Chapter 20 Managing inventory and quality

The importance of inventory management §Cope with uncertainties in customer demand and in production processes §Qualify for quantity discounts §Avoid future price increases in raw materials §Avoid the costs of placing numerous small orders with suppliers

Conventional approaches to inventory management §Focused on balancing l ordering costs the incremental costs of placing an order for inventory l carrying costs the costs of carrying inventory in stock l shortage costs (or out of stock costs)

Economic order quantity (EOQ) §The optimum order size for individual inventory items, to minimise the total ordering and carrying costs

Timing of orders under EOQ §Inventory reorder point (ROP) l the level of inventory on hand that triggers the placement of a new order (or setup) l safety stock the extra inventory kept on hand to cover any above- average usage or demand

Assumptions underlying EOQ §Demand is known and constant §Incremental ordering costs are known, constant per order §Acquisition cost per unit is constant §Entire order is delivered at one time §Carrying costs are known, constant per unit §On average, one-half of order is in stock at any time

MRP §Material requirements planning (MRPI) l assists managers to estimate inventory requirements and to schedule production §Manufacturing resource planning (MRPII) l allows managers to link production planning to the overall planning function of the business §MRP is a push system

MRP terminology §Bill of materials l identifies all the materials, components and sub- assemblies required to make a product §Inventory master file l records the quantity of inventory on hand and movements in and out of stock §Master production schedule l identifies the quantity and timing of each item to be produced in each department

Benefits of MRP §Increased customer responsiveness l significantly more on-time deliveries l much less expediting §Increased labour productivity §Reduced inventory levels l reduced cost of holding inventory

Costs of MRP §Expensive to install §Requires extensive employee training and discipline §If bill of materials or inventory master files are inaccurate - system is unreliable

Just-in-time (JIT) inventory management §JIT inventory and production system is l a comprehensive system for controlling the flow of manufacturing in a multistage production environment §An underlying philosophy of simplifying the production process by removing non- value-added activities

Key features of JIT production §A pull method of co-ordinating production, uses kanbans §Simplified production processes §Purchase of materials, and manufacture of sub-assemblies and products in small lots §Quick and inexpensive setups of production machinery Cont.

Key features of JIT production §High-quality levels for raw materials, components and finished products §Effective preventative maintenance of equipment §Flexible work cells l to take advantage of group technology and remove bottlenecks

JIT purchasing §A few suppliers §Long-term contracts with suppliers §Materials and parts delivered in small lots as needed §Minimal inspection of delivered materials and parts §Grouped payments to each supplier

Costs of JIT §Substantial investment to change the production to minimise non-value-added activities §An increase in the risk of inventory shortages and the associated loss of production, expediting materials costs and loss of sales

Benefits of JIT §Savings in inventory-carrying costs §Lower insurance costs §Fewer losses due to spoilage, obsolescence and theft §No opportunity costs of high inventory §Elimination of non-value-added activities §Meets customers needs more effectively

JIT and backflush costing §Backflush costing l a simplified method of product costing under JIT l no raw material or WIP inventory account l raw material charged to raw and in process inventory (RIP) account used l conversion costs charged to finished goods inventory

Costs and benefits of backflush costing §Benefits of backflush costing l simpler and less expensive than conventional costing §Costs of backflush costing are l provides much less detail than conventional costing §Is the loss of detail overcome by cost savings?

Role of the management accountant in managing inventory §MPR: may maintain inventory master files and bills of material for all products §JIT l co-ordinate the flow of information to eliminate non-value activities l provide reports to appropriate levels of management

Managing quality §TQM is a management approach that focuses on meeting customer requirements by achieving continuous improvement in products or services §TQM is a broad philosophy with a number of features which are not included in JIT

Quality accreditation §Organisations may achieve quality accreditation by meeting a series of quality standards set out in the ISO 9000 series. §ISO 9000’s are l expensive to implement and maintain l may have little relevance to many small businesses and service organisations

Quality accreditation (QA) versus total quality management (TQM) §Organisations can have QA without TQM §TQM is a philosophy - QA is a documentation process §QA may encourage employees to think about quality

Features of TQM §TQM is holistic §Customer-driven §Involves empowerment §Has a process perspective §Is supported by a quality management system §Involves continuous improvement

Benefits and costs of TQM §Benefits l improved quality l shorter lead times l increased efficiency l improved customer satisfaction §TQM can be difficult and expensive to achieve because it may involve a change in organisational culture

Cost of quality reports §Quality of design l degree to which a product’s design specifications meet customers’ expectations §Quality of conformance l degree to which a product meets formal design specifications Cont.

Cost of quality reports §Costs incurred in ensuring that the organisation maintains a high level of quality in its products, and the costs that arise from having poor-quality products §Internal failure costs l incurred when defective products or services are detected before they leave the firm

Cost of quality reports §External failure costs l incurred as a result of defective products or services being delivered to customers §Appraisal costs l incurred to determine whether defects exist §Prevention costs l incurred to prevent internal or external failures and to minimise appraisal activities

Usefulness of cost of quality reports §Places a dollar figure on the costs of poor quality §Helps prioritise quality improvement programs §Helps managers monitor the effects of the ‘quality effort’ §Can help identify the optimal level of quality for the firm

Reasons for lack of use of cost of quality reports §Managers may believe costs outweigh the benefits §Information is difficult to extract from conventional costing systems §Many of the quality costs are spread across the organisation

Exhibit 20.3

Exhibit 20.4

Exhibit 20.6