21-1 hansen & mowen cost management accounting and control
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21-1
HANSEN & MOWENHANSEN & MOWEN
Cost ManagementCost ManagementACCOUNTING AND CONTROLACCOUNTING AND CONTROL
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Inventory Management: Economic Order Inventory Management: Economic Order Quantity, JIT, and the Theory of ConstraintsQuantity, JIT, and the Theory of Constraints
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Three types of inventory costs can be readily identified with inventory:
(1) The cost of acquiring inventory.
(2) The cost of holding inventory.
(3) The cost of not having inventory on hand when needed.
Just-in-Case Inventory ManagementJust-in-Case Inventory Management 1
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1. Ordering Costs: The costs of placing and receiving an order.
Examples: Clerical costs, documents, insurance for shipment, and unloading.
2. Setup Costs: The costs of preparing equipment and facilities so they can be used to produce a particular product or component.
Examples: Setup labor, lost income (from idled facilities), and test runs.
Just-in-Case Inventory ManagementJust-in-Case Inventory Management 1
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3. Stock-Out Costs: The costs of not having sufficient inventory.
Examples: Lost sales, costs of expediting (extra setup, transportation, etc.) and the costs of interrupted production.
4. Carrying Costs: The costs of carrying inventory.Examples: Insurance, inventory taxes,
obsolescence, opportunity cost of capital tied up in inventory, and storage.
Just-in-Case Inventory ManagementJust-in-Case Inventory Management 1
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Just-in-Case Inventory ManagementJust-in-Case Inventory Management 1
Traditional Reasons for Carrying InventoryTraditional Reasons for Carrying InventoryTraditional Reasons for Carrying InventoryTraditional Reasons for Carrying Inventory
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Economic Order Quantity
TC = PD/Q + CQ/2
The total ordering (or setup) and carrying cost
The cost of placing and receiving an order (or
the cost of setting up a production run)
The known annual demand
The number of units ordered each time an order is placed (or the lot size for production)
The cost of carrying one unit of stock for one
year
Just-in-Case Inventory ManagementJust-in-Case Inventory Management 1
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An EOQ Illustration
EOQ = 2PD/C
D = 25,000 units
Q = 500 units
P = $40 per order
C = $2 per unit
EOQ = (2 x 25,000 x $40) / $2
EOQ = 1,000,000
EOQ = 1,000 units
Just-in-Case Inventory ManagementJust-in-Case Inventory Management 1
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Reorder point = Rate of usage x Lead time
Example: Assume that the average rate of usage is 100 parts per day. Assume also that the lead time is 4 days. What is the reorder point?
Reorder point = 4 x 100 = 400 units
Thus, an order should be placed when inventory drops to 400 units.
When to Order or Produce
Just-in-Case Inventory ManagementJust-in-Case Inventory Management 1
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Just-in-Case Inventory ManagementJust-in-Case Inventory Management 1
The Reorder PointThe Reorder PointThe Reorder PointThe Reorder Point
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Demand Uncertainty and Reordering
To avoid running out of parts, organizations often choose to carry safety stock. Safety stock is extra inventory carried to serve as insurance against fluctuations in demand.
Example: If the maximum usage of the VCR part is 120 units per day, the average usage is 100 units per day, and the lead time is four days, the safety stock is 80.
Maximum usage 120Average usage -100Difference 20Lead time x 4Safety stock 80
Just-in-Case Inventory ManagementJust-in-Case Inventory Management 1
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Just-in-Case Inventory ManagementJust-in-Case Inventory Management 1
EOQ and Reorder Point IllustratedEOQ and Reorder Point IllustratedEOQ and Reorder Point IllustratedEOQ and Reorder Point Illustrated
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JIT reduces the costs of acquiring inventory to insignificant levels by:
1. Drastically reducing setup time
2. Using long-term contracts for outside purchases
Carrying costs are reduced to insignificant levels by reducing inventories to insignificant levels.
Setup and Carrying Costs: The JIT Approach
JIT Inventory ManagementJIT Inventory Management 2
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Due-Date Performance: The JIT Solution
Lead times are reduced so that the company can meet requested delivery dates and to respond quickly to customer demand.
Lead times are reduced by:
reducing setup times
improving quality
using cellular manufacturing
JIT Inventory ManagementJIT Inventory Management 2
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Avoidance of Shutdown: The JIT Approach
Total preventive maintenance to reduce machine failures
Total quality control to reduce defective parts
The use of the Kanban system is also essential
JIT Inventory ManagementJIT Inventory Management 2
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What is the Kanban System?
