cost 20

20 - 1

Inventory Management, Inventory Management, Just-in-Time, and Just-in-Time, and

Backflush CostingBackflush Costing

Chapter 20Chapter 20

20 - 2

IntroductionIntroduction

Inventory management is a pivotal part of Inventory management is a pivotal part of profit planning for manufacturing and profit planning for manufacturing and merchandising companies.merchandising companies.

Accounting information can play a key role Accounting information can play a key role in inventory management.in inventory management.

20 - 3

Learning ObjectivesLearning Objectives

1 Identify five categories of costs associated Identify five categories of costs associated with goods for salewith goods for sale

2 Balance ordering costs and carrying costs Balance ordering costs and carrying costs using the economic-order-quantity (EOQ) using the economic-order-quantity (EOQ) decision modeldecision model

3 Identify and reduce conflicts that can arise Identify and reduce conflicts that can arise between EOQ decision models and models between EOQ decision models and models used for performance evaluationused for performance evaluation

20 - 4


4 Use a supply-chain approach to inventory Use a supply-chain approach to inventory managementmanagement

5 Differentiate materials requirements planning Differentiate materials requirements planning (MRP) systems from just-in-time (JIT) (MRP) systems from just-in-time (JIT) systems for manufacturingsystems for manufacturing

20 - 5


6 Identify the major features of a just-in-time Identify the major features of a just-in-time production systemproduction system

7 Use backflush costingUse backflush costing8 Describe different ways backflush costing Describe different ways backflush costing

can simplify traditional job-costing systemscan simplify traditional job-costing systems

20 - 6

Learning Objective 1Learning Objective 1

Identify five categories of costs Identify five categories of costs associated with goods for saleassociated with goods for sale

20 - 7

Costs Associated with Costs Associated with Goods for SaleGoods for Sale

Five categories of costs associated with Five categories of costs associated with goods for sale are:goods for sale are:

1 Purchasing costsPurchasing costs2 Ordering costsOrdering costs3 Carrying costsCarrying costs4 Stockout costsStockout costs5 Quality costsQuality costs

20 - 8

Purchasing CostsPurchasing Costs

Purchasing costs Purchasing costs are the costs of goods are the costs of goods acquired from suppliers including incoming acquired from suppliers including incoming freight or transportation costs.freight or transportation costs.

These costs usually make up the largest These costs usually make up the largest single cost category of goods for sale.single cost category of goods for sale.

Discounts for different purchase-order sizes Discounts for different purchase-order sizes and supplier credit terms affect purchasing and supplier credit terms affect purchasing costs.costs.

20 - 9

Ordering CostsOrdering Costs

Ordering costs Ordering costs are the costs of preparing, are the costs of preparing, issuing, and paying purchase orders, plus issuing, and paying purchase orders, plus receiving and inspecting the items included receiving and inspecting the items included in the orders.in the orders.

Purchase approval and special processing Purchase approval and special processing costs are related to the number of purchase costs are related to the number of purchase orders processed.orders processed.

20 - 10

Carrying CostsCarrying Costs

Carrying costs Carrying costs arise when an organization arise when an organization holds an inventory of goods for sale.holds an inventory of goods for sale.

These costs include the opportunity cost of These costs include the opportunity cost of the investment tied up in inventory and the the investment tied up in inventory and the costs associated with storage such as space costs associated with storage such as space rental, insurance, obsolescence, and spoilage.rental, insurance, obsolescence, and spoilage.

20 - 11

Stockout CostsStockout Costs

A A stockout cost stockout cost occurs when an organization occurs when an organization runs out of a particular item for which there runs out of a particular item for which there is a customer demand.is a customer demand.

Expediting costs of a stockout include:Expediting costs of a stockout include:– Additional ordering costsAdditional ordering costs– Associated transportation costsAssociated transportation costs

20 - 12

Stockout CostsStockout Costs

Opportunity cost of a stockout includes:Opportunity cost of a stockout includes:– Lost contribution margin on the sale not madeLost contribution margin on the sale not made– Any contribution margin lost on future sales Any contribution margin lost on future sales

hurt by customer ill-will caused by the hurt by customer ill-will caused by the stockout.stockout.

