Horngren\'s Cost Accounting: A Managerial Emphasis, 16th Global Edition Chapter 20 Questions and solutions PDF

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CHAPTER 20INVENTORY MANAGEMENT, JUST-IN-TIME,AND SIMPLIFIED COSTING METHODS20-1 Why do better decisions regarding the purchasing and managing of goods for sale frequently cause dramatic percentage increases in net income?Cost of goods sold (in retail organizations) or direct materials costs (in orga...

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CHAPTER 20 INVENTORY MANAGEMENT, JUST-IN-TIME, AND SIMPLIFIED COSTING METHODS 20-1 Why do better decisions regarding the purchasing and managing of goods for sale frequently cause dramatic percentage increases in net income? 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 Costco retailer example cited in the text, cost of goods sold to sales is 86.9%, and net income to sales is 2%. Thus, a 10% reduction in the ratio of cost of goods sold to sales (86.9 to 78.2% equal to 8.7%) without any other changes can result in a 435% increase in net income to sales (2% plus 8.7% equal to 10.7%). 20-2 Name six cost categories that are important in managing goods for sale in a retail company. Six cost categories important in managing goods for sale in a retail company are the following: 1. purchasing costs 2. ordering costs 3. carrying costs 4. stockout costs 5. costs of quality 6. shrinkage costs 20-3 What assumptions are made when using the simplest version of the economic-orderquantity (EOQ) decision model? Five assumptions made when using the simplest version of the EOQ model are the following: 1. The same quantity is ordered at each reorder point. 2. Demand, ordering costs, carrying costs, and the purchase-order lead time are certain. 3. Purchasing cost per unit is unaffected by the quantity ordered. 4. No stockouts occur. 5. Costs of quality and shrinkage costs are considered only to the extent that these costs affect ordering costs or carrying costs. 20-4 Give examples of costs included in annual carrying costs of inventory when using the EOQ decision model. Costs included in the carrying costs of inventory are incremental costs for such items as insurance, rent, and obsolescence plus the opportunity cost of capital (or required return on investment). 20-5 Give three examples of opportunity costs that typically are not recorded in accounting systems, although they are relevant when using the EOQ model in the presence of demand uncertainty.

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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; 3. lost contribution margin on potential future sales that will not be made to disgruntled customers 20-6 What are the steps in computing the cost of a prediction error when using the EOQ decision model? 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. 20-7 Why might goal-congruence issues arise when managers use an EOQ model to guide decisions on how much to order? 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

“JIT purchasing has many benefits but also some risks.” Do you agree? Explain briefly.

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 inventory obsolescence and spoilage. The risk in JIT purchasing is the risk of stockouts—delays in supply of materials (or goods) may result in materials (goods) not being available when needed for production (or sales). 20-9 What are three factors causing reductions in the cost to place purchase orders for materials? Factors causing reductions in the cost to place purchase orders of materials are the following:  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 “You should always choose the supplier who offers the lowest price per unit.” Do you agree? Explain.

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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, quality costs, and shrinkage 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 What is supply-chain analysis, and how can it benefit manufacturers and retailers? 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 company or in other companies. Sharing of information across companies benefits manufacturers and retailers because it enables a reduction in inventory levels at all stages of the supply chain, fewer stockouts at the retail level, reduced manufacture of product not subsequently demanded by retailers, and a reduction in expedited manufacturing orders. 20-12 What are the main features of JIT production, and what are its benefits and costs? Just-in-time (JIT) production is a “demand-pull” manufacturing system that manufactures each component in a production line as soon as, and only when, needed by the next step in the production line. It 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 cycle time.  Carefully select suppliers who are capable of delivering quality materials in a timely manner. The benefits of JIT production include lower costs and higher margins from better flow of information, higher quality, and faster delivery, as well as simpler accounting systems. The cost of JIT production is the risk of stockouts—a production problem in any step of the manufacturing process will result in materials (goods) not being produced in time. 20-13 Distinguish inventory-costing systems using sequential tracking from those using backflush costing. 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,

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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. 20-14 Backflush costing is comparable to cost accounting in a service firm. Discuss. Backflush costing: all manufacturing costs flow directly into the cost of good, because inventories are minimized (compare to JIT) and allocation of costs to the inventories of WIP and Finished Goods “disappear”. In this way it is comparable to a service organization, in which the inventories are minimal or zero. 20-15 Discuss the differences between lean accounting and traditional cost accounting. Traditional accounting systems calculate costs of individual products and distinguish product costs from selling, general, and administrative costs. Lean accounting costs the entire value stream instead of individual products. Rework costs, unused capacity costs, and common costs that cannot reasonably be assigned to value streams are excluded from value stream costs. In addition, many lean accounting systems expense material costs in the period they are purchased, rather than storing them on the balance sheet until the products using the material are sold.

