Solution manual cost accounting 12e by horngren ch 20

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CHAPTER 20
INVENTORY MANAGEMENT, JUST-IN-TIME,
AND BACKFLUSH COSTING
20-1 Cost of goods sold (in retail organizations) or direct materials costs (in organizations with
a manufacturing function) as a percentage of sales frequently exceeds net income as a percentage
of sales by many orders of magnitude. In the Kroger grocery store example cited in the text, cost
of goods sold to sales is 73.7%, and net income to sales is 0.6%. Thus, a 10% reduction in the
ratio of cost of goods sold to sales (73.7 to 66.3%) without any other changes can result in a
1233% increase in net income to sales (0.6% to 8.0%).
20-2 Five cost categories important in managing goods for sale in a retail organization are the
following:
1. purchasing costs;
2. ordering costs;
3. carrying costs;
4. stockout costs; and
5. quality costs
20-3
1.
2.
3.
4.
5.

Five assumptions made when using the simplest version of the EOQ model are:
The same quantity is ordered at each reorder point.
Demand, ordering costs, carrying costs, and the purchase-order lead time are certain.
Purchasing cost per unit is unaffected by the quantity ordered.
No stockouts occur.
Costs of quality are considered only to the extent that these costs affect ordering costs or

carrying costs.

20-4 Costs included in the carrying costs of inventory are incremental costs for such items as
insurance, rent, obsolescence, spoilage, and breakage plus the opportunity cost of capital (or
required return on investment).
20-5 Examples of opportunity costs relevant to the EOQ decision model but typically not
recorded in accounting systems are the following:
1. the return forgone by investing capital in inventory;
2. lost contribution margin on existing sales when a stockout occurs; and
3. lost contribution margin on potential future sales that will not be made to disgruntled
customers.
20-6 The steps in computing the costs of a prediction error when using the EOQ decision
model are:
Step 1: Compute the monetary outcome from the best action that could be taken, given
the actual amount of the cost input.
Step 2: Compute the monetary outcome from the best action based on the incorrect
amount of the predicted cost input.
Step 3: Compute the difference between the monetary outcomes from Steps 1 and 2.

20-1


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20-7 Goal congruence issues arise when there is an inconsistency between the EOQ decision
model and the model used for evaluating the performance of the person implementing the model.
For example, if opportunity costs are ignored in performance evaluation, the manager may be
induced to purchase in a quantity larger than the EOQ model indicates is optimal.
20-8 Just-in-time (JIT) purchasing is the purchase of materials (or goods) so that they are
delivered just as needed for production (or sales). Benefits include lower inventory holdings

(reduced warehouse space required and less money tied up in inventory) and less risk of
inventory obsolescence and spoilage.
20-9

Factors causing reductions in the cost to place purchase orders of materials are:
Companies are establishing long-run purchasing agreements that define price and
quality terms over an extended period.
Companies are using electronic links, such as the Internet, to place purchase orders.
Companies are increasing the use of purchase-order cards.

20-10 Disagree. Choosing the supplier who offers the lowest price will not necessarily result in
the lowest total purchase cost to the buyer. This is because the price or purchase cost of the
goods is only one—and perhaps, most obvious—element of cost associated with purchasing and
managing inventories. Other relevant cost items are ordering costs, carrying costs, stockout costs
and quality costs. A low-cost supplier may well impose conditions on the buyer—such as poor
quality, or frequent stockouts, or excessively high inventories—that result in high total costs of
purchase. Buyers must examine all the elements of costs relevant to inventory management, not
just the purchase price.
20-11 Supply-chain analysis describes the flow of goods, services, and information from the
initial sources of materials and services to the delivery of products to consumers, regardless of
whether those activities occur in the same organization or in other organizations. Sharing of
information across companies enables a reduction in inventory levels at all stages, fewer
stockouts at the retail level, reduced manufacture of product not subsequently demanded by
retailers, and a reduction in expedited manufacturing orders.
20-12 Obstacles to companies adopting a supply-chain approach include:
Communication obstacles—the unwillingness of some parties to share information.
Trust obstacles—includes the concern that all parties will not meet their agreed-upon
commitments.
Information system obstacles—includes problems due to the information systems of
different parties not being technically compatible.

Limited resources—includes problems due to the people and financial resources
given to support a supply chain initiative not being adequate.