20 - 13

Quality CostsQuality Costs

Quality costs Quality costs of a product or service is its lack of of a product or service is its lack of conformance with a preannounced or conformance with a preannounced or prespecified standard.prespecified standard.

There are four categories of costs of quality:There are four categories of costs of quality:1 Prevention costsPrevention costs2 Appraisal costsAppraisal costs3 Internal failure costsInternal failure costs4 External failure costsExternal failure costs

20 - 14


Balance ordering costs and Balance ordering costs and carrying costs using the carrying costs using the

economic-order-quantity economic-order-quantity (EOQ) decision model(EOQ) decision model

20 - 15

Economic-Order-Quantity Economic-Order-Quantity Decision ModelDecision Model

The economic-order-quantity (EOQ) is a The economic-order-quantity (EOQ) is a decision model that calculates the optimal decision model that calculates the optimal quantity of inventory to order under a quantity of inventory to order under a restrictive set of assumptions.restrictive set of assumptions.

The simplest version of this model The simplest version of this model incorporates only ordering costs and carrying incorporates only ordering costs and carrying costs into the calculations.costs into the calculations.

20 - 16


Assumptions:Assumptions:1 The same fixed quantity is ordered at each The same fixed quantity is ordered at each

reorder point.reorder point.2 Demand, ordering costs, and carrying costs are Demand, ordering costs, and carrying costs are

known with certainty.known with certainty.3 Purchase-order lead time – the time between Purchase-order lead time – the time between

placing of an order and its delivery – is also placing of an order and its delivery – is also known with certainty.known with certainty.

20 - 17


4 Purchasing costs per unit are unaffected by the Purchasing costs per unit are unaffected by the quantity ordered.quantity ordered.

5 No stockouts occur. One justification for this No stockouts occur. One justification for this assumption is that the costs of a stockout can be assumption is that the costs of a stockout can be prohibitively high.prohibitively high.

6 In deciding the size of the purchase order, In deciding the size of the purchase order, managers consider the costs of quality only to the managers consider the costs of quality only to the extent that these costs affect ordering costs or extent that these costs affect ordering costs or carrying costs.carrying costs.

20 - 18


The EOQ minimizes the relevant ordering costs The EOQ minimizes the relevant ordering costs and carrying costs.and carrying costs.

Relevant total costs = Relevant ordering costs + Relevant total costs = Relevant ordering costs + Relevant carrying costsRelevant carrying costs

Little Video store sells packages of blank video Little Video store sells packages of blank video tapes.tapes.

Little Video purchases packages of video tapes Little Video purchases packages of video tapes from White Oaks, Inc., at $15/package.from White Oaks, Inc., at $15/package.

20 - 19


Annual demand is 12,844 packages, at the Annual demand is 12,844 packages, at the rate of 247 packages per week.rate of 247 packages per week.

Little Video requires a 15% annual return on Little Video requires a 15% annual return on investment. investment.

The purchase-order lead time is two weeks.The purchase-order lead time is two weeks. What is the economic-order-quantity?What is the economic-order-quantity?

20 - 20


Little Video additional data: Little Video additional data: Relevant ordering cots per purchase Relevant ordering cots per purchase orderorder $209 $209 Relevant carrying costs per Relevant carrying costs per package per year: package per year: Required annual return on Required annual return on investment (15% × $15)investment (15% × $15) $2.25 $2.25 Relevant other costsRelevant other costs 3.25 3.25

$5.50$5.50

20 - 21


The formula for the EOQ model is:The formula for the EOQ model is:

EOQ =EOQ =

D = Demand in units for a specified time periodD = Demand in units for a specified time periodP = Relevant ordering costs per purchase orderP = Relevant ordering costs per purchase orderC = Relevant carrying costs of one unit inC = Relevant carrying costs of one unit in stock for the time period used for Dstock for the time period used for D

2DP

C

20 - 22


EOQ =EOQ =

EOQ =EOQ = EOQ = 988 EOQ = 988 Little Video should purchase 988 tape Little Video should purchase 988 tape

packages per order to minimize total packages per order to minimize total ordering and carrying costs.ordering and carrying costs.

976 144,

2 12 84450

x x, $209$5.

