1. Inventory Management, Just-in-Time, and Backflush Costing

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5. Identify five categories of costs associated with goods for sale.
Learning Objective 1
Identify five categories of costs
associated with goods for sale.

6. Costs Associated with Goods for Sale
1. Purchasing costs include transportation costs.
2. Ordering costs include receiving and
inspecting the items in the orders.
3. Carrying costs include the opportunity cost
of the investment tied up in inventory and
the costs associated with storage.

7. Costs Associated with Goods for Sale
4. Stockout costs occur when an organization
runs out of a particular item for which
there is a customer demand.
5. Quality costs of a product or service is its lack
of conformance with a prespecified standard.

8. Balance ordering costs with carrying costs using the
Learning Objective 2
Balance ordering costs with
carrying costs using the
economic-order-quantity
(EOQ) decision model.

9. Economic-Order-Quantity Decision Model Assumptions
1. The same quantity is ordered at each
reorder point.
2. Demand, ordering costs, carrying costs,
and purchase-order lead time are
known with certainty.
3. Purchasing costs per unit are unaffected
by the quantity ordered.

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11. Economic-Order-Quantity Decision Model Assumptions
4. No stockouts occur.
5. Quality costs are considered only to the
extent that these costs affect ordering
costs or carrying costs.

12. Economic-Order-Quantity Decision Model Assumptions
The EOQ minimizes the relevant ordering
costs and carrying costs.
Video store sells packages of blank video tapes.
Video purchases packages of video tapes from
Oaks, Inc., at Rs15/package.

13. Economic-Order-Quantity Decision Model Assumptions
Annual demand is 12,844 packages, at the
rate of 247 packages per week.
Video requires a 15% annual return on investment.
The purchase-order lead time is two weeks.
What is the economic-order-quantity?

14. Economic-Order-Quantity Decision Model Assumptions
Relevant ordering cost per purchase order: Rs209
Relevant carrying costs per package per year:
Required annual ROI (15% × Rs15) Rs2.25
Relevant other costs
Total Rs5.50

15. Economic-Order-Quantity Decision Model Example
EOQ =
D = Demand in units for a specified time period
P = Relevant ordering costs per purchase order
C = Relevant carrying costs of one unit in
stock for the time period used for D

16. Economic-Order-Quantity Decision Model Example
EOQ =
= packages

17. Economic-Order-Quantity Decision Model Example
What are the relevant total costs (RTC)?
RTC = Annual relevant ordering costs
+ Annual relevant carrying costs
RTC = D Q × P + Q 2 × C or DP Q + QC 2
Q can be any order quantity, not just the EOQ.

18. Economic-Order-Quantity Decision Model Example
When Q = 988 units,
RTC = (12,844 × Rs209 ÷ 988) + (988 × Rs5.50 ÷ 2)
= Rs5,434 total relevant costs
How many deliveries should occur each time period? D
EOQ =
12,844
988 =
13 deliveries

19. Economic-Order-Quantity Decision Model Example
10,000
8,000
Annual relevant total costs
Relevant Total Costs (Dollars)
6,000
5,434
Annual relevant ordering costs
4,000
Annual relevant carrying costs
2,000
600
988
EOQ
1,200
1,800
2,400
Order Quantity (Units)

20. Reorder Point Reorder point = Number of units sold per unit of time
× Purchase-order lead time
EOQ = 988 packages
Number of units sold/week = 247
Purchase-order lead time = 2 weeks
Reorder point = 247 × 2 = 494 packages

21. Demand = 247 tape packages/week Purchase-order lead time = 2 weeks
Reorder Point
988
Reorder Point
Reorder Point
494
Weeks 1 2 3 4 5 6 7 8
Lead Time
2 weeks
Lead Time
2 weeks
This exhibit assumes that demand and purchase-order lead time are certain:
Demand = 247 tape packages/week Purchase-order lead time = 2 weeks

22. Safety Stock Example Safety stock is inventory held at all times
regardless of the quantity of inventory
ordered using the EOQ model.
Video’s expected demand is 247 packages per week.
Management feels that a maximum demand of
350 packages per week may occur.