20-16 The order size associated with the economic-order-quantity (EOQ) model will necessarily decline if: a. Ordering costs rise b. Storage costs rise c. Insurance costs for materials in storage fall d. Stockout costs rise SOLUTION Choice "b" is correct. Storage costs are a component of carrying costs. Since carrying costs are in the denominator of the EOQ model, a higher denominator means a lower order size. (Logically, if the cost of storing the item increases, you will keep less on hand, and the EOQ will decline.) Choice "a" is incorrect. Order costs are in the numerator of the EOQ model, so higher order costs will lead to a higher order size. Choice "c" is incorrect. If insurance costs (a form of carrying costs) fall, the denominator of the EOQ model will fall and the order size will rise.Choice "d" is incorrect. Stock‐out costs are not accounted for in the EOQ model. 20-17 Jack’s Tracks sells 24,000 custom-designed GoKarts per year. These GoKarts are sold evenly throughout the year. The manufacturer charges Jack a $50 processing cost per order, and Jack incurs a carrying cost of $240 per year including storing each GoKart at a local warehouse. 20-4

What is the economic order quantity for ordering materials? a. 100 b. 1,000 c. 2,000 d. 10,000 SOLUTION Choice "a" is correct. Jack sells 24,000 Go‐Karts per year (2,000 per month). The equation for economic order quantity is the square root of [(2 × annual sales × ordering cost)/annual carrying cost per unit]. 2 DP 224, 000$50 = 100 Go-Karts per order  EOQ  C 240 Choices "b", "c", and "d" are incorrect based on the above. 20-18 Jill’s Custom Bags manufacturers and sells 12,000 customer designer bags per year, each requiring three yards of a specially manufactured fabric. These bags are sold evenly throughout the year. The materials for these bags require two months’ lead time. Jill desires to maintain a safety stock of sufficient material to meet one month’s demand. What is Jill’s reorder point? a. 3,000 b. 6,000 c. 9,000 d. 12,000 SOLUTION Choice "c" is correct. Jill uses an average of 3,000 yards of fabric per month (12,000 units per year / 12 months × 3 yards per unit). Reorder Point = Safety Stock + (Purchase order lead time × Number of yards of fabric used per month). = 3,000 yards + (2 months × 3,000 yards per month) = 9,000 yards Choices "a", "b", and "d" are incorrect based on the above calculation. 20-19 Lyle Co. has only one product line. For that line, the reorder point is 500 units, the lead time for production is three weeks, and the sales volume is estimated at 50 units per week. Lyle has established which of the following amounts as its safety stock? a. 150 b. 350 c. 500 d. 650 SOLUTION Choice "b" is correct. The relevant formula for this calculation is as follows: Reorder Point = Safety Stock + (Purchase order lead time × Number of units sold per week). Substituting values for Reorder point, Purchase order lead time, and Number of units sold per week into this equation, we can solve for the safety stock as follows: 500 = Safety Stock + (3 × 50) Safety Stock = 500 – 150 = 350 units Choice "a" is incorrect. This answer choice only takes into account the lead time multiplied by the sales volume per week. Choice "c" is incorrect. This choice only reflects the reorder point of 500 units, without taking into account the lead time and the sales volume per week.

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Choice "d" is incorrect. This choice adds the lead time multiplied by sales per week to the reorder point, i.e. 500 + (3 × 50) = 650. The correct answer is 500 − (3 × 50) = 350. 20-20 Just-in-time inventory assumes all of the following, except: 1. Zero defects. 2. Resources will only be introduced as they are needed. 3. Just-in-time inventory presumes first-in, first-out costing. 4. Production of components only occurs only when requested further downstream in the manufacturing cycle. SOLUTION Choice "3" is correct. Just in time inventory methods make no assumptions regarding costing methods. Choice "1" is incorrect. Just in time inventory methods presume zero defects. Choice "2" is incorrect. Just in time inventory methods assume that resources will only be introduced as they are needed. Choice "4" is incorrect. Just in time inventory methods presume that production of components at intermediate intervals in the production process will only occur as they are needed. 20-21 Economic order quantity for retailer. RightTime (RT) Corporation operates a retail store featuring wristwatches. It maintains an EOQ decision model to make inventory decisions. Currently, it is considering inventory decisions for its TagMe wristwatches product line, which is a very popular product line. Data for 2017 are as follows: Expected annual demand for TagMe watches Ordering cost per purchase order Carrying cost per year

7,000 $300 $14 per wristwatch

Each watch costs RT $75, and sells for $200. The $14 carrying cost per jersey per year consists of the required return on investment of $9.00 (12% × $75 purchase price) plus $5.00 in relevant insurance, handling, and storage costs. The purchasing lead time is 10 days. RT is open 365 days a year. Required: 1. Calculate the EOQ for the TagMe product line. 2. Calculate the number of orders that will be placed each year. 3. Calculate the reorder point. SOLUTION (20 min.) Economic order quantity for retailer. 1.

D = 7,000 watches per year, P = $300, C = $14 per watch per year

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EOQ 

2 DP 2 7,000 $300 = 547.72 ≅ 548 watches  C 14 D 7,000 = 12.77 ≅ 13 orders = EOQ 548

2.

Number of orders per year =

3.