20 - 23


What are the relevant total costs?What are the relevant total costs? The formula for annual relevant costs (RTC) is: RTC = The formula for annual relevant costs (RTC) is: RTC =

Annual relevant ordering costs + Annual relevant Annual relevant ordering costs + Annual relevant carrying costs carrying costs

RTC = RTC = (( )) × P + × P + (( ) ) × C = + × C = +

Q can be any order quantity, not just the EOQ.Q can be any order quantity, not just the EOQ.

DQ

Q 2

DP Q

QC 2

20 - 24


When Q = 988 units,When Q = 988 units, RTC = RTC = 12,84412,844 × $209 + × $209 + 988988 × $5.50 × $5.50 ==

988988 2 2 $5,434 total relevant costs$5,434 total relevant costs

20 - 25


How many deliveries should occur each time How many deliveries should occur each time period?period?

The number of deliveries each time period is: The number of deliveries each time period is:

= = 13 deliveries = = 13 deliveries D EOQ

12,844 12,844 988988


20 - 26

Rel

evan

t Tot

al C

osts

(D

olla

rs)

2,000

4,000

6,000

8,000

10,000

5,434

600 1,200 1,800 2,400988EOQ

Annual relevant carrying costs

Annual relevant total costs

Annual relevant ordering costs

Order Quantity (Units)

20 - 27

Reorder PointReorder Point

The reorder point is the quantity level of the The reorder point is the quantity level of the inventory on hand that triggers a new order.inventory on hand that triggers a new order.

The reorder point is simplest to compute The reorder point is simplest to compute when both demand and purchase-order lead when both demand and purchase-order lead time are known with certainty.time are known with certainty.

Reorder point = Number of units sold per unit Reorder point = Number of units sold per unit of time × Purchase-order lead timeof time × Purchase-order lead time

20 - 28


What is the reorder point for Little Video?What is the reorder point for Little Video?– Economic order quantity = 988 packages Economic order quantity = 988 packages

– Number of units sold/week = 247 packagesNumber of units sold/week = 247 packages– Purchase-order lead time = 2 weeksPurchase-order lead time = 2 weeks Reorder point = 247 × 2 = 494 packagesReorder point = 247 × 2 = 494 packages

20 - 29


Little Video will order 988 packages of tapes Little Video will order 988 packages of tapes each time its inventory stock falls to 494 each time its inventory stock falls to 494 packages.packages.

Reorder PointReorder Point988

494

Weeks 1 2 3 4 5 6 7 8

Reorder Point

Reorder Point

Lead Time

2 weeks

This exhibit assumes that demand and purchase-order lead time are certain:

Demand = 247 tape packages/week Purchase-order lead time = 2 weeks20 - 30

20 - 31

Safety StockSafety Stock

Safety stock Safety stock is inventory held at all times is inventory held at all times regardless of the quantity of inventory regardless of the quantity of inventory ordered using the EOQ model.ordered using the EOQ model.

Safety stock is used as a buffer against Safety stock is used as a buffer against unexpected increases in demand or lead time unexpected increases in demand or lead time and unavailability of stock from suppliers.and unavailability of stock from suppliers.

20 - 32


Little Video’s expected demand is 247 Little Video’s expected demand is 247 packages per week.packages per week.

Management feels that a maximum demand Management feels that a maximum demand of 350 packages per week may occur.of 350 packages per week may occur.

Management decides that the costs of Management decides that the costs of stockouts are prohibitive.stockouts are prohibitive.

How much safety stock should be carried?How much safety stock should be carried?

20 - 33


350 Maximum demand – 247 Expected 350 Maximum demand – 247 Expected demand = 103 Excess demand per weekdemand = 103 Excess demand per week

103 packages × 2 weeks lead time = 206 103 packages × 2 weeks lead time = 206 packages of safety stock.packages of safety stock.

20 - 34

Considerations in Obtaining Considerations in Obtaining Estimates of Relevant CostsEstimates of Relevant Costs

Obtaining accurate estimates of the cost Obtaining accurate estimates of the cost parameters used in the EOQ decision model parameters used in the EOQ decision model is a challenging task.is a challenging task.

What are the relevant incremental costs of What are the relevant incremental costs of carrying inventory?carrying inventory?

