Solution manual cost accounting 8th by kinney chapter 18

Terminology Autonomation: the use of equipment that has been preprogrammed to sense certain conditions Backflush costing: a streamlined cost accounting method that speeds up, simplifies,

Learning Objectives

After reading and studying Chapter 18, you should be able to answer the following questions:

1 What value chain relationships are important to organizations?

2 What costs are associated with buying, producing, and carrying inventory?

3 How do push and pull systems control production?

4 Why do product life cycles affect profitability?

5 What is target costing, and how does it influence production cost management?

6 What is the just-in-time philosophy and what modifications does JIT require in accounting

systems?

7 What are flexible manufacturing systems?

8 Why are lean enterprises important in today’s business environment?

9 How can the theory of constraints help in determining production flow?

10 (Appendix) How are economic order quantity, reorder point, and safety stock determined and used?

INVENTORY AND PRODUCTION

MANAGEMENT

CHAPTER

18

Terminology Autonomation: the use of equipment that has been preprogrammed to sense certain conditions

Backflush costing: a streamlined cost accounting method that speeds up, simplifies, and minimizes

accounting effort in an environment that minimizes inventory balances, requires few allocations, uses standard costs, and has few variances from standard

Bottleneck: a point at which the processing levels are sufficiently slow to cause the other processing

mechanisms in the network to experience idle time

Computer-integrated manufacturing (CIM): the integration of two or more flexible manufacturing

systems through the use of a host computer and an information networking system

Constraint: anything that confines or limits the ability of a person or machine to perform a project or

function

Cost table: a database providing information about the impact on product costs of using different input

resources, manufacturing processes, and design specifications

Economic order quantity (EOQ): an estimate of the number of units per order that will be the least

costly and provide the optimal balance between the costs of ordering and the costs of carrying inventory

Economic production run (EPR): an estimate of the number of units to produce at one time that

minimizes the total costs of setting up production runs and carrying inventory

Flexible manufacturing system (FMS): a production system involving a network of robots and material

conveyance devices monitored and controlled by computers that allows for rapid production and

responsiveness to changes in production needs

Focused factory arrangement: an arrangement in which a vendor (which may be an external party or an

internal corporate division) agrees to provide a limited number of products according to specifications or

to perform a limited number of unique services for a company that is typically operating a just-in-time system

Internet business model: a business model that involves (1) few physical assets, (2) little management

hierarchy, and (3) a direct pipeline to customers

Just-in-time (JIT): a philosophy about when to do something; the “when” is as needed and the

“something” is a production, purchasing, or delivery activity

Just-in-time manufacturing system: a production system that attempts to acquire components and

produce inventory only as needed, to minimize product defects, and to reduce cycle/setup times for acquisition and production

Kaizen costing: a costing technique to reflect continuous efforts to reduce product costs, improve

product quality, and/or improve the production process after manufacturing activities have begun

Kanban: the Japanese word for card; it was the original name for a JIT system because of the use of

cards that indicated a work center’s need for additional components during a manufacturing process

Lead time: the days between the placement of an order to the time the goods arrive for usage or are

produced by the company

Lean manufacturing: approach in which the manufacturer makes only those items demanded by

customers and attempts to make those items without waste

Manufacturing cell: S- or U-shaped production grouping of workers or machines to achieve the most

efficient and effective production process for a particular product type

Order point: the level of inventory that triggers the placement of an order for additional units; it is a

function of usage, lead time, and safety stock

Pareto inventory analysis: an analysis that separates inventory into three groups based on annual

cost-to-volume usage

Product life cycle: a model depicting the stages through which a product class (not each product)

passes from the time that an idea is conceived until production is discontinued

Pull system: a production system dictated by product sales and demand; a system in which parts are

delivered or produced only as they are needed by the next work center in the value chain; it requires only minimal storage facilities

Purchasing cost: the quoted price of inventory minus any discounts allowed plus shipping charges Push system: the traditional production system in which work centers buy or produce inventory that is

not currently needed because of lead time or economic production/order requirements; it requires that excess inventory be stored until needed

