Management Accounting - Hansen Mowen CH19

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Inventory Inventory ManagementManagement

CHAPTERCHAPTER

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1. Describe the traditional inventory management model.

2. Discuss JIT inventory management.3. Explain the theory of constraints, and tell

how it can be used to manage inventory.

ObjectivesObjectivesObjectivesObjectives

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

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Inventory CostsInventory CostsInventory CostsInventory Costs

1. Ordering costs are the costs of placing and receiving an order.

2. Setup costs are the costs of preparing equipment and facilities so they can be used to produce a particular product or component.

3. Carrying costs are the costs of carrying inventory.

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1. To balance ordering or setup costs and carrying costs.

2. To satisfy customer demand.

3. To avoid shutting down manufacturing facilities because of machine failure, defective parts, unavailable parts, or late delivery of parts.

4. To buffer against unreliable production processes.

5. To take advantage of discounts.

6. To hedge against future price increases.

Traditional Reasons for Carrying InventoryTraditional Reasons for Carrying InventoryTraditional Reasons for Carrying InventoryTraditional Reasons for Carrying Inventory

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The Appropriate Inventory PolicyThe Appropriate Inventory Policy

How much should be ordered or produced?

When should the order be placed or the setup be performed?

Two Basic Questions Must be Addressed

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Total Costs = Ordering costs + Carrying costs

TC = PD/Q + CQ/2

The Traditional Inventory ModelThe Traditional Inventory ModelThe Traditional Inventory ModelThe Traditional Inventory Model

Where TC = The total ordering (or setup) and carrying costs

P = The cost of placing and receiving an order (or the cost of setting up a production run)

Q = The number of units ordered each time an order is placed

D = The known annual demand

C = The cost of carrying one unit of stock for one year

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Economic order quantity (EOQ)

= 2PD/C

D = 10,000 units

Q = 1,000 units

P = $25 per order

C = $2 per unit

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EOQ = ($2 x $25 x 10,000)/2

EOQ = 250,000

EOQ = 500 units

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Reorder point = Rate of usage x Lead time

Example: The producer uses 50 parts per day and that the lead time is 4 days.

Reorder point = 4 x 50 = 200 units

Thus, an order should be placed when inventory drops to 200 units.

Reorder PointReorder PointReorder PointReorder Point

Demand is CertainDemand is Certain

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Demand is CertainDemand is Certain

500

400

300

200

100

Inventory (units)

(EOQ)

(ROP)

2 4 6 8 10 12 14 16 18 20Days

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Safety StockSafety Stock

If the refrigerator part was used at a rate of 60 parts a day instead of 50, the firm would use 200 parts after three and one-third days. The safety

stock is determined as follows:Maximum usage 60

Average usage 50

Difference 10

Lead time x4

Safety stock 40

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Safety StockSafety Stock

ROP = (Average rate of usage x Lead time) +Safety stock

ROP = (50 x 4) + 40

ROP = 240 units

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A Manufacturing Example

The manager of Benson Company is trying to determine the size of the production runs for the blade fabrication.

The controller supplies the following information:

Average demand for blades 320 per dayMaximum demand for blades 340 per dayAnnual demand for blades 80,000Unit carrying cost $5Setup cost $12,500Lead time 20 days

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EOQ =2PD

C

2 x 80,000 x 2,500=

5

400,000,000=

= 20,000 blades

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Maximum usage 340

Average usage 320

Difference 20

Lead time x20

Total safety stock 400

Reorder point = (Average usage x Lead time) + Safety stock= (320 x 20) + 400= 6,800 units

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Push-through system Significant inventories Large supplier base Short-term supplier contracts Departmental structure Specialized labor Centralized services Low employee involvement Supervisory management style Acceptable quality level Driver tracing dominates

Traditional Inventory SystemsTraditional Inventory SystemsTraditional Inventory SystemsTraditional Inventory Systems

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Traditional Manufacturing LayoutTraditional Manufacturing LayoutTraditional Manufacturing LayoutTraditional Manufacturing Layout

Product A

Product B

Department. 1

Lathes

Finished Product A

Finished Product B

Each process passes Each process passes through departments through departments that specialize in one that specialize in one

process.process.

Each process passes Each process passes through departments through departments that specialize in one that specialize in one

process.process.