– Only those costs of the purchasing company Only those costs of the purchasing company that change with the quantity of inventory that change with the quantity of inventory heldheld

20 - 35

Considerations in Obtaining Considerations in Obtaining Estimates of Relevant CostsEstimates of Relevant Costs

What is the relevant opportunity cost of What is the relevant opportunity cost of capital?capital?

– It is the return forgone by investing capital It is the return forgone by investing capital in inventory rather than elsewhere.in inventory rather than elsewhere.

– It is calculated as the required rate of return It is calculated as the required rate of return multiplied by those costs per unit that vary multiplied by those costs per unit that vary with the number of units purchased and that with the number of units purchased and that are incurred at the time the units are received.are incurred at the time the units are received.

20 - 36

Cost of Prediction ErrorCost of Prediction Error

Predicting relevant costs requires care and is Predicting relevant costs requires care and is difficult.difficult.

Assume that Little Video’s relevant ordering Assume that Little Video’s relevant ordering cost is $97.84 instead of the $209 prediction cost is $97.84 instead of the $209 prediction used.used.

What is the cost of this prediction error?What is the cost of this prediction error?

20 - 37


Step 1: Step 1: Compute the monetary outcome Compute the monetary outcome from from the best action that could have been the best action that could have been taken, taken, given the actual amount of the given the actual amount of the cost input. cost input.

= 676 packages (approx.)= 676 packages (approx.)

2 12 844 97 84

50

x x, .

$5.

456 966,

EOQ =

EOQ =

20 - 38


The annual relevant total costs when EOQ The annual relevant total costs when EOQ is 767 packages is:is 767 packages is:

RTC = + RTC = + 12,844 × $97.84 + 676 × $5.5 = $3,718 12,844 × $97.84 + 676 × $5.5 = $3,718 676 2 676 2

DP Q

QC 2

20 - 39


Step 2: Step 2: Compute the monetary outcome Compute the monetary outcome from from the best action based on the the best action based on the

incorrect incorrect amount of the predicted cost amount of the predicted cost input.input.

The planned action when the relevant ordering The planned action when the relevant ordering costs per purchase order are predicted to be costs per purchase order are predicted to be $209 is to purchase 988 packages in each $209 is to purchase 988 packages in each order.order.

20 - 40


What are the annual relevant costs using What are the annual relevant costs using this order quantity when D = 12,844 units, this order quantity when D = 12,844 units, P = $97.84, and C = $5.50? P = $97.84, and C = $5.50?

RTC = RTC = 12,844 × $97.84 12,844 × $97.84 + + 988 × $5.5 988 × $5.5 988 2 988 2

RTC = $3,989RTC = $3,989

20 - 41


Step 3: Step 3: Compute the difference Compute the difference between the between the monetary outcomes from Steps 1 & 2. monetary outcomes from Steps 1 & 2.

Monetary OutcomeMonetary Outcome Step 1Step 1 $3,718 $3,718 Step 2 Step 2 3,989 3,989 DifferenceDifference $ (271) $ (271)

The cost of prediction error is $271.The cost of prediction error is $271.

20 - 42


Identify and reduce conflicts Identify and reduce conflicts that can arise between EOQ that can arise between EOQ decision models and models decision models and models

used for performance used for performance evaluationevaluation

20 - 43

Evaluating Managers and Evaluating Managers and Goal-Congruence IssuesGoal-Congruence Issues

Goal-congruence issues can arise when there Goal-congruence issues can arise when there is an inconsistency between the EOQ decision is an inconsistency between the EOQ decision model and the model used to evaluate the model and the model used to evaluate the performance of the manager implementing performance of the manager implementing the inventory management decisions.the inventory management decisions.

20 - 44

Evaluating Managers and Evaluating Managers and Goal-Congruence IssuesGoal-Congruence Issues

The opportunity cost of investment tied up in The opportunity cost of investment tied up in inventory is a key input in the EOQ decision inventory is a key input in the EOQ decision model.model.

Some companies now include opportunity Some companies now include opportunity costs as well as actual costs when evaluating costs as well as actual costs when evaluating managers so that there is goal-congruence managers so that there is goal-congruence between managers and the company.between managers and the company.