23. Safety Stock Example How much safety stock should be carried?
350 Maximum demand – 247 Expected demand
= 103 Excess demand per week
103 packages × 2 weeks lead time
= 206 packages of safety stock.

24. Considerations in Obtaining Estimates of Relevant Costs
What are the relevant incremental costs
of carrying inventory?
– only those costs of the purchasing company
that change with the quantity of inventory held

25. Cost of Prediction Error
Predicting relevant costs requires care
and is difficult.
Assume that Video’s relevant ordering cost
is Rs97.84 instead of the Rs209 prediction used.
What is the cost of this prediction error?

26. Cost of Prediction Error
Step 1: Compute the monetary outcome
from the best action that could have been
taken, given the actual amount of the cost input.
EOQ =
EOQ =
= 676 packages

27. Cost of Prediction Error
The annual relevant total costs when EOQ is
676 packages is:
RTC = DP Q + QC 2
RTC = (12,844 × Rs97.84 ÷ 676) + (676 × Rs5.50 ÷ 2)
= Rs3,718 total relevant costs

28. Cost of Prediction Error
Step 2: Compute the monetary outcome
from the best action based on the incorrect
amount of the predicted cost input.
EOQ =
= 988 packages

29. Cost of Prediction Error
What are the annual relevant costs using
this order quantity when
D = 12,844 units, P = Rs97.84, and C = Rs5.50?
RTC = (12,844 × Rs97.84 ÷ 988) + (988 × Rs5.50 ÷ 2)
= Rs 3,989 total relevant costs

30. Cost of Prediction Error
Step 3: Compute the difference between
the monetary outcomes from Steps 1 & 2.
Step Rs3,718
Step ,989
Difference Rs (271)
The cost of prediction error is Rs271.

31. Identify and reduce conflicts that can arise between EOQ
Learning Objective 3
Identify and reduce conflicts
that can arise between EOQ
decision model and models used
for performance evaluation.

32. Evaluating Managers and Goal-Congruence Issues
The opportunity cost of investment tied up
in inventory is a key input in the
EOQ decision model.
Some companies now include opportunity
costs as well as actual costs when
evaluating managers.

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34. Just-In-Time Purchasing
Just-in-time (JIT) purchasing is the purchase
of goods or materials such that a delivery
immediately precedes demand or use.
Companies moving toward JIT purchasing
argue that the cost of carrying inventories
(parameter C in the EOQ model) has been
dramatically underestimated in the past.

35. JIT Purchasing and EOQ Model Parameters
The cost of placing a purchase order
(parameter P in the EOQ model) is
also being re-evaluated.
Three factors are causing sizable reduction
in the cost of placing a purchase order (P).
1. Companies increasingly are establishing
long-run purchasing arrangements.

36. JIT Purchasing and EOQ Model Parameters
2. Companies are using electronic links,
such as the Internet, to place purchase orders.
3. Companies are increasing the use of
purchase order cards (similar to consumer
credit cards like Visa and Master Card).

37. Use a supply-chain approach to inventory management.
Learning Objective 4
Use a supply-chain approach
to inventory management.

38. Supply-Chain Analysis
Supply-chain analysis describes the flow
of goods, services, and information from
cradle to grave, regardless of whether
those activities occur in the same
organization or other organizations.
“bullwhip effect” or “whiplash effect”

39. Differentiate materials requirements planning (MRP)
Learning Objective 5
Differentiate materials
requirements planning (MRP)
systems from just-in-time (JIT)
systems for manufacturing.

40. Materials Requirement Planning (MRP)
Materials requirements planning (MRP)
systems take a “push-through” approach
that manufactures finished goods for
inventory on the basis of demand forecasts.
MRP predetermines the necessary outputs
at each stage of production.