Abrasive Grinders

A

B

Department 2

A

B

Welding

Equipment

Department 3

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JIT Inventory SystemsJIT Inventory SystemsJIT Inventory SystemsJIT Inventory Systems

Pull-through system Insignificant inventories Small supplier base Long-term supplier contracts Cellular structure Multiskilled labor Decentralized services High employee involvement Facilitating management style Total quality control Direct tracing dominates

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JIT has two strategic objectives:JIT has two strategic objectives:

JIT Inventory SystemsJIT Inventory SystemsJIT Inventory SystemsJIT Inventory Systems

To increase profits

To improve a firm’s competitive positions

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JIT Manufacturing LayoutJIT Manufacturing LayoutJIT Manufacturing LayoutJIT Manufacturing Layout

Welding

Grinder

Cell A

Lathe

Product A

Finished Product

Cell B

Welding

Grinder

Lathe

Product B

Finished Product

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JIT And Inventory Management

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

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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 And Inventory ManagementDue Date Performance: The JIT Solution

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JIT And Inventory ManagementAvoidance of Shutdown: The JIT Approach

Total preventive maintenance to reduce machine failures

Total quality control to reduce defective parts

Cultivation of supplier relationships to ensure availability of quality raw materials and subassemblies

The use of the Kanban system is also essential

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What is the Kanban System?What is the Kanban System?What is the Kanban System?What is the Kanban System?

A Card System is used to monitor work-in-processA withdrawal Kanban

A production Kanban

A vendor Kanban

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Withdrawal KanbanWithdrawal KanbanWithdrawal KanbanWithdrawal Kanban

Item No.___________________ _____________

Item Name_________________ _____________

Computer Type_____________ _____________

Box Capacity_______________ _____________

Box Type__________________ _____________

15670T07

Circuit Board

TR6547 PC

8

C

Processing Process

CB Assembly

Subsequent Process

Final Assembly

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Production KanbanProduction KanbanProduction KanbanProduction Kanban

Item No.___________________ _____________

Item Name_________________ _____________

Computer Type_____________

Box Capacity_______________

Box Type__________________

15670T07

Circuit Board

TR6547 PC

8

C

Process

CB Assembly

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Vendor KanbanVendor KanbanVendor KanbanVendor Kanban

Item No.___________________

Item Name_________________ _____________

Box Capacity_______________

Box Type__________________

Time to Deliver

Name of Supplier

15670T08

Computer Casing

8

C

Name of Receiving Co.

Electro PC

Receiving Gate

75

8:30 A.M., 12:30 P.M., 2:30 P.M.

Garry Supply

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Lot with P-Kanban

Production

Ordering Post

(6) Signal

CD Assembly

Remove

(4) P-Kanban

Attach to Post

(5) Attach

W-Kanban(1) Remove

W-Kanban

Attach to

Post

Withdrawal Post

(2), (3)

(7)

Final Assembly

(1)

Kanban ProcessKanban ProcessKanban ProcessKanban Process

CB StoresCB Stores

WithdrawalWithdrawalStoreStore

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JIT’s LimitationsJIT’s LimitationsJIT’s LimitationsJIT’s Limitations

Time is required to build sound relationships with suppliers.

Sharp reductions in inventory buffers may cause a regimented workflow and high levels of stress among production workers.

The absence of inventory to buffer production interruptions.

Current sales are placed at risk to achieve assurance of future sales.

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JIT And Inventory ManagementDiscounts 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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Throughput

Inventory

Operating expenses

Three Measures of Organizational Performance

Theory of ConstraintsTheory of Constraints

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Five Steps to Improve Performance

1. Identify the organization’s constraint(s).

2. Exploit the binding constraint(s).

3. Subordinate everything else to the decisions made in Step 2.

4. Elevate the binding constraint(s).

5. Repeat the process.

Theory of ConstraintsTheory of Constraints

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Materials

Process AProcess A

Process BProcess B

DrummerDrummer ProcessProcess

Time BufferFinished Goods

Drum-Buffer-Rope SystemDrum-Buffer-Rope SystemDrum-Buffer-Rope SystemDrum-Buffer-Rope System

Process CProcess C

Final ProcessFinal ProcessRope

Initial ProcessInitial Process

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Drum-Buffer-Rope SystemDrum-Buffer-Rope SystemDrum-Buffer-Rope SystemDrum-Buffer-Rope System

Material for 12 Parts per Day (Part X: 6 and Part Y: 6)

DRUMMERDRUMMERDrilling Drilling ProcessProcess

Grinding Grinding ProcessProcess

Polishing Polishing ProcessProcess

RopeTime

12 Units Part X

6 Units Part X per Day6 Units Part Y per Day

Confer Company

Confer Company

Buffer12 Units

Part Y

Finished Goods

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The EndThe EndThe EndThe End

Chapter NineteenChapter Nineteen

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Management Accounting - Hansen Mowen CH19