20 - 45

Just-In-Time PurchasingJust-In-Time Purchasing

Just-in-time (JIT) purchasing Just-in-time (JIT) purchasing is the purchase is the purchase of goods or materials such that a delivery of goods or materials such that a delivery immediately precedes demand or use.immediately precedes demand or use.

Just-in-time purchasing can be implemented Just-in-time purchasing can be implemented in both the retail and manufacturing sectors in both the retail and manufacturing sectors of the economy.of the economy.

20 - 46

JIT Purchasing and EOQ JIT Purchasing and EOQ Model ParametersModel Parameters

Companies moving toward JIT purchasing Companies moving toward JIT purchasing argue that the cost of carrying inventories argue that the cost of carrying inventories (parameter C in the EOQ model) has been (parameter C in the EOQ model) has been dramatically underestimated in the past.dramatically underestimated in the past.

This cost includes storage costs, spoilage, This cost includes storage costs, spoilage, obsolescence, and opportunity costs such as obsolescence, and opportunity costs such as investment tied up in inventory.investment tied up in inventory.

20 - 47


The cost of placing a purchase order The cost of placing a purchase order (parameter P in the EOQ model) is also (parameter P in the EOQ model) is also being re-evaluated.being re-evaluated.

Three factors are causing sizable reduction Three factors are causing sizable reduction in the cost of placing a purchase order (P).in the cost of placing a purchase order (P).

1 Companies increasingly are establishing Companies increasingly are establishing long-run purchasing arrangements.long-run purchasing arrangements.

20 - 48


2 Companies are using electronic link, such as Companies are using electronic link, such as the Internet, to place purchase orders.the Internet, to place purchase orders.

3 Companies are increasing the use of purchase Companies are increasing the use of purchase order cards (similar to consumer credit cards order cards (similar to consumer credit cards like Visa and Master Card).like Visa and Master Card).

Both increases in the carrying cost (C) and Both increases in the carrying cost (C) and decreases in the ordering cost per purchase decreases in the ordering cost per purchase order (P) result in smaller EOQ amounts.order (P) result in smaller EOQ amounts.

20 - 49

Relevant Costs of JIT PurchasingRelevant Costs of JIT Purchasing

When comparing two or more purchasing When comparing two or more purchasing policies the analysis should include only policies the analysis should include only the relevant costs – those costs that differ the relevant costs – those costs that differ between alternatives.between alternatives.

The difference between two incremental The difference between two incremental costs is the relevant savings from choosing costs is the relevant savings from choosing a given purchasing policy.a given purchasing policy.

20 - 50

Supplier EvaluationSupplier Evaluation

The timely delivery of quality products is The timely delivery of quality products is particularly crucial in JIT purchasing particularly crucial in JIT purchasing environments.environments.

Defective goods and late deliveries often Defective goods and late deliveries often result in contribution margin lost on current result in contribution margin lost on current and future sales.and future sales.

Companies that implement JIT purchasing Companies that implement JIT purchasing choose their suppliers carefully.choose their suppliers carefully.

20 - 51

Supplier EvaluationSupplier Evaluation

What are some examples of relevant costs? What are some examples of relevant costs? – Purchasing costsPurchasing costs– Ordering costsOrdering costs– Inspection costsInspection costs– Stockout costsStockout costs– Customer returns costsCustomer returns costs– Outlay carrying costsOutlay carrying costs

20 - 52


Use a supply-chain approach Use a supply-chain approach to inventory managementto inventory management

20 - 53

Supply-Chain AnalysisSupply-Chain Analysis

The level of inventory held by retailers is The level of inventory held by retailers is influenced by demand patterns of their influenced by demand patterns of their customers and supply relationships with their customers and supply relationships with their distributors, manufacturers, and suppliers.distributors, manufacturers, and suppliers.

20 - 54


Supply-chain analysis Supply-chain analysis describes the flow of describes the flow of goods, services, and information from cradle goods, services, and information from cradle to grave, regardless of whether those activities to grave, regardless of whether those activities occur in the same organization or other occur in the same organization or other organizations.organizations.

There are significant total gains to companies There are significant total gains to companies in the supply chain from coordinating their in the supply chain from coordinating their activities and sharing information.activities and sharing information.