20-2


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20-13 Just-in-time (JIT) production is a ―demand-pull‖ manufacturing system that has the
following features:
Organize production in manufacturing cells,
Hire and retain workers who are multi-skilled,
Aggressively pursue total quality management (TQM) to eliminate defects,
Place emphasis on reducing both setup time and manufacturing lead time, and
Carefully select suppliers who are capable of delivering quality materials in a timely
manner.

20-14 Traditional normal and standard costing systems use sequential tracking, in which journal
entries are recorded in the same order as actual purchases and progress in production, typically at
four different trigger points in the process.
Backflush costing omits recording some of the journal entries relating to the cycle from
purchase of direct materials to sale of finished goods, i.e., it has fewer trigger points at which
journal entries are made. When 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.

20-15 Versions of backflush costing differ in the number and placement of trigger points at
which journal entries are made in the accounting system:

Version 1

Number of
Journal Entry
Trigger Points
3

Version 2

2

Stage A. Purchase of direct materials
Stage D. Sale of finished goods

Version 3

2

Stage C. Completion of good finished units of product
Stage D. Sale of finished goods

Location in Cycle Where
Journal Entries Made
Stage A. Purchase of direct materials
Stage C. Completion of good finished units of product
Stage D. Sale of finished goods

20-3


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20-16 (20 min.) Economic order quantity for retailer.
1.

D = 10,000, P = $225, C = $10

EOQ

2 DP
C

2 10,000 $225
10

= 670.82
671 jerseys
D
10,000
=
EOQ
671
= 14.90
15 orders

2.

Number of orders per year =

3.

Demand each
working day

=

D
Number of working days

Purchase lead time

10,000
365
= 27.40 jerseys per day
= 7 days

Reorder point

= 27.40

=

= 191.80

7
192 jerseys

20-4


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20-17 (20 min.) Economic order quantity, effect of parameter changes (continuation of 20-16).
1. D = 10,000, P = $20, C = $10

EOQ

2 DP
C

2 10,000 $20
10

= 200 jerseys
The sizable reduction in ordering cost (from $225 to $20 per purchase order) has reduced the
EOQ from 671 to 200.
2.
The AP proposal has both upsides and downsides. The upside is potentially higher sales.
SW customers may purchase more online than if they have to physically visit a store. SW would
also have lower administrative costs and lower inventory holding costs with the proposal.
The downside is that AP could capture SW’s customers. Repeat customers to the AP web
site need not be classified as SW customers. SW would have to establish enforceable rules to
make sure it captures ongoing revenues from customers it directs to the AP web site.
There is insufficient information to determine whether SW should accept AP’s proposal.
Much depends on whether SW views AP as a credible, ―honest‖ partner.

20-18 (15 min.) EOQ for a retailer.
1.

D = 20,000, P = $160, C = 20%

$8 = $1.60

EOQ = Error!= Error!= 2,000 yards
2.

Number of orders per year: Error!= Error!= 10 orders

3.

Demand each working day

= Error!
= Error!
= 80 yards per day
= 400 yards per week

Purchasing lead time = 2 weeks
Reorder point = 400 yards per week

2 weeks = 800 yards

20-5


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20-19 (20 min.) EOQ for manufacturer.
1.

Relevant carrying costs per part per year:

Required annual return on investment 15% $60 =
Relevant insurance, materials handling, breakage, etc.
costs per year
Relevant carrying costs per part per year
With D = 18,000; P = $150; C = $15, EOQ for manufacturer is:
2 18,000 $150
Error!=
= 600 units
$15
2.

Total relevant
ordering costs =

D
Q

$9
6
$15

P

18,000
$150
600
= $4,500
where Q = 600 units, the EOQ.
=

3.
At the EOQ, total relevant ordering costs and total relevant carrying costs will be exactly
equal. Therefore, total relevant carrying costs at the EOQ = $4,500 (from requirement 2). We
can also confirm this with direct calculation:
Q
Total relevant carrying costs =
C
2
600
=
$15
2
= $4,500
where Q = 600 units, the EOQ.
4.

Purchase order lead time is half a month.
Monthly demand is 18,000 units ÷ 12 months = 1,500 units per month.
Demand in half a month is Error! 1,500 units or 750 units.
Lakeland should reorder when the inventory of rotor blades falls to 750 units.