Red-line system: an inventory ordering system in which a red line is painted on the inventory container

at a point deemed to be the reorder point

Safety stock: a buffer level of inventory kept by a company in the event of fluctuating usage or unusual

delays in lead time

Supply-chain management: the cooperative strategic planning, controlling, and problem solving by a

company and its vendors and customers to conduct efficient and effective transfers of goods and services

within the supply chain

Target costing: a method of determining what the maximum cost of a product should be based on the

product’s estimated selling price less the desired profit and selling and administrative costs

Theory of constraints (TOC): a method of analyzing the bottlenecks (constraints) that keep a system

from achieving higher performance since production cannot take place at a rate faster than the slowest machine or person in the process

Two-bin system: an inventory ordering system in which two containers (or stacks) of raw materials or

parts are available for use; when one container is depleted, the removal of materials from the second container begins and a purchase order is placed to refill the first container

Usage: the quantity of inventory used or sold each day

Value engineering: a disciplined search for various feasible combinations of resources and methods that

will increase product functionality and reduce costs

Virtual reality: an artificial, computer-generated environment in which the user has the impression of

being part of the environment and thus has the ability to navigate and manipulate objects (such as products) which behave like real-world objects

Lecture Outline

LO.1: What value chain relationships are important to organizations?

A Introduction

1 Manufacturing and retail firms face two significant challenges in managing inventory

a They must have the inventory available to match the demand from their customers

b To avoid excessive costs and remain competitive, firms must avoid producing or ordering products that are not demanded by their customers

2 Other than plant assets and development of human resources, inventory is often the largest investment a company makes

3 This chapter deals with ways companies minimize their monetary commitments to inventory while still satisfying customer demands

a The chapter appendix covers the concepts of economic order quantity (EOQ), order point, safety stock, and Pareto inventory analysis

B Important Relationships in the Value Chain

1 Every company has upstream suppliers and downstream customers, which together comprise a supply or value chain

a It is at the interfaces of these relationships where real opportunities for improvements exist

2 By building improved cooperation, communication, and integration, the entities within the value chain can treat each other as extensions of themselves and thereby obtain gains in quality, throughput, and cost efficiency

3 Non-value-added activities can be reduced or eliminated and performance of value-added activities can be enhanced; shared expertise and problem solving can be very beneficial

4 Products and services can be provided faster and with fewer defects, and activities can be performed more effectively and reliably with less deficiencies and redundancy Consider the following opportunities for improvement between each entity:

a improved communication of requirements and specifications;

b greater clarity in requests for products or services;

c improved feedback regarding unsatisfactory products or services;

d improvements in planning, controlling, and problem solving; and

e shared managerial and technical expertise, supervision, and training

5 If employees perceive their internal suppliers and customers as extensions of themselves and work to exploit the previous opportunities, teamwork will be significantly enhanced

a Improved teamwork helps companies in their implementation of pull systems, which are part

of a just-in-time work environment Increased productivity benefits all company stakeholders by:

i reducing investment in inventory;

ii improving cash-to-cash cycle time;

iii generating higher asset turnover;

iv generating higher inventory turnover; and

v reducing inventory risk

LO.2: What costs are associated with buying, producing, and carrying inventory?

C Buying or Producing and Carrying Inventory

1 Organizations can increase their profit margins by reducing or minimizing inventory investments, assuming that the demand for products can still be met

a The term inventory is used to refer to any of the following: raw material, work in process,

finished goods, indirect material (supplies), and retail merchandise inventory

2 Efficient inventory management relies mostly on cost-minimization strategies

a As indicated in text Exhibit 18-1, there are three basic costs associated with inventory:

i purchasing/production;

ii ordering/setup; and

iii carrying/not carrying goods in stock

3 The purchasing cost of inventory is the quoted purchase price of inventory, minus any discounts

allowed, plus shipping charges

4 Production cost for a manufacturer refers to the costs associated with purchasing direct materials, paying for direct labor, and absorbing variable and fixed overhead

a Fixed manufacturing overhead is the least susceptible to cost minimization in the short run except in the case where management is able to somewhat control it by managing production capacity utilization relative to demand in the short run Otherwise, most efforts to minimize fixed overhead costs involve long-run measures

LO.3: How do push and pull systems control production?