20 - 55


The higher level of variability at suppliers The higher level of variability at suppliers than at manufacturers, and at manufacturers than at manufacturers, and at manufacturers than at retailers, is called the “bullwhip effect” than at retailers, is called the “bullwhip effect” or the “whiplash effect.” or the “whiplash effect.”

One consequence of the bullwhip effect is One consequence of the bullwhip effect is that high levels of inventory are often held that high levels of inventory are often held at various stages in the supply chain.at various stages in the supply chain.

20 - 56


There are multiple gains to companies in a There are multiple gains to companies in a supply chain by coordinating their activities supply chain by coordinating their activities and sharing information.and sharing information.

Updated sales information reduces the level Updated sales information reduces the level of uncertainty that manufacturers and of uncertainty that manufacturers and suppliers have about retail demand.suppliers have about retail demand.

20 - 57


A reduction in demand uncertainty may...A reduction in demand uncertainty may...– lead to fewer stockouts at the retail level.lead to fewer stockouts at the retail level.– reduce the number of units manufactured not reduce the number of units manufactured not

subsequently demanded by retailers.subsequently demanded by retailers.– reduce the number of expedited manufacturing reduce the number of expedited manufacturing

orders.orders.– lower inventories being held by each company lower inventories being held by each company

in the supply chain.in the supply chain.

20 - 58


Differentiate materials Differentiate materials requirements planning (MRP) requirements planning (MRP) systems from just-in-time (JIT) systems from just-in-time (JIT)

systems for manufacturingsystems for manufacturing

20 - 59

Materials Requirement Materials Requirement Planning (MRP)Planning (MRP)

Materials requirements planning (MRP) Materials requirements planning (MRP) systems systems take a “push-through” approach that take a “push-through” approach that manufactures finished goods for inventory on manufactures finished goods for inventory on the basis of demand forecasts.the basis of demand forecasts.

MRP predetermines the necessary outputs at MRP predetermines the necessary outputs at each stage of production.each stage of production.

Inventory management is a key challenge in Inventory management is a key challenge in an MRP system.an MRP system.

20 - 60


Materials requirement planning uses...Materials requirement planning uses...– demand forecasts for the final products.demand forecasts for the final products.– a bill of materials outlining the materials, a bill of materials outlining the materials,

components and subassemblies of each final components and subassemblies of each final product.product.

– the quantities of materials, components, the quantities of materials, components, finished products and product inventories.finished products and product inventories.

20 - 61


Management accountants play key roles in Management accountants play key roles in an MRP system, including...an MRP system, including...

1 maintaining accurate and timely information maintaining accurate and timely information pertaining to materials, work in process, and pertaining to materials, work in process, and finished goods, and...finished goods, and...

2 providing estimates of the setup costs for each providing estimates of the setup costs for each production run at a plant, the downtime costs, production run at a plant, the downtime costs, and carrying costs of inventory.and carrying costs of inventory.

20 - 62


Identify the major features of a Identify the major features of a just-in-time production systemjust-in-time production system

20 - 63

Just-In-Time Production SystemsJust-In-Time Production Systems

Just-in-time (JIT) production systems Just-in-time (JIT) production systems take a take a “demand pull” approach in which goods are “demand pull” approach in which goods are only manufactured to satisfy customer orders.only manufactured to satisfy customer orders.

Demand triggers each step of the production Demand triggers each step of the production process, starting with customer demand for a process, starting with customer demand for a finished product at the end of the process, to finished product at the end of the process, to the demand for direct materials at the the demand for direct materials at the beginning of the process.beginning of the process.

20 - 64

Major Features of a JIT SystemMajor Features of a JIT System

JIT production systems aim to simultaneously JIT production systems aim to simultaneously meet customer demand in a timely way...meet customer demand in a timely way...

– with high quality products, and...with high quality products, and...– at the lowest possible total cost.at the lowest possible total cost.

