost of 8oods 7old H##,###
)inished 8oods Control H##,###
(e) Enderallocated Con*ersion Costs =llocated -'#,###
or o*erallocated Cost of 8oods 7old '#,###
con*ersion costs Con*ersion Costs Control --#,###
'.

3 i r e c t

A a t e r i a l s
C o n * e r s i o n

C o s t s
C o n * e r s i o n

C o s t s

= l l o c a t e d
( c )

- ' # , # # #
C o n * e r s i o n

C o s t s

C o n t r o l
( b )

- - # , # # #

( e )

- ' # , # # #
( e )

- - # , # # #
( c )

H - / , # # # ( d )

H # # , # # # ( d )

H # # , # # #
( e )

' # , # # #
)inished 8oods Control Cost of 8oods 7old
;al. -/,###
'#4'!
20-36 ('# min.) L&+* +22(#*-/*0!
&. %he cost ob:ect in lean accounting is the *alue stream, not the indi*idual product. )73
has identified two distinct *alue streams+ Aechanical 3e*ices and 0lectronic 3e*ices. =ll direct
costs are traced to the *alue streams. @owe*er, not all plant4le*el o*erhead costs are allocated to
the *alue streams when computing operating income. Calue streams are only charged for the
percentage of space they actually use, only (/" of the G&'#,### occupancy costs are charged to
the two *alue streams. %he remaining &/", or G&(,###, is not used to compute *alue stream
profits, nor are other plant4le*el o*erhead costs.
'. 1perating income under lean accounting are the following (in thousands of dollars)+
M&24+*/2+,
D&</2&1
E,&2-'(*/2
D&</2&1
7ales (G## N G/##, GH## N G-/#) G&,'## G&,!/#
Costs
3irect material purchased
(G&H# N G&'/, G'/# N GH#) !&/ !-#
3irect manufacturing labor
(G&/# N G/, G'## N G$#) ''/ '$#
0quipment costs
(GH# N G&'/, G'## N G&##) '&/ !##
5roduct4line o*erhead
(G&&# N G$#, G&'/ N G/#) &# &/
1ccupancy costs
(G&'#,### L -#")
(G&'#,### L -/") -( /-
Calue stream operating income G '' G ''&
In addition to the differences discussed in Iequirement &, )73Js lean accounting system treats
all direct material costs as expenses in the period they are purchased. %he following factors
explain the differences between traditional operating income and lean accounting income for the
two *alue streams+
M&24+*/2+,
D&</2&1
E,&2-'(*/2
D&</2&1
%raditional operating income
(G&## N G&#/, G-/ N G&-#) G'#/ G&(/
=dditional cost of direct materials
(G!&/ S G!##, G!-# S G!'/) (&/) (&/)
3ecrease in allocated plant4le*el o*erhead
(G(/ S G-(, G&#/ S G/-) ! /&
Calue stream operating income G'' G''&

'#4'-
20-37 (!/M-# min.) ?+2@),#14/*0!
&. 8lendale has successfully implemented 9I% in its production operations and, as a result,
minimized wor.4in4process in*entory. @owe*er, it still has a fair amount of raw material and
finished goods in*entory. 8lendale should, therefore, adopt a bac.flush costing system with two
trigger points, as follows+
a. 3irect materials purchases charged to In*entory+ Aaterials and In45rocess Control
b. Completion of finished goods recorded as )inished 8oods Control
%he bac.flush approach described closely approximates the costs computed using sequential
trac.ing. %here is no wor. in process so there is no need for a Bor. in 5rocess in*entory account.
)urther, by maintaining a Aaterials and In45rocess In*entory Control and )inished 8oods
Control account, 8lendale can .eep trac. of and control the in*entories of direct materials and
finished goods in its plant.
'a. 8lendale should adopt a bac.flush costing system with trigger points at completion of
finished goods and at the sale of finished goods. %his would approximate the sequential trac.ing
approach since the question assumes 8lendale has no direct materials or wor.4in4process
in*entories. %here is, therefore, no need for these in*entory accounts.
b. = bac.flush costing system with two trigger points<when purchases of direct materials
are made (debited to In*entory Control), and when )inished 8oods are sold<would approximate
sequential trac.ing, since the question assumes 8lendale has no wor.4in4process or finished
goods in*entories.
c. = bac.flush costing system with a single trigger point when finished goods are sold would
approximate sequential trac.ing, since the question assumes 8lendale has no direct material,
wor.4in4process or finished goods in*entories. %his is a further simplification of the examples in
the text.
%he principle here is that bac.flushing of costs should be triggered at the finished goods
in*entory stage if 8lendale plans to hold finished goods in*entory. If 8lendale plans to hold no
finished goods in*entory, bac.flushing can be postponed until the finished goods are sold. In
other words, the trigger points for bac.flushing relate to the points where in*entory is being
accumulated. =s a result, bac.flushing matches the sequential trac.ing approach and also
maintains a record for the monitoring and control of the in*entory.
!. 7ome comments on the quotation follow+
a. %he bac.flush system is a standard costing system, not an actual costing system.
b. If standard costing is used, an up4to4date, realistic set of standard costs is always
desirableMMas long as the set meets the cost4benefit test of updating.
c. %he operating en*ironments of >the present 9I% era? ha*e induced many companies
toward more simplicity (bac.flush) and abandoning the typical standard costing
system (sequential trac.ing).
d. ;ac.flush is probably closer to being a periodic system than a perpetual system.
@owe*er, a periodic system may be cost4effecti*e, particularly where physical
in*entories are relati*ely low or stable.
e. %he textboo. points out that, to be attracti*e, bac.flush costing should generate the
same financial measurements as sequential trac.ingMMand at a lower accounting cost.
f. %he choice of a product costing system is highly contextual. Its characteristics should
be hea*ily affected by its costs, the preferences of operating managers, and the
underlying operating processes. 7weeping generalizations about any cost accounting
system or technique are un:ustified.
'#4'/
'#4'$