20-6


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20-20 (20 min.) Sensitivity of EOQ to changes in relevant ordering and carrying costs.
1.
A straightforward approach to the requirement is to construct the following table for
EOQ at relevant carrying and ordering costs. Annual demand is 10,000 units. The formula for the

EOQ model is:
EOQ =
Error!
where D = demand in units for a specified period of time
P = relevant ordering costs per purchase order
C = relevant carrying costs of one unit in stock for the time period used for D (one year in
this problem.
Relevant Carrying
Costs per Unit
per Year
$10

15

20

Relevant Ordering Costs per Purchase Order
$300
$200
2 10,000 $300
$10
2 10,000 $300
$15

2 10,000 $300
$20

= 775

= 632

= 548

2 10,000 $200
$10
2 10,000 $200
$15

2 10,000 $200
$20

= 632

= 516

= 447

2.
For a given demand level, as relevant carrying costs increase, EOQ becomes smaller. For
a given demand level, as relevant order costs increase, EOQ increases.

20-7


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20-21 (20–30 min.) Purchase-order size for retailer, EOQ, just-in-time purchasing.
1.
a.

EOQ = Error!
D = 6,000; P = $30; C = $1
EOQ = Error!= Error!= 600 cases

b.

D = 6,000; P = $30; C = $1.50
EOQ = Error!= Error!= 489.9 cases Error!490 cases

c.

D = 6,000; P = $5; C = $1.50
EOQ

= Error!= Error!

= 200 cases

2.
A just-in-time purchasing policy involves the purchase of goods or materials such that
their delivery immediately precedes their demand or use. Given the purchase order sizes
calculated in requirement 1, the number of purchase orders placed each month is (D ÷ EOQ):
a.

Error!= Error!= 10

orders per month or Error!1 every 3 days

b.

Error!= Error!= 12.24

c.

Error!= Error!= 30

orders per month or Error!1 every 2.45 days

orders per month or Error!1 every day

An increase in C and a decrease in P leads to increases in the optimal frequency of orders. The
24-Hour Mart has increased the frequency of delivery from every third day (1a:
P = $30; C = $1) to a delivery every day (1c: P = $5; C = $1.50). There is a reduction of 200
cases in the average inventory level: (600 – 200) ÷ 2 = 200.

20-8


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20-22 (20 min.) JIT production, relevant benefits, relevant costs.
1.
Solution Exhibit 20-22 presents the annual net benefit of $315,000 to Champion
Hardware Company of implementing a JIT production system.
2.
Other nonfinancial and qualitative factors that Champion should consider in deciding
whether it should implement a JIT system include:
a. The possibility of developing and implementing a detailed system for integrating the
sequential operations of the manufacturing process. Direct materials must arrive when
needed for each subassembly so that the production process functions smoothly.

b. The ability to design products that use standardized parts and reduce manufacturing
time.
c. The ease of obtaining reliable vendors who can deliver quality direct materials on
time with minimum lead time.
d. Willingness of suppliers to deliver smaller and more frequent orders.
e. The confidence of being able to deliver quality products on time. Failure to do so
would result in customer dissatisfaction.
f. The skill levels of workers to perform multiple tasks such as minor repairs,
maintenance, quality testing and inspection.
SOLUTION EXHIBIT 20-22
Annual Relevant Costs of Current Production System and JIT Production System
for Champion Hardware Company

Relevant Items
Annual tooling costs
Required return on investment:
15% per year $1,000,000 of average inventory per year
15% per year $200,000a of average inventory per year
Insurance, space, materials handling, and setup costs
Rework costs
Incremental revenues from higher selling prices
Total net incremental costs
Annual difference in favor of JIT production
a

$1,000,000 (1 – 80%) = $200,000
$300,000 (1 – 0.25) = $225,000
c
$200,000 (1 – 0.30) = $140,000
d

$4 × 40,000 units = $160,000
b

20-9

Relevant
Costs under
Current
Production
System
–

Relevant
Costs under
JIT
Production
System
$100,000

$150,000
30,000
300,000
225,000b
200,000
140,000c
–
(160,000)d
$650,000
$335,000
$315,000

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3.
Personal observation by production line workers and managers is more effective in JIT
plants than in traditional plants. A JIT plant’s production process layout is streamlined.
Operations are not obscured by piles of inventory or rework. As a result, such plants are easier to
evaluate by personal observation than cluttered plants where the flow of production is not
logically laid out.
Besides personal observation, nonfinancial performance measures are the dominant
methods of control. Nonfinancial performance measures provide most timely and easy to
understand measures of plant performance. Examples of nonfinancial performance measures of
time, inventory, and quality include:
Manufacturing lead time
Units produced per hour
Machine setup time ÷ manufacturing time
Number of defective units ÷ number of units completed
In addition to personal observation and nonfinancial performance measures, financial
performance measures are also used. Examples of financial performance measures include:
Cost of rework
Ordering costs
Stockout costs
Inventory turnover (cost of goods sold average inventory)
The success of a JIT system depends on the speed of information flows from customers to
manufacturers to suppliers. The Enterprise Resource Planning (ERP) system has a single
database, and gives lower-level managers, workers, customers, and suppliers access to operating
information. This benefit, accompanied by tight coordination across business functions, enables
the ERP system to rapidly transmit information in response to changes in supply and demand so
that manufacturing and distribution plans may be revised accordingly.

