management accounting by horngren 11th edition chapter 20

8/2/2019 Management Accounting by Horngren 11th edition chapter 20

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20 - 1©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Inventory Management,

Just-in-Time, andBackflush Costing

Chapter 20




Learning Objective 1

Identify five categories of costs

associated with goods for sale.




Costs Associated with

Goods for Sale

1. Purchasing costs include transportation costs.

2. Ordering costs include receiving andinspecting the items in the orders.

3. Carrying costs include the opportunity cost

of the investment tied up in inventory andthe costs associated with storage.




Costs Associated with

Goods for Sale

4. Stockout costs occur when an organization

runs out of a particular item for whichthere is a customer demand.

5. Quality costs of a product or service is its lack

of conformance with a prespecified standard.





Balance ordering costs with

carrying costs using the

economic-order-quantity

(EOQ) decision model.




Economic-Order-Quantity

Decision Model Assumptions1. The same quantity is ordered at each

reorder point.

2. Demand, ordering costs, carrying costs,

and purchase-order lead time are

known with certainty.

3. Purchasing costs per unit are unaffected

by the quantity ordered.





Decision Model Assumptions

4. No stockouts occur.

5. Quality costs are considered only to theextent that these costs affect ordering

costs or carrying costs.






The EOQ minimizes the relevant ordering

costs and carrying costs.Video store sells packages of blank video tapes.

Video purchases packages of video tapes from

Oaks, Inc., at $15/package.






Annual demand is 12,844 packages, at the

rate of 247 packages per week.Video requires a 15% annual return on investment.

The purchase-order lead time is two weeks.

What is the economic-order-quantity?






Relevant ordering cost per purchase order: $209

Relevant carrying costs per package per year:Required annual ROI (15% × $15) $2.25

Relevant other costs 3.25

Total $5.50





Decision Model Example

EOQ =2 D P

C

D = Demand in units for a specified time period

P = Relevant ordering costs per purchase order

C = Relevant carrying costs of one unit in

stock for the time period used for D






2 12844

50

x x, $209

$5.

97614, = 988 packages

EOQ =






What are the relevant total costs (RTC)?

RTC = Annual relevant ordering costs+ Annual relevant carrying costs

RTC =

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

D

Q × P +

Q

2 C×

DP

Q +

QC

2or






When Q = 988 units,

RTC = (12,844 × $209 ÷ 988) + (988 × $5.50 ÷ 2)= $5,434 total relevant costs

How many deliveries should occur each time period?

DEOQ

12,844988= = 13 deliveries





20 - 15

R e

l e v a n t T o t a l C o s t s ( D o l l a r s )

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)




Reorder Point

Reorder point

= Number of units sold per unit of time

× Purchase-order lead time

EOQ = 988 packages

Number of units sold/week = 247

Purchase-order lead time = 2 weeks

Reorder point = 247 × 2 = 494 packages



Reorder Point988

494

Weeks 1 2 3 4 5 6 7 8

Reorder

Point

Reorder

Point

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

Demand = 247 tape packages/week Purchase-order lead time = 2 weeks20 - 17

Lead Time

2 weeks

Lead Time

2 weeks




Safety Stock Example

Safety stock is inventory held at all times

regardless of the quantity of inventoryordered using the EOQ model.

Video’s expected demand is 247 packages per week.

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




Safety Stock Example

How much safety stock should be carried?

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

103 packages × 2 weeks lead time

= 206 packages of safety stock.




Considerations in Obtaining

Estimates of Relevant Costs

What are the relevant incremental costs

of carrying inventory? – only those costs of the purchasing company

that change with the quantity of inventory held




Cost of Prediction Error

45696,

EOQ =

EOQ =

Step 1: Compute the monetary outcome

from the best action that could have been

taken, given the actual amount of the cost input.

2 12844 9784

50

x x, .

$5.

= 676 packages





The annual relevant total costs when EOQ is

676 packages is:

RTC =DP

Q+

QC

2

RTC = (12,844 × $97.84 ÷ 676) + (676 × $5.50 ÷ 2)

= $3,718 total relevant costs





Step 2: Compute the monetary outcome

from the best action based on the incorrectamount of the predicted cost input.

EOQ = 2 1284450

x x, $209$5.

= 988 packages





What are the annual relevant costs using

this order quantity whenD = 12,844 units, P = $97.84, and C = $5.50?

RTC = (12,844 × $97.84 ÷ 988) + (988 × $5.50 ÷ 2)

= $ 3,989 total relevant costs





Step 3: Compute the difference between

the monetary outcomes from Steps 1 & 2.Step 1 $3,718

Step 2 3,989

Difference $ (271)The cost of prediction error is $271.





Identify and reduce conflicts

that can arise between EOQ

decision model and models used

for performance evaluation.




Evaluating Managers and

Goal-Congruence Issues

The opportunity cost of investment tied up

in inventory is a key input in theEOQ decision model.

Some companies now include opportunity

costs as well as actual costs whenevaluating managers.




