Presentation on theme: "Cost Management ACCOUNTING AND CONTROL"— Presentation transcript:
1 Cost Management ACCOUNTING AND CONTROL HANSEN & MOWEN
2 CHAPTER21Inventory Management: Economic Order Quantity, JIT, and the Theory of Constraints
3 1 Just-in-Case Inventory Management OBJECTIVE1Three types of inventory costs can be readily identified with inventory:The cost of acquiring inventory.The cost of holding inventory.The cost of not having inventory on hand when needed.
4 1 Just-in-Case Inventory Management OBJECTIVE11. Ordering Costs: The costs of placing and receiving an order.Examples: Clerical costs, documents, insurance for shipment, and unloading.2. Setup Costs: The costs of preparing equipment and facilities so they can be used to produce a particular product or component.Examples: Setup labor, lost income (from idled facilities), and test runs.
5 1 Just-in-Case Inventory Management OBJECTIVE13. Stock-Out Costs: The costs of not having sufficient inventory.Examples: Lost sales, costs of expediting (extra setup, transportation, etc.) and the costs of interrupted production.4. Carrying Costs: The costs of carrying inventory.Examples: Insurance, inventory taxes, obsolescence, opportunity cost of capital tied up in inventory, and storage.
6 Traditional Reasons for Carrying Inventory Just-in-Case Inventory ManagementOBJECTIVE1Traditional Reasons for Carrying Inventory
7 1 TC = PD/Q + CQ/2 Economic Order Quantity Just-in-Case Inventory ManagementOBJECTIVE1Economic Order QuantityTC = PD/Q + CQ/2The total ordering (or setup) and carrying costThe cost of placing and receiving an order (or the cost of setting up a production run)The known annual demandThe number of units ordered each time an order is placed (or the lot size for production)The cost of carrying one unit of stock for one year
8 1 An EOQ Illustration Just-in-Case Inventory Management EOQ = 2PD/C OBJECTIVE1An EOQ IllustrationEOQ = 2PD/CD = 25,000 unitsQ = 500 unitsP = $40 per orderC = $2 per unitEOQ = (2 x 25,000 x $40) / $2EOQ = 1,000,000EOQ = 1,000 units8
9 When to Order or Produce Just-in-Case Inventory ManagementOBJECTIVE1When to Order or ProduceReorder point = Rate of usage x Lead timeExample: Assume that the average rate of usage is 100 parts per day. Assume also that the lead time is 4 days. What is the reorder point?Reorder point = 4 x 100 = 400 unitsThus, an order should be placed when inventory drops to 400 units.
10 Just-in-Case Inventory Management OBJECTIVE1The Reorder Point
11 Demand Uncertainty and Reordering Just-in-Case Inventory ManagementOBJECTIVE1Demand Uncertainty and ReorderingTo avoid running out of parts, organizations often choose to carry safety stock. Safety stock is extra inventory carried to serve as insurance against fluctuations in demand.Example: If the maximum usage of the VCR part is 120 units per day, the average usage is 100 units per day, and the lead time is four days, the safety stock is 80.Maximum usage 120Average usage -100Difference 20Lead time x 4Safety stock 80
12 EOQ and Reorder Point Illustrated Just-in-Case Inventory ManagementOBJECTIVE1EOQ and Reorder Point Illustrated
13 Setup and Carrying Costs: The JIT Approach JIT Inventory ManagementOBJECTIVE2Setup and Carrying Costs: The JIT ApproachJIT reduces the costs of acquiring inventory to insignificant levels by:1. Drastically reducing setup time2. Using long-term contracts for outside purchasesCarrying costs are reduced to insignificant levels by reducing inventories to insignificant levels.
14 Due-Date Performance: The JIT Solution JIT Inventory ManagementOBJECTIVE2Due-Date Performance: The JIT SolutionLead 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 timesimproving qualityusing cellular manufacturing
15 Avoidance of Shutdown: The JIT Approach JIT Inventory ManagementOBJECTIVE2Avoidance of Shutdown: The JIT ApproachTotal preventive maintenance to reduce machine failuresTotal quality control to reduce defective partsThe use of the Kanban system is also essential
16 What is the Kanban System? JIT Inventory ManagementOBJECTIVE2What is the Kanban System?A card system is used to monitor work in processA withdrawal KanbanA production KanbanA vendor KanbanThe Kanban system is responsible for ensuring that the necessary products are produced in the necessary quantities at the necessary time.12
19 JIT Inventory Management OBJECTIVE2The Kanban Process
20 2 JIT Inventory Management OBJECTIVE2Discounts and Price Increases: JIT Purchasing versus Holding InventoriesCareful vendor selectionLong-term contracts with vendorsPrices are stipulated (usually producing a significant savings)Quality is stipulatedThe number of orders placed are reduced
21 2 JIT Limitations JIT Inventory Management OBJECTIVE2JIT LimitationsPatience in implications is needed.Time is required.JIT may cause lost sales and stressed workers.Production may be interrupted due to an absence of inventory.
22 Basic Concepts of Constrained Optimization OBJECTIVE3Every firm faces limited resources and limited demand for each product.External constraints, such as market demandInternal constraints, such as machine or labor time availabilityConstrained optimization is choosing the optimal mix given the constraints faced by the firm.
23 Total contribution margin Basic Concepts of Constrained OptimizationOBJECTIVE3Linear ProgrammingThe unit contribution margins are $300 and $600 for X and Y, respectively.Z = $300X + $600 YTotal contribution marginThis equation is called the objective function, the function to be optimized.
24 3 Linear Programming Internal constraints: External constraints: Basic Concepts of Constrained OptimizationOBJECTIVE3Linear ProgrammingInternal constraints:X + Y 80X + 3Y 1202X + Y 90External constraints:X 60Y 100
25 3 Linear Programming Basic Concepts of Constrained Optimization OBJECTIVE3Linear ProgrammingX + Y 80X + 3Y 1202X + Y 90X 60Y 100X 0Y 0
26 Basic Concepts of Constrained Optimization OBJECTIVE3Graphical Solution16014012010080604020X 60Y 1002X + Y 90X + Y 80BCX + 3Y 120AD
27 C is the optimal solution! Basic Concepts of Constrained OptimizationOBJECTIVE3Linear ProgrammingCorner Point X-Value Y-Value Z = $300X + $600YA 0 0 $B ,000C ,000D ,500C is the optimal solution!
28 4 Three Measures of Systems Performance: Throughput Inventory Theory of ConstraintsOBJECTIVE4Three Measures of Systems Performance:(Sales revenue – Unit-level variable expenses)/TimeThroughputInventoryOperating expenses17
29 Five-Step Method for Improving Performance Theory of ConstraintsOBJECTIVE4Five-Step Method for Improving Performance1. Identify an organization’s constraints.2. Exploit the binding constraints.3. Subordinate everything else to the decisions made in Step 2.4. Elevate the organization’s binding constraints.5. Repeat the process as a new constraint emerges to limit output.18
30 Drum-Buffer-Rope System: General Description Theory of ConstraintsOBJECTIVE4Drum-Buffer-Rope System: General DescriptionContinued from leftContinued
31 Drum-Buffer-Rope System: Schaller Company Theory of ConstraintsOBJECTIVE4Drum-Buffer-Rope System: Schaller Company
32 New Constraint Set: Schaller Company Theory of ConstraintsOBJECTIVE4New Constraint Set: Schaller Company