20 - 65

Major Features of a JIT SystemMajor Features of a JIT System

The five major features of a JIT system are:The five major features of a JIT system are:1 Organizing production in manufacturing cellsOrganizing production in manufacturing cells2 Hiring and retaining multi-skilled workersHiring and retaining multi-skilled workers3 Emphasizing total quality managementEmphasizing total quality management4 Reducing manufacturing lead time and setup Reducing manufacturing lead time and setup

timetime5 Building strong supplier relationshipsBuilding strong supplier relationships

20 - 66

Benefits of JIT SystemsBenefits of JIT Systems

Benefits of JIT production:Benefits of JIT production:– Lower carrying costs of inventoryLower carrying costs of inventory– Eliminating the root causes of rework, scrap, Eliminating the root causes of rework, scrap,

waste, and manufacturing lead time.waste, and manufacturing lead time.

20 - 67

Performance Measures and Performance Measures and Control in JIT ProductionControl in JIT Production

To manage and reduce inventories, the To manage and reduce inventories, the management accountant must design management accountant must design performance measures to control and performance measures to control and evaluate JIT production.evaluate JIT production.

What information may management What information may management accountants use?accountants use?

– Personal observation by production line Personal observation by production line workers and managersworkers and managers

20 - 68


– Financial performance measures, such as Financial performance measures, such as inventory turnover ratiosinventory turnover ratios

What are nonfinancial performance measures What are nonfinancial performance measures of time, inventory, and quality?of time, inventory, and quality?

– Manufacturing lead timeManufacturing lead time– Units produced per hourUnits produced per hour– Days’ inventory on handDays’ inventory on hand

20 - 69


– Total setup time for machines/Total Total setup time for machines/Total manufacturing timemanufacturing time

– Number of units requiring rework or Number of units requiring rework or scrap/Total number of units started and scrap/Total number of units started and completedcompleted

20 - 70

JIT’s Effect on Costing SystemsJIT’s Effect on Costing Systems

In reducing the need for materials handling, In reducing the need for materials handling, warehousing and incoming inspection, JIT warehousing and incoming inspection, JIT systems reduce overhead costs.systems reduce overhead costs.

JIT systems also facilitate the direct tracing JIT systems also facilitate the direct tracing of some costs that were formerly classified of some costs that were formerly classified as overhead.as overhead.

20 - 71


Use backflush costingUse backflush costing

20 - 72


A unique production system such as JIT often A unique production system such as JIT often leads to its own unique costing system.leads to its own unique costing system.

Organizing manufacturing in cells, reducing Organizing manufacturing in cells, reducing defects and manufacturing lead time, and defects and manufacturing lead time, and ensuring timely delivery of materials enables ensuring timely delivery of materials enables purchasing, production, and sales to occur in purchasing, production, and sales to occur in quick succession with minimal inventories.quick succession with minimal inventories.

20 - 73


Traditional normal and standard costing Traditional normal and standard costing systems use sequential tracking.systems use sequential tracking.

Sequential tracking is any product-costing Sequential tracking is any product-costing method where recording of the journal entries method where recording of the journal entries occurs in the same order as actual purchases occurs in the same order as actual purchases and progress in production.and progress in production.

20 - 74


Backflush costing Backflush costing describes a costing system describes a costing system that delays recording some or all of the that delays recording some or all of the journal entries relating to the cycle from journal entries relating to the cycle from purchase of direct materials to the sale of purchase of direct materials to the sale of finished goods.finished goods.

20 - 75


Where journal entries for one or more stages Where journal entries for one or more stages in the cycle are omitted, the journal entries for in the cycle are omitted, the journal entries for a subsequent stage use normal or standard a subsequent stage use normal or standard costs to work backward to flush out the costs costs to work backward to flush out the costs in the cycle for which journal entries were not in the cycle for which journal entries were not made.made.

20 - 76


Describe different ways Describe different ways backflush costing can simplify backflush costing can simplify traditional job-costing systemstraditional job-costing systems

20 - 77

Trigger PointsTrigger Points

The term The term trigger point trigger point refers to a stage in a refers to a stage in a cycle going from purchase of direct materials cycle going from purchase of direct materials to sale of finished goods at which journal to sale of finished goods at which journal entries are made in the accounting system.entries are made in the accounting system.

A sequential tracking costing system would A sequential tracking costing system would have four trigger points, corresponding to have four trigger points, corresponding to separate journal entries being made at separate journal entries being made at different stages.different stages.