20-10


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20-23 (30 min.) Backflush costing and JIT production.
1.
(a) Purchases of direct materials

Inventory: Materials and In-Process
Control
Accounts Payable Control
Conversion Costs Control
Various Accounts

(b) Incur conversion costs
(c) Completion of finished goods

(d) Sale of finished goods

2,754,000
2,754,000
723,600
723,600

Finished Goods Controla
Inventory: Materials and In-Process
Control
Conversion Costs Allocated

3,484,000

Cost of Goods Soldb
Finished Goods Control

3,432,000

2,733,600
750,400

3,432,000

a

26,800 × ($102 + $28) = $3,484,000
b
26,400 × ($102 + $28) = $3,432,000

2.
Inventory:
Materials and In-Process Control

Direct
Materials

(a) 2,754,000

(c) 2,733,600

Finished Goods Control
(c) 3,484,000 (d ) 3,432,000

Cost of Good s Sold
(d) 3,432,000

Bal. 52,000

Bal. 20,400

Conversion Costs Allocated
(c) 750,400

Conversion
Costs

Conversion Costs Control
(b) 723,600

3.
Under an ideal JIT production system, there could be zero inventories at the end of each
day. Entry (c) would be $3,432,000 finished goods production, not $3,484,000. Also, there
would be no inventory of direct materials instead of $2,754,000 – $2,733,600 = $20,400.
20-11


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20-24 (20 min.) Backflush costing, two trigger
sale (continuation of 20-23).

1.
(a) Purchases of direct materials

points,

Inventory Control
Accounts Payable Control

(b) Incur conversion costs

purchase

2,754,000
723,600
723,600

No entry

(d) Sale of finished goods

Cost of Goods Sold
Inventory Control
Conversion Costs Allocated

3,432,000
2,692,800
739,200

Conversion Costs Allocated
Costs of Goods Sold

Conversion Costs Control

739,200
15,600
723,600

2.
Inventory Control
(a) 2,754,000

Direct
Materials

(d) 2,692,800

Bal. 61,200

Conversion Costs Allocated
(e) 739,200
(d) 739,200

Conversion
Costs

Conversion Costs Control
(b) 723,600

(e) 723,600

20-12

and

2,754,000

Conversion Costs Control
Various Accounts

(c) Completion of finished goods

(e) Underallocated or
overallocated conversion
costs

materials

Cost of Goods Sold
(d) 3,432,000

(e) 15,600


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20-25 (20 min.) Backflush costing, two trigger points, completion of production and sale
(continuation of 20-23).
(a) Purchases of direct materials

No Entry

(b) Incur conversion costs

Conversion Costs Control
Various Accounts

(c) Completion of finished goods

(d) Sale of finished goods

(e) Underallocated or
Overallocated conversion
Costs

3,484,000

Cost of Goods Sold
Finished Goods Control

3,432,000

(d) 3,432,000

Bal. 52,000

Conversion Costs Allocated
(e) 750,400
(c) 750,400

Conversion Costs Control
(b) 723,600

(e) 723,600

20-13

2,733,600
750,400

3,432,000

Conversion Costs Allocated
Costs of Goods Sold
Conversion Costs Control

(c) 3,484,000

Conversion
Costs

723,600

Finished Goods Control
Accounts Payable Control
Conversion Costs Allocated

Finished Goods Control

Direct
Materials

723,600

750,400
26,800
723,600

Cost of Goods Sold
(d) 3,432,000

(e) 26,800


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20-26 (30 min.) Effect of different order quantities on ordering costs and carrying costs, EOQ.
1.