D Inventory and Production Management Philosophies

1 The two theoretical approaches to producing inventory are push systems and pull systems

a A push system is the traditional production system in which work centers may produce

inventory that is not currently needed because of lead time or economic production/order

requirements; it requires that excess inventory be stored until needed (See text Exhibit 2)

18-b A pull system is a production system dictated by product sales and demand; it is a system in

which parts are delivered or produced only as they are needed by the next work center in the

value chain; it requires only minimal storage facilities (See text Exhibit 18-3)

LO.4: Why do product life cycles affect profitability?

E Understanding and Managing Production Activities and Costs

1 Product life cycles

a The product life cycle is a model depicting the stages through which a product class (not

necessarily each product) passes

i A product’s life cycle stage can have a tremendous impact on costs, sales, and pricing strategies

b The five specific product life cycle stages are:

i development (which includes design);

 See the next section in this outline

iv maturity; and

 Sales begin to stabilize or slowly decline and firms often compete on the basis of selling price Costs are often at their lowest level during this period, so profits can be high Some products remain at this stage for a very long time

v decline

 Sales begin to wane Prices must be cut dramatically to stimulate business

Production costs per unit generally increase during this stage because fixed overhead is spread over a smaller production volume

c Text Exhibit 18-4 illustrates a conventional sales trend line as the product class passes

through each life cycle stage

LO.5: What is target costing, and how does it influence production cost management?

2 Lifecycle and target costing

a General

i The development stage is fundamentally ignored by the standard financial accounting model

ii Effective development efforts are critical to a product’s profitability, even though

development stage time has been greatly reduced by technology and competition iii Decisions made during the development stage can: reduce production and life cycle costs through material specifications; shorten manufacturing time through process design; increase quality by minimizing potential design defects; and add flexibility

iv Many manufacturers are keenly aware of the need to target attention on the product development stage and of the “time-to-market” as a critical performance measure

v One technology that is increasingly used in the design stage is virtual reality

 Virtual realityis an artificial, computer-generated environment in which the user has the impression of being part of that environment and has the ability to navigate and manipulate objects (such as products) behaving like real-world objects

 With virtual reality, much of the testing of new products can focus on a virtual prototype rather than a real prototype

vi Once a product or service idea is formulated, the market is typically researched to

determine the features that customers desire

vii After a product is designed, the producing firm has traditionally determined product cost and set a selling price based on that cost

 If the market will not bear the resulting selling price then the firm either earns less profit than desired or attempts to lower production costs

b Target costing

i Target costing is a technique that is used to determine what the cost of a product should

be, based on the estimated selling price of the product less the desired profit

ii It is used to estimate an allowable product cost by applying market research to estimate how much the market will pay for a product with specific characteristics

iii As expressed in the following formula, target costing develops an “allowable” product

cost:

TC = ESP - APM - S&A

where TC = target cost ESP = estimated selling price APM = acceptable profit margin S&A = expected per-unit selling and administrative cost

iv Subtracting an acceptable profit margin and selling and administrative costs from the estimated selling price leaves an implied maximum per-unit target product cost This cost

is then compared to an expected product cost

v A company has several alternatives if the expected cost is higher than the target cost

 Cost tables are databases providing information about the impact on product costs

of using different input resources, manufacturing processes, and design specifications They assist in determining how adjustments can be made

 A less-than-desired profit margin can be accepted

 The company can decide that it does not want to enter this particular product market

at the present time since it cannot achieve the desired profit margin

vi Value engineering involves a disciplined search for various feasible combinations of

resources and methods that will increase product functionality and reduce costs

vii Target costing can be applied to a service if it is adequately uniform to justify the

necessary modeling effort

viii In designing a product to meet an allowable cost, engineers strive to eliminate all

nonessential activities from the production process

 Properly designed products should require only minimal engineering change orders (EOCs) after being released to production