20 - 78


Stage A: Purchase of direct materialsStage A: Purchase of direct materials Stage B: Production resulting in work in Stage B: Production resulting in work in

processprocess Stage C: Completion of a good finished unit Stage C: Completion of a good finished unit

or productor product Stage D: Sale of finished goodsStage D: Sale of finished goods

20 - 79


Assume trigger points A, C, and D.Assume trigger points A, C, and D. This company would have two inventory accounts:This company would have two inventory accounts: Type Account Title Type Account Title

1. Combined materials1. Combined materials Inventory: Raw Inventory: Raw and materials in work-in-and materials in work-in- and In-Process and In-Process process inventory process inventory ControlControl

2. Finished goods2. Finished goods Finished Goods Finished Goods ControlControl

20 - 80


What is the journal entry when trigger point What is the journal entry when trigger point A occurs?A occurs?

Inventory: Raw and Inventory: Raw and In-Process Control XX In-Process Control XX Accounts Payable Control Accounts Payable Control XX To record direct material purchased XX To record direct material purchased during the periodduring the period

20 - 81


What is the journal entry to record conversion What is the journal entry to record conversion costs?costs?

Conversion Costs Control XX Conversion Costs Control XX Various accounts XX Various accounts XX

To record the incurrence of To record the incurrence of conversion costs during the accounting periodconversion costs during the accounting period

Underallocated or overallocated conversion Underallocated or overallocated conversion costs are written off to cost of goods sold.costs are written off to cost of goods sold.

20 - 82


What is the journal entry when trigger point What is the journal entry when trigger point C occurs?C occurs?

Finished Goods Control XX Finished Goods Control XX Inventory: Raw and Inventory: Raw and In-Process ControlIn-Process Control XX XX

Conversion Costs AllocatedConversion Costs AllocatedXX To record the cost of goods XX To record the cost of goods completed during the accounting periodcompleted during the accounting period

20 - 83


What is the journal entry when trigger point What is the journal entry when trigger point D occurs?D occurs?

Cost of Goods Sold XX Cost of Goods Sold XX Finished Goods Control XX Finished Goods Control XX To record the cost of goods sold during To record the cost of goods sold during the accounting periodthe accounting period

20 - 84


Assume trigger points A and D.Assume trigger points A and D. This company would have one inventory account:This company would have one inventory account: Type Account Title Type Account Title

Combines direct materials Inventory Combines direct materials Inventory inventory and any direct inventory and any direct Control materials in work-in-process Control materials in work-in-process and finished goods inventories and finished goods inventories

20 - 85


What is the journal entry when trigger point What is the journal entry when trigger point A occurs?A occurs?

Inventory: Raw and Inventory: Raw and In-Process Control XX In-Process Control XX Accounts Payable Control Accounts Payable Control XX To record direct material purchased XX To record direct material purchased during the periodduring the period

Same as the A, C, and D example.Same as the A, C, and D example.

20 - 86






20 - 87


What is the journal entry to record the cost What is the journal entry to record the cost of goods completed during the accounting of goods completed during the accounting period (trigger point C)?period (trigger point C)?

No journal entry.No journal entry.

20 - 88



Cost of Goods Sold XX Cost of Goods Sold XX Inventory Control XX Inventory Control XX Conversion Costs Allocated XX Conversion Costs Allocated XX

To record the cost of goods sold during To record the cost of goods sold during the accounting periodthe accounting period

20 - 89


Assume trigger points C and D.Assume trigger points C and D. What is the journal entry when trigger point What is the journal entry when trigger point

A occurs?A occurs? No journal entry.No journal entry.

20 - 90






20 - 91


What is the journal entry to record the cost What is the journal entry to record the cost of goods completed during the accounting of goods completed during the accounting period (trigger point C) ?period (trigger point C) ?

Finished Goods Control XX Finished Goods Control XX Accounts Payable ControlAccounts Payable Control XX XX Conversion Costs AllocatedConversion Costs Allocated

XX To record the cost of goods XX To record the cost of goods completed during the accounting periodcompleted during the accounting period

20 - 92



Cost of Goods Sold XX Cost of Goods Sold XX Finished Goods Control XX Finished Goods Control XX To To record the cost of goods sold during the record the cost of goods sold during the accounting periodaccounting period

20 - 93

End of Chapter 20End of Chapter 20

cost 20

Documents