Demand each working day

=

Purchase lead time

= 10 days

Reorder point

= 19.18  10

D 7,000 = = 19.18 watches per day Number of working days 365

= 19.18  192 watches

20-22 Economic order quantity, effect of parameter changes (continuation of 20-21). MakeWatch (MW) manufactures the TagMe wristwatches that RightTime (RT) sells to its customers. MW has recently installed computer software that enables its customers to conduct “one-stop” purchasing using state-of-the-art Web site technology. RT’s ordering cost per purchase order will be $50 using this new technology. Required: 1. Calculate the EOQ for the TagMe wristwatches using the revised ordering cost of $50 per purchase order. Assume all other data from Exercise 20-21 are the same. Comment on the result. 2. Suppose MW proposes to “assist” RT by allowing RT customers to order directly from the MW Web site. MW would ship their product directly to these customers. MW would pay $20 to RT for every TagMe watch purchased by one of RT’s customers. Comment qualitatively on how this offer would affect inventory management at RT. What factors should RT consider in deciding whether to accept MW’s proposal? SOLUTION (20 min.) Economic order quantity, effect of parameter changes (continuation of 20-21). 1. D = 7,000 watches per year, P = $50, C = $14 per watch per year EOQ 

2 DP 2 7,000 $50 = 223.61 watches ≅ 224 watches  C 14

The sizable reduction in ordering cost (from $300 to $50 per purchase order) has reduced the EOQ from 548 to 224.

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2. The MW proposal has both upsides and downsides. The upside is potentially higher sales. RT customers may purchase more online than if they have to physically visit a store. As a result of the proposal, RT would have lower administrative costs and would need to hold lower inventories (as more sales occur directly through MW’s Web site) resulting in lower inventory carrying costs. The downside is that MW could capture RT’s customers. Repeat customers to the MW Web site need not be classified as RT customers. RT would have to establish enforceable rules to make sure that it captures ongoing revenues from customers it directs to the MW Web site. There is insufficient information to determine whether RT should accept MW’s proposal. Much depends on whether RT views MW as a credible, “honest” partner. 20-23 EOQ for a retailer. The HomeServe Corporation provides a wide range of household essentials to householders. One of the products it offers is dotted paper rolls, used in kitchens and toilets. The supplier for the dotted paper rolls pays all incoming freight. No incoming inspection of the paper roll is necessary because the supplier has a track record of delivering high-quality merchandise. The purchasing officer of the HomeServe Corporation has collected the following information: Annual demand for dotted paper rolls

24,200 rolls

Ordering cost per purchase order

$175

Carrying cost per year

15% of purchase costs

Safety-stock requirements

None

Cost of dotted paper rolls

$10 per roll

The purchasing lead time is 4 weeks. The HomeServe Corporation is open 260 days a year (52 weeks for 5 days a week). Required: 1. Calculate the EOQ for dotted paper roll. 2. Calculate the number of orders that will be placed each year. 3. Calculate the reorder point for dotted paper roll. SOLUTION (15 min.) EOQ for a retailer. 1.

D = 24,200 rolls per year, P = $175, C = 15% × $10 = $1.50 per roll per year EOQ 

2 DP 2 24, 200 $175  2,377 rolls C $1.5

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2.

Number of orders per year:

3.

Demand each working day

D 24, 200  11 orders per year EOQ 2,377 = =

24, 200 260

= 93 rolls per day = 465 rolls per week (93 × 5 days per week) Purchasing lead time = 4 weeks Reorder point = 465 paper rolls per week × 4 weeks = 1,860 paper rolls 20-24 EOQ for manufacturer. Turfpro Company produces lawn mowers and purchases 4,500 units of a rotor blade part each year at a cost of $30 per unit. Turfpro requires a 15% annual rate of return on investment. In addition, the relevant carrying cost (for insurance, materials handling, breakage, etc.) is $3 per unit per year. The relevant ordering cost per purchase order is $75. Required: 1. Calculate Turfpro’s EOQ for the rotor blade part. 2. Calculate Turfpro’s annual relevant ordering costs for the EOQ calculated in requirement 1. 3. Calculate Turfpro’s annual relevant carrying costs for the EOQ calculated in requirement 1. 4. Assume that demand is uniform throughout the year and known with certainty so there is no need for safety stocks. The purchase-order lead time is half a month. Calculate Turfpro’s reorder point for the rotor blade part. SOLUTION (20 min.) EOQ for manufacturer. 1.

Relevant carrying costs per part per year: Required annual return on investment 15%  $30 = Relevant insurance, materials handling, breakage, etc. costs per year = Relevant carrying costs per part per year

$4.50 3.00 $7.50

With D = 4,500 parts per year; P = $75; C = $7.50 per part per year, EOQ for manufacturer is: 2 DP 2 4,500 $75 EOQ    300 units C 7.50

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2.

 Relevant annual =  D Q  P  ordering costs    4,500   $75  =  300  = $1,125 where Q = 300 units, the EOQ.

3. At the EOQ, total relevant ordering costs and total relevant carrying costs wil...