Just-In-Time Purchasing

Just-in-time (JIT) purchasing is the purchase

of goods or materials such that a deliveryimmediately precedes demand or use.

Companies moving toward JIT purchasing

argue that the cost of carrying inventories(parameter C in the EOQ model) has been

dramatically underestimated in the past.




JIT Purchasing and EOQ

Model Parameters

The cost of placing a purchase order

(parameter P in the EOQ model) isalso being re-evaluated.

Three factors are causing sizable reduction

in the cost of placing a purchase order (P).1. Companies increasingly are establishing

long-run purchasing arrangements.




JIT Purchasing and EOQ

Model Parameters

2. Companies are using electronic links,

such as the Internet, to place purchase orders.3. Companies are increasing the use of

purchase order cards (similar to consumer

credit cards like Visa and Master Card).





Use a supply-chain approach

to inventory management.




Supply-Chain Analysis

Supply-chain analysis describes the flow

of goods, services, and information from

cradle to grave, regardless of whether

those activities occur in the same

organization or other organizations.

“bullwhip effect” or “whiplash effect”





Differentiate materials

requirements planning (MRP)

systems from just-in-time (JIT)

systems for manufacturing.




Materials Requirement

Planning (MRP)

Materials requirements planning (MRP)

systems take a “push-through” approach that manufactures finished goods for

inventory on the basis of demand forecasts.

MRP predetermines the necessary outputsat each stage of production.




Materials Requirement

Planning (MRP)

Management accountants play key roles in

an MRP system, including...

– maintaining accurate and timely informationpertaining to materials, work in process,

and finished goods, and...

– providing estimates of the setup costs for eachproduction run, the downtime costs,

and carrying costs of inventory.





Identify the features of a

just-in-time production system.




Just-In-Time Production Systems

Just-in-time (JIT) production systems take a

“demand pull” approach in which goods are only manufactured to satisfy customer orders.




Major Features of a JIT System

1. Organizing production in manufacturing cells

2. Hiring and retaining multi-skilled workers

3. Emphasizing total quality management

4. Reducing manufacturing lead time and setup time

5. Building strong supplier relationships




Major Features of a JIT System

What information may management accountants use?

Personal observation by productionline workers and managers

Financial performance measures,

such as inventory turnover ratios

Nonfinancial performance measures

of time, inventory, and quality.





Use backflush costing.




Backflush Costing

Backflush costing describes a costing

system that delays recording some or

all of the journal entries relating to the

cycle from purchase of direct materials

to the sale of finished goods.




Backflush Costing

Where journal entries for one or more stages

in the cycle are omitted, the journal entries

for a subsequent stage use normal or standard

costs to work backward to flush out the costs in

the cycle for which journal entries were not made.





Describe different ways

backflush costing can simplify

traditional job-costing systems.




Trigger Points

The term trigger point refers to a stage in a cycle

going from purchase of direct materials to saleof finished goods at which journal entries are

made in the accounting system.




Trigger Points

Stage A:

Purchase of direct materials

Stage B:

Production resultingin work in process

Stage C:Completion of good

units of product

Stage D:Sale of

finished goods




Trigger Points

Assume trigger points A, C, and D.

This company would have two inventory accounts:

Type

1. Combined materials

and materials in work in process inventory

2. Finished goods

Account Title

1. Inventory:

Raw and In-processControl

2. Finished Goods Control




Trigger Points

What is the journal entry when trigger point A occurs?

Inventory: Raw and In-process Control XXAccounts Payable Control XX

To record direct material purchased during the period




Trigger Points

What is the journal entry to record conversion costs?

Conversion Costs Control XXVarious accounts XX

To record the incurrence of conversion costs during

the accounting periodUnderallocated or overallocated conversion costs

are written off to cost of goods sold.




Trigger Points

What is the journal entry when trigger point C occurs?

Finished Goods Control XXInventory: Raw and

In-Process Control XX

Conversion Costs Allocated XXTo record the cost of goods completed during the

accounting period




Trigger Points

What is the journal entry when trigger point D occurs?

Cost of Goods Sold XXFinished Goods Control XX

To record the cost of goods sold during the

accounting period




Trigger Points

Assume trigger points A and D.

This company would have one inventory account:

Type

Combines direct materials

inventory and any directmaterials in work in process

and finished goods inventories

Account Title

Inventory Control




Trigger Points

What is the journal entry when trigger point A occurs?

Inventory: Raw and In-process Control XXAccounts Payable Control XX

To record direct material purchased during the period

Same as the A, C, and D example.




Trigger Points

What is the journal entry to record conversion costs?

Conversion Costs Control XXVarious accounts XX

To record the incurrence of conversion costs during

the accounting periodSame as the A, C, and D example.




Trigger Points

What is the journal entry to record the

cost of goods completed during the

accounting period (trigger point C)?No journal entry.




Trigger Points

What is the journal entry when trigger point D occurs?

Cost of Goods Sold XXInventory Control XX

Conversion Costs Allocated XX

To record the cost of goods sold during theaccounting period



End of Chapter 20

management accounting by horngren 11th edition chapter 20

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