41. Materials Requirement Planning (MRP)
Management accountants play key roles in
an MRP system, including...
– maintaining accurate and timely information
pertaining to materials, work in process,
and finished goods, and...
– providing estimates of the setup costs for each
production run, the downtime costs,
and carrying costs of inventory.

42. Identify the features of a just-in-time production system.
Learning Objective 6
Identify the features of a
just-in-time production system.

43. Just-In-Time Production Systems
Just-in-time (JIT) production systems take a
“demand pull” approach in which goods are
only manufactured to satisfy customer orders.

44. Major Features of a JIT System
1. Organizing production in manufacturing cells
2. Hiring and retaining multi-skilled workers
3. Emphasizing total quality management
4. Reducing manufacturing lead time and setup time
5. Building strong supplier relationships

45. Major Features of a JIT System
What information may management accountants use?
Personal observation by production
line workers and managers
Financial performance measures,
such as inventory turnover ratios
Nonfinancial performance measures
of time, inventory, and quality.

46. Learning Objective 7
Use backflush costing.

47. Backflush Costing Backflush costing describes a costing
system that delays recording some or
all of the journal entries relating to the
cycle from purchase of direct materials
to the sale of finished goods.

48. Backflush Costing Where 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.

49. Describe different ways backflush costing can simplify
Learning Objective 8
Describe different ways
backflush costing can simplify
traditional job-costing systems.

50. Trigger Points The term trigger point refers to a stage in a cycle
going from purchase of direct materials to sale
of finished goods at which journal entries are
made in the accounting system.

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52. Trigger Points Stage A: Purchase of direct materials Stage B:
Production resulting
in work in process
Stage C:
Completion of good
units of product
Stage D:
Sale of
finished goods

53. Trigger Points Assume trigger points A, C, and D.
This company would have two inventory accounts:
Type
1. Combined materials
and materials in work
in process inventory
2. Finished goods
Account Title
1. Inventory:
Raw and In-process
Control
2. Finished Goods Control

54. What is the journal entry when trigger point A occurs?
Trigger Points
What is the journal entry when trigger point A occurs?
Inventory: Raw and In-process Control XX
Accounts Payable Control XX
To record direct material purchased during the period

55. Trigger Points What is the journal entry to record conversion costs?
Conversion Costs Control XX
Various accounts XX
To record the incurrence of conversion costs during
the accounting period
Underallocated or overallocated conversion costs
are written off to cost of goods sold.

56. What is the journal entry when trigger point C occurs?
Trigger Points
What is the journal entry when trigger point C occurs?
Finished Goods Control XX
Inventory: Raw and
In-Process Control XX
Conversion Costs Allocated XX
To record the cost of goods completed during the
accounting period

57. What is the journal entry when trigger point D occurs?
Trigger Points
What is the journal entry when trigger point D occurs?
Cost of Goods Sold XX
Finished Goods Control XX
To record the cost of goods sold during the
accounting period

58. Trigger Points Assume trigger points A and D.
This company would have one inventory account:
Type
Combines direct materials
inventory and any direct
materials in work in process
and finished goods inventories
Account Title
Inventory Control

59. Trigger Points What is the journal entry when trigger point A occurs?
Inventory: Raw and In-process Control XX
Accounts Payable Control XX
To record direct material purchased during the period
Same as the A, C, and D example.

60. Trigger Points What is the journal entry to record conversion costs?
Conversion Costs Control XX
Various accounts XX
To record the incurrence of conversion costs during
the accounting period
Same as the A, C, and D example.

61. Trigger Points What is the journal entry to record the
cost of goods completed during the
accounting period (trigger point C)?
No journal entry.

62. What is the journal entry when trigger point D occurs?
Trigger Points
What is the journal entry when trigger point D occurs?
Cost of Goods Sold XX
Inventory Control XX
Conversion Costs Allocated XX
To record the cost of goods sold during the
accounting period

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