Demand (units) (D)
Cost per purchase order (P)
Annual carrying cost per package (C)
Order quantity per purchase order (units) (Q)
Number of purchase orders per year (D Q)
Annual ordering costs (D Q) P
Annual carrying costs (QC 2)
Total relevant costs of ordering and carrying inventory

1
234,000
$ 81.00
$ 11.70

900
260.00
$21,060
$ 5,265
$26,325

2
234,000
$ 81.00
$ 11.70
1,500
156.00
$12,636
$ 8,775
$21,411

Scenario
3
234,000
$ 81.00
$ 11.70
1,800
130.00
$10,530
$10,530
$21,060

4
234,000
$ 81.00

$ 11.70
2,100
111.43
$ 9,026
$12,285
$21,311

The economic order quantity is 1,800 packages. It is the order quantity at which carrying costs
equal ordering costs and total relevant ordering and carrying costs are minimized.
We can also confirm this from direct calculation. Using D = 234,000; P = $81 and C = $11.70
2 234 ,000 $81
EOQ =
= 1,800 packages
$11.70
It is interesting to note that Koala Blue faces a situation where total relevant ordering and
carrying costs do not vary very much when order quantity ranges from 1,500 packages to 2,700
packages.
2.

When the ordering cost per purchase order is reduced to $49:
2 234 ,000 $49
EOQ =
= 1,400 packages
$11.70
The EOQ drops from 1,800 packages to 1,400 packages when Koala Blue’s ordering cost per
purchase order decreases from $81 to $49.
D
234 ,000
P =
$49 = $8,190

And the new relevant costs of ordering inventory =
Q
1,400
1,400
Q
and the new relevant costs or carrying inventory =
$11.70 = $8,190
C =
2
2
The total new costs of ordering and carrying inventory = $8,190 2 = $16,380
3.
As summarized below, the new Mona Lisa web-based ordering system, by lowering the
EOQ to 1,400 packages, will lower the carrying and ordering costs by $4,680. Koala Blue will
spend $2,000 to train its purchasing assistants on the new system. Overall, Koala Blue will still
save $2,680 in the first year alone.
Total relevant costs at EOQ (from Requirement 2)
Annual cost benefit over old system ($21,060 – $16,380)
Training costs
Net benefit in first year alone

20-14

$16,380
$ 4,680
$ 2,000
$ 2,680

5
234,000

$ 81.00
$ 11.70
2,700
86.67
$ 7,020
$15,795
$22,815


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20-27 (30–45 min.) EOQ, uncertainty, safety stock, reorder point.
1.
The Starr Company is searching for the safety stock level that will minimize the expected
total of the costs of carrying additional inventory and the costs associated with insufficient
inventories (stockout costs). The present reorder point, alternative safety stock levels, and
probability of usage during lead time have to be computed before this level can be determined.
The present reorder point is calculated as follows:
Average daily usage = Error!
= Error!= 100 units per day
Reorder point

= Average daily usage
= (100 units per day)

Lead time
5 days = 500 units

Alternative safety stock levels would be the number of units needed to cover possible demand
levels during lead time. These safety levels can be determined as follows:

Possible safety stock levels = Possible demand – Reorder point
The alternative safety stock levels are 0, 20, 40, and 60 units. The probability of demand during
lead time is:
Demand During
Lead Time
440
460
480
500
520
540
560

Number of
Times Quantity
Was Demanded
6
12
16
130
20
10
6
200

20-15

Probability
0.03
0.06

0.08
0.65
0.10
0.05
0.03
1.00


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Safety
Stock
Level
in Units
(1)
0

20

Demand
Realizations
Resulting
in Stockouts
(2)
520
540
560

540
560

Stockout
in Unitsa
(3) = (2) – 500 – (1)
20
40
60

20
40

40

560

20

60

––

––

Probability
of Stockout
(4)
0.10
0.05
0.03

0.05
0.03

0.03
––

Relevant
Stockout
Costsb
(5) = (3) $20
$ 400
800
1,200

400
800

Number
of Orders
Per Yearc
(6)
10
10
10

10
10

Expected
Stockout

Costsd
(7) = (4) (5) (6)
$ 400
400
360
$1,160

Relevant
Total
Carrying
Relevant
Costse
Costs
(8) = (1) $10 (9) = (7) + (8)

$

0

$1,160

$ 200
240
$ 440

$200

$ 640

400

10

$ 120

$400

$ 520

––

––

$

0f

$600

$ 600

a Realized demand – inventory available during lead time (excluding safety stock), 500 units – safety stock.
b Stockout units relevant stockout costs of $20 per motor.
c Annual demand 30,000 ÷ 3,000 EOQ = 10 orders per year.
d Probability of stockout relevant stockout costs number of orders per year.
e Safety stock annual relevant carrying costs of $10 per motor (assumes that safety stock is on hand at all times and that there is no overstocking caused by
decreases in expected usage).
f At a safety stock level of 60 motors, no stockouts will occur and, hence, expected stockout costs = $0.