A card system is used to monitor work in process
A withdrawal Kanban A production Kanban A vendor Kanban
The Kanban system is responsible for ensuring
that the necessary products are produced in the necessary quantities at the necessary time.
The Kanban system is responsible for ensuring
that the necessary products are produced in the necessary quantities at the necessary time.
JIT Inventory ManagementJIT Inventory Management 2
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Withdrawal KanbanWithdrawal KanbanWithdrawal KanbanWithdrawal Kanban
JIT Inventory ManagementJIT Inventory Management 2
Production KanbanProduction KanbanProduction KanbanProduction Kanban
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Vendor KanbanVendor KanbanVendor KanbanVendor Kanban
JIT Inventory ManagementJIT Inventory Management 2
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The Kanban ProcessThe Kanban ProcessThe Kanban ProcessThe Kanban Process
JIT Inventory ManagementJIT Inventory Management 2
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Discounts and Price Increases: JIT Purchasing versus Holding Inventories
Careful vendor selection Long-term contracts with vendors
Prices are stipulated (usually producing a significant savings)
Quality is stipulated The number of orders placed are reduced
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JIT LimitationsJIT Limitations
• Patience in implications is needed.
• Time is required.
• JIT may cause lost sales and stressed workers.
• Production may be interrupted due to an absence of inventory.
JIT Inventory ManagementJIT Inventory Management 2
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Basic Concepts of Constrained OptimizationBasic Concepts of Constrained Optimization 3
Every firm faces limited resources and limited demand for each product.
External constraints, such as market demand
Internal constraints, such as machine or labor time availability
Constrained optimization is choosing the optimal mix given the constraints faced by the firm.
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Linear ProgrammingThe unit contribution margins are $300 and
$600 for X and Y, respectively.
Z = $300X + $600 Y
Total contribution margin
This equation is called the objective This equation is called the objective function, the function to be optimized.function, the function to be optimized.
Basic Concepts of Constrained OptimizationBasic Concepts of Constrained Optimization 3
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Internal constraints:
X + Y 80
X + 3Y 120
2X + Y 90
External constraints:
X 60
Y 100
Basic Concepts of Constrained OptimizationBasic Concepts of Constrained Optimization 3
Linear Programming
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X + Y 80
X + 3Y 120
2X + Y 90
X 60
Y 100
X 0
Y 0
Linear Programming
Basic Concepts of Constrained OptimizationBasic Concepts of Constrained Optimization 3
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160
140
120
100
80
60
40
20
20 40 60 80 100 120 140
Y 100
X 60
X + Y 80
X + 3Y 120
2X + Y 90
Basic Concepts of Constrained OptimizationBasic Concepts of Constrained Optimization 3
D
CB
A
Graphical SolutionGraphical SolutionGraphical SolutionGraphical Solution
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Linear Programming
Corner Point X-Value Y-Value Z = $300X + $600Y
A 0 0 $ 0
B 0 40 24,000
C 30 30 27,000
D 45 0 13,500
C is the optimal solution!
Basic Concepts of Constrained OptimizationBasic Concepts of Constrained Optimization 3
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Throughput Inventory Operating expenses
Three Measures of Systems Performance:
(Sales revenue – Unit-level variable expenses)/Time
Theory of ConstraintsTheory of Constraints 4
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1. Identify an organization’s constraints.
2. Exploit the binding constraints.
3. Subordinate everything else to the decisions made in Step 2.
4. Elevate the organization’s binding constraints.
5. Repeat the process as a new constraint emerges to limit output.
Five-Step Method for Improving Performance
Theory of ConstraintsTheory of Constraints 4
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Drum-Buffer-Rope System: General DescriptionDrum-Buffer-Rope System: General DescriptionDrum-Buffer-Rope System: General DescriptionDrum-Buffer-Rope System: General Description
Theory of ConstraintsTheory of Constraints 4
Continued
Continued from left
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Drum-Buffer-Rope System: Drum-Buffer-Rope System: Schaller Company Schaller Company
Drum-Buffer-Rope System: Drum-Buffer-Rope System: Schaller Company Schaller Company
Theory of ConstraintsTheory of Constraints 4
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New Constraint Set: Schaller CompanyNew Constraint Set: Schaller CompanyNew Constraint Set: Schaller CompanyNew Constraint Set: Schaller Company
Theory of ConstraintsTheory of Constraints 4
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End of End of Chapter 21Chapter 21