 Each time an ECO is issued, one or more of the following problems can occur and create additional costs: Production documents must be reprinted, workers must relearn tasks, machine dies or setups must be changed, and parts in stock or currently ordered can be made obsolete

ix Target costing requires a shift in the way managers think about the relationships among cost, selling price, and profitability

 The traditional attitude has been that a product is developed, production cost is identified and measured, a selling price is set (or a market price is met), and profits or losses result

 Target costing takes a different perspective: A product is developed, a selling price and desired profit amount are determined, and maximum allowable costs are calculated When allowable costs are constrained by selling price, all costs must be justified Unnecessary costs should be eliminated without reducing quality

x The target costing process is depicted in text Exhibit 18-5

c Kaizen costing involves continuous efforts to reduce product costs, improve product quality,

and/or improve the production process after manufacturing activities have begun

i Text Exhibit 18-6 compares target costing and Kaizen costing

ii Kaizen initiatives often involve multifunctional teams that study specific production issues

to lower costs or improve quality

LO.6: What is the just-in-time philosophy and what modifications does JIT require in accounting systems?

F Just-in-Time Systems

1 Just-in-time (JIT) is a philosophy about when to do something; the “when” is as needed and the

“something” is a production, purchasing, or delivery activity A JIT system has three primary goals:

a eliminating any production process or operation that does not add value to the

product/service;

b continuously improving production/performance efficiency; and

c reducing the total cost of production/performance while increasing quality

2 Text Exhibit 18-7 outlines the elements of a JIT philosophy

3 JIT originated in Japan where a card was used to communicate between work centers

a Kanban is the Japanese word for card or ticket; it was the original name for a JIT system

because of the use of cards that indicated a work center’s need for additional components during a manufacturing process

b A just-in-time (JIT) manufacturing system is a production system that attempts to acquire

components and produce inventory only as needed, to minimize product defects, and to reduce lead/setup times for acquisition and production

4 Production has traditionally been dictated by the need to smooth operating activities over time

a Although allowing a company to maintain a steady work force and continuous machine utilization, smooth production often creates products that must be stored until they are sold

5 Management’s preoccupation with spreading overhead over a maximum number of units of production resulted in much unwanted inventory, huge inventory carrying costs, and other

operating problems

a Text Exhibit 18–8 depicts these inefficiencies or problems as “rocks” in a stream of “water”

that represents inventory

G Changes Needed to Implement JIT Manufacturing

1 General

a Implementation of a JIT system requires a long-term commitment

b Certain modifications must be made to supplier relationships, distribution, product design, product processing, and plant layout

i JIT depends on the ability of employees and suppliers to compress time, distance, resources, and activities to enhance the interactions needed to produce a company’s products and services

2 Supplier relationships and distribution

a The optimal JIT situation would be to have only one vendor for any given item, but that would create the risk of not having alternative sources in the event of vendor production strikes, unfair pricing, or shipment delays

i The realistic and feasible solution is to have a limited number of vendors that are

selected and company certified as to quality and reliability

b The company then enters into long-term relationships with these suppliers, who become

“partners” in the process

c Vendor certification is becoming increasingly popular Factors commonly considered in selecting suppliers include: reliability and responsiveness; delivery performance; ability to provide service; personnel qualifications; research and development strength; and production capacity

d Forming partnerships with fewer vendors on a long-term basis provides the opportunity to improve quality and reduce costs

i Such partnerships permit members of the supply chain to eliminate redundancies in warehousing, packaging, labeling, transportation, and inventories

3 Product design

a Products must be designed to use the fewest number of parts and the parts need to be standardized to the extent possible

i Parts standardization does not necessarily mean identical products

b Products should be designed for the desired quality and should require minimal engineering changes once the design is released for production

i Approximately 80-90 percent of all product costs have been established by the time the production design team has completed only 25 – 50 percent of its work

ii Any design changes have to be made early in the process if costs are to be significantly affected

c Good product design should address all concerns of the intended consumers including the degree of recycle-ability of the product

d The environmental impact is likely to become a much more significant concern in coming years as countries place caps on industrial emissions and tax firms for the right to generate those emissions

4 Product processing