Safety stock of 40 units would minimize Starr Company's total expected stockout and carrying costs.

20-16


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2.

The new reorder point would be:
Present reorder point
(demand during lead time: 100 units per day
Safety stock
New reorder point

3.

5 days)

500 units
40 units
540 units

Some factors that Starr Company should consider when estimating the stockout costs:
a. possible lost contribution margin on motors not sold;
b. costs associated with disruption or idle time;
c. forgone contribution margin on future sales from possible loss of customers and
customer goodwill;
d. additional clerical costs involved in keeping records of back orders;
e. the validity of using the past empirical distribution of demand in predicting the future
demand distribution; and

f. additional order costs and transportation costs.

20-17


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20-28 (20–30 min.) EOQ, cost of prediction error.
1.
EOQ = Error!
D = 2,000; P = $40; C = $4 + (10% $50) = $9
EOQ =
TRC

2 2,000 $40
= 133.333 tires –,~ 133 tires (approximately)
$9

= Error!+ Error!where Q can be any quantity, including the EOQ
2‚000 $40
133 .333 $9
=
+
= $600 + $600 = $1,200
133 .333
2

If students used an EOQ of 133 tires (order quantities rounded to the nearest whole
number),
2‚000 $40 133 $9

+
= $601.50 + $598.50 = $1,200.
133
2
Sum of annual relevant ordering and carrying costs equals $1,200.

TRC =

2.

The prediction error affects C, which is now:
C

= $4 + (10%

$30) = $7

D

= 2,000, P = $40, C = $7

EOQ = Error!= 151.186 tires = 151 tires (rounded)
The cost of the prediction error can be calculated using a three-step procedure:
Step 1: Compute the monetary outcome from the best action that could have been taken, given
the actual amount of the cost input.
TRC

= Error!+ Error!
=

2, 000 $40 151 .186 $7
+
151.186
2

= $529.15 + $529.15 = $1,058.30

20-18


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Step 2: Compute the monetary outcome from the best action based on the incorrect amount of
the predicted cost input.
TRC

= Error!+ Error!
=

2‚000 $40 133.333
+
133.333
2

$7

= $600 + $466.67 = $1,066.67
Step 3: Compute the difference between the monetary outcomes from Step 1 and Step 2:

Step 1

Step 2
Difference

Monetary Outcome
$1,058.30
1,066.67
$
(8.37)

The cost of the prediction error is $8.37.
Note: The $20 prediction error for the purchase price of the heavy-duty tires is irrelevant in
computing purchase costs under the two alternatives because the same purchase costs will be
incurred whatever the order size.
Some students may prefer to round off the EOQs to 133 tires and 151 tires, respectively.
The calculations under each step in this case follow:
2‚000 $40 151 $7
+
= $529.80 + $528.50 = $1058.30
151
2
2‚000 $40 133 $7
Step 2: TRC =
+
= $601.50 + $465.50 = $1067.00
133
2
Step 3: Difference = $1,058.30 – $1,067.00 = ($8.70)

Step 1: TRC =

20-19


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20-29 (30 min.) JIT purchasing, relevant benefits, relevant costs.
1.
Solution Exhibit 20-29 presents the $37,500 cash savings that would result if Margro
Corporation adopted the just-in-time inventory system in 2005.
2.
Conditions that should exist in order for a company to successfully adopt just-in-time
purchasing include the following:
•

Top management must be committed and provide the necessary leadership support to
ensure a company-wide, coordinated effort.

•

A detailed system for integrating the sequential operations of the manufacturing
process needs to be developed and implemented. Direct materials must arrive when
needed for each subassembly so that the production process functions smoothly.

•

Accurate sales forecasts must be available for effective finished goods planning and
production scheduling.

•

Products should be designed to maximize use of standardized parts to reduce
manufacturing time and costs.

•

Reliable vendors who can deliver quality direct materials on time with minimum lead
time must be obtained.

20-20


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SOLUTION EXHIBIT 20-29
Annual Relevant Costs of Current Purchasing Policy and JIT Purchasing Policy
for Margro Corporation
Relevant
Relevant
Costs under
Costs under
Current
JIT
Purchasing
Purchasing
Policy
Policy
Required return on investment
20% per year $600,000 of average inventory per year
$120,000
20% per year $0 inventory per year

$
0
Annual insurance and property tax costs
14,000
0
Warehouse rent
60,000
(13,500)a
Overtime costs
No overtime
0
Overtime premium
40,000
Stockout costs
No stockouts
0
$6.50b contribution margin per unit 20,000 units
130,000
Total incremental costs
$194,000
$156,500
Difference in favor of JIT purchasing
$37,500
a

$(13,500) = Warehouse rental revenues, [(75% 12,000)
Calculation of unit contribution margin
Selling price
($10,800,000 ÷ 900,000 units)
Variable costs per unit :

Variable manufacturing cost per unit
($4,050,000 ÷ 900,000 units)
Variable marketing and distribution cost per unit
($900,000 ÷ 900,000 units)
Total variable costs per unit
Contribution margin per unit

$1.50].

b

$12.00

$4.50
1.00
5.50
$ 6.50

Note that the incremental costs of $40,000 in overtime premiums to make the additional 15,000
units are less than the contribution margin from losing these sales equal to $97,500 ($6.50
15,000). Margro would rather incur overtime than lose 15,000 units of sales.

20-21


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20-30 (25 min.) Relevant benefits and costs of JIT purchasing, supply chain.
Solution Exhibit 20-30 presents the cash savings of $609.90 that would result if Codleff Medical
Instruments adopted the just-in-time inventory system.

SOLUTION EXHIBIT 20-30
Annual Relevant Costs of Current Purchasing Policy and JIT Purchasing Policy for Codleff
Medical Instruments

Relevant Item
Purchasing costs
$18 per unit × 25,000 units per year
$18.02 per unit × 25,000 units per year
Ordering costs
$2 per order × 50 orders per year
$2 per order × 500 orders per year
Opportunity carrying costs, required return on investment
20% × $18 cost per unit × 250a units of average inventory per year
20% × $18.02 cost per unit × 25b units of average inventory per year
Other carrying costs (insurance, materials handling, breakage, and so on)
$6 per unit per year × 250 a units of average inventory per year
$6 per unit per year × 25b units of average inventory per year
Stockout costs
No stockouts
$3 per unit × 50 units per year
Total annual relevant costs
Annual difference in favor of JIT purchasing
a
b

Relevant Costs Under
Current
JIT
Purchasing Purchasing
Policy

Policy
$450,000.00
$450,500.00
100.00
1,000.00
900.00
90.10
1,500.00
150.00
0.00
__________
150.00
$452,500.00 $451,890.10
$609.90

Order quantity = 25,000 ÷ 50 = 500; Average inventory = 500 ÷ 2 = 250.
Order quantity = 25,000 ÷ 500 = 50; Average inventory = 50 ÷ 2 = 25.

2.
Codleff may benefit from Slocombe managing all its inventories if there is high order
variability caused by randomness in when consumers purchase surgical scalpels or by trade
promotions that prompt retailers to stock for the future. By coordinating their activities and
sharing information about retail sales and inventory held throughout the supply chain, Slocombe
can plan its manufacturing activities to ensure adequate supply of product to Codleff while
keeping inventory low. For this to succeed, Codleff and Slocombe must have compatible
information systems, build trust, and communicate freely.

20-22

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20-31 (30 min.) Supplier evaluation and relevant costs of quality and timely deliveries.
Solution Exhibit 20-31 shows that annual relevant purchasing costs are $4,045.90 lower if
purchases are made from Slocombe instead of Pruitt. Basically, Pruitt's lower quality and the
resulting $10,000 in customer support costs (relative to $1,000 for Slocombe’s product), swings
the decision in favor of Slocombe, despite Pruitt's lower purchase costs. Based on financial
considerations alone, Codleff should purchase RM-27 from Slocombe.
Codleff should also consider other factors before reaching a final decision. For example if
Codleff purchases from Pruitt, will the lower quality of scalpels:
lead to lost contribution margins on future sales? or
affect Codleff's reputation for quality on other products that it sells? or
affect employee morale?
In this case, it is likely that these other considerations will further lead Codleff to
purchase from Slocombe.
SOLUTION EXHIBIT 20-31
Annual Relevant Costs of Purchasing from Slocombe and Pruitt

Relevant Item
Purchasing costs
$18.02 per unit × 25,000 units per year
$17.70 per unit × 25,000 units per year
Ordering costs
$2 per order × 500 orders per year a
$2 per order × 500 orders per year a
Inspection costs
No inspection necessary
$0.08 per unit × 25,000 units
Opportunity carrying costs, required return on investment
20% × $18.02 × 25b units of average inventory per year

20% × $17.70 × 25b units of average inventory per year
Other carrying costs (insurance, materials handling, breakage, etc.)
$6 per unit per year × 25b units of average inventory per year
$5.90 per unit per year × 25b units of average inventory per year
Stockout costs
$3 per unit × 50 units per year
$3 per unit × 400 units per year
Customer support costs
Total annual relevant costs
Annual difference in favor of Slocombe
a
b

No. of orders = 25,000 units ÷ 50 units per order = 500 orders
Order quantity ÷ 2 = 50 ÷ 2 = 25.

20-23

Relevant Costs of
Purchasing from
Slocombe
Pruitt
$450,500.00
$442,500.00
1,000.00
1,000.00
0.00
2,000.00
90.10
88.50

150.00
147.50
150.00
1,200.00
1,000.00
10,000.00
$452,890.10
$456,936.00
$4,045.90


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20-32 (25 min.) Supplier evaluation and relevant costs of quality and timely deliveries.
Solution Exhibit 20-32 presents the $6,236 annual relevant costs difference in favor of Wayland
purchasing the footballs from Bigby. On the basis of financial considerations alone, Wayland
should buy the footballs from Bigby.
SOLUTION EXHIBIT 20-32
Annual Relevant Costs of Purchasing from Bigby and Kendall

Relevant Item
Purchasing costs
$40 per unit × 15,000 units per year
$41 per unit × 15,000 units per year
Ordering costs
$4 per order × 25a orders per year
$4 per order × 25a orders per year
Inspection costs
$0.03 per unit × 15,000 units
No inspection necessary

Opportunity carrying costs, required return on investment
12% × $40 × 300 units of average inventory per year
12% × $41 × 300 units of average inventory per year
Other carrying costs (insurance, materials handling, breakage, etc.)
$5 per unit per year × 300 units of average inventory per year
$4.50 per unit per year × 300 units of average inventory per year
Stockout costs
$10 per unit × 400 units per year
$8 per unit × 100 units per year
Customer returns costs
$20 per unit returned × 300 units
$20 per unit returned × 50 units
Total annual relevant costs
Annual difference in favor of Bigby
a

Relevant Costs of
Purchasing from
Bigby
Kendall
$600,000
$615,000
100
100
450
0
1,440
1,476
1,500
1,350

4,000
800
6,000
1,000
$613,490 $619,726
$6,236

Order quantity per purchase order = 2 × average inventory held = 2 × 300 = 600 units;
No. of orders = 15,000 units ÷ 600 units per order = 25 orders

Although Kendall is the more reliable and higher quality supplier, the financial
benefits of better quality and reliability do not outweigh Kendall’s higher price. Of course,
Wayland should consider other financial and nonfinancial benefits of purchasing from Kendall
before reaching a final decision. For example, will Kendall’s higher quality and reliability
lead to higher future sales and contribution margins? or
improve its reputation for quality and reliability and so increase sales on other products? or
improve employee morale?
Despite these benefits, Wayland may conclude that purchasing from Bigby is preferred,
unless Kendall can lower its $41 price.

20-24


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20-33 (20 min.) Blackflush costing and JIT production.
1.
(a) Purchases of direct materials

(b) Incur conversion costs

(c) Completion of finished goods

(d) Sale of finished goods
a
b

Inventory: Materials and In-Process Control
Accounts Payable Control

550 000

Conversion Costs Control
Various Accounts

440 000

Finished Goods Controla
Inventory: Materials & In-Process Control
Conversion Costs Allocated

945 000

Cost of Goods Soldb
Finished Goods Control

900 000

550 000

440 000

525 000
420 000

900 000

21 000 × $45 ($25 + $20) = $945 000
20 000 × $45 = $900 000

2.
Direct
Materials

Inventory
Materials and In-Process Control
( a ) 5 50 ,00 0 (c ) 5 25 ,00 0
Bal . 2 5,0 00

Conversion
Costs

Finished Goods Control
(c)

9 45 ,0 00 (d )

Ba l. 4 5, 00 0

Conversion Costs Allocated

(c ) 4 20 ,0 00
Conversion Costs Control
(b ) 4 40 ,0 00

20-25

9 00 ,00 0

Cost of Goods Sold
(d )

9 00 ,00 0