Week 11 Tutorial Questions and Answers

Question 1:
Name six cost categories that are important in managing goods for sale in a
retail company.
Solution:
Six cost categories important in managing goods for sale in a retail
organisation are the following:
1. purchasing costs;
2. ordering costs;
3. carrying costs;
4. stockout costs;
5. quality costs; and
6. shrinkage costs.

Question 2:
What assumptions are made when using the simplest version of the
economic-order-quantity (EOQ) decision model?
Solution:
Five assumptions made when using the simplest version of the EOQ model
are:
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 are considered only to the extent that
these costs affect ordering costs or carrying costs.

Question 3:
What are the main features of JIT production?
Solution:
Just-in-time (JIT) production is a ‘demand-pull’ manufacturing system that has
the following features:
 organise 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.
Question 4:
(a)Distinguish inventory-costing systems using sequential tracking from those
using backflush costing.
(b) Describe two different versions of backflush costing.

Answer:
(a) 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.

(b) Versions of backflush costing differ in the number and placement of

trigger points at which journal entries are made in the accounting
system:

Number of Journal Location in Cycle Where

Entry Trigger Journal Entries Made
Points
Version 3 Stage A. Purchase of direct materials
1

Stage C. Completion of good finished units of

product

Stage D. Sale of finished goods

Version 2 Stage C. Completion of good finished units of

2 product

Stage D. Sale of finished goods

In both versions above, there are no journal entries in the accounting system
for work in process (stage B) because JIT production results in minimal work
in process.
Question 5:
Landsborough Lawns Ltd, which produces lawn mowers, purchases 27 500
units of a rotor blade part each year at a cost of $35 per unit. Landsborough
Lawns requires a 13% annual rate of return on investment. In addition, the
relevant carrying cost (for insurance, materials handling, breakage and so on)
is $9.50 per unit per year. The relevant ordering cost per purchase order is
$125.

Required
1. Calculate Landsborough Lawns’ EOQ for the rotor blade part.
2. Calculate Landsborough Lawns’ annual relevant ordering costs for the EOQ
calculated in requirement 1.
3. Calculate Landsborough Lawns’ 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 that there is no need for safety stocks. The purchase order lead time is 1
week. Calculate Landsborough Lawns’ reorder point for the rotor blade part.

Solution:
EOQ for manufacturer
1. Relevant carrying costs per part per year:

Required annual return on investment 13%  $35 = $ 4.55

Relevant insurance, materials handling, breakage, etc.
costs per year 9.50
Relevant carrying costs per part per year $14.05

With D = 27 500; P = $125; C = $14.05, EOQ for manufacturer is:

EOQ=
√ 2 DP
C
=
√2× 27 500 ×125 = 699.52 =700 units
14.05

D 
 P 
2. = 
Q 
27 500
= × $ 125
700
= $4 910.71
where Q = 700 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 = $4 910.71 (from requirement 2). We can also confirm this
with direct calculation:

Q 
 C 
Total relevant carrying costs =  2 

 700 
 $14.05 
= 2 

= $4 917.50
where Q = 700 units, the EOQ. The slight difference is due to rounding
the EOQ from 699.51 to 700.

4. Purchase order lead time is one week.

Demand in a week is 27500 /52 weeks is 529 units (rounded up).

Landsborough Lawns should reorder when the inventory of rotor blades falls
to 529 units.

Question 6:
Harris Hardware Ltd manufactures security screens at its Borallon plant.
Harris Hardware is considering implementing a JIT production system. The
following are the estimated costs and benefits of JIT production. The required
rate of return is 12%.
a. Annual additional tooling costs would be $105 000.
b. Average inventory would decline by 85% from the current level of $750
000.
c. Insurance, space, materials-handling and set-up costs, which currently
total $350 000 annually, would decline by 18%.
d. The emphasis on quality inherent in JIT production would reduce
rework costs by 45%. Harris Hardware currently incurs $150 000 in
annual rework costs.
e. Improved product quality under JIT production would enable Harris
Hardware to raise the price of its product by $4 per unit. Harris
Hardware sells 45 000 units each year.

Required
 1. Calculate the net benefit or cost to Harris Hardware if it adopts
JIT production at the Borallon plant.
2. What non-financial and qualitative factors should Harris
Hardware consider when making the decision to adopt JIT
production?
3. Suppose that Harris Hardware implements JIT production at its
Borallon plant. Give examples of performance measures that
Harris Hardware could use to evaluate and control JIT production.
What would be the benefit of Harris Hardware implementing an
enterprise resource planning (ERP) system?

Solution:
JIT production, relevant benefits, relevant costs
1. Solution Exhibit 17.22 presents the annual net benefit of $282 000 to
Harris Hardware Company of implementing a JIT production system.

Solution Exhibit 17.22

Annual Relevant Costs of Current Production System and JIT Production
System for Harris Hardware Company
Releva
nt
Costs
Relevant
under
Costs
JIT
under
Current Product
Productio ion
Relevant Items n System System

Annual tooling costs –

$105 000
Required return on investment:
12% per year  $750 000 of average
inventory per year $90 000
12% per year  $112 500a of average inventory
per year 13 500
Insurance, space, materials handling, and 350
setup costs 000 287 000
150
Rework costs 000 82 500c
Incremental revenues from higher selling – (180
prices 000
$590
Total net incremental costs 000 $308 000
 Annual difference in favour of JIT production $282 000

a
$750 000  (1 – 0.85) = $112 500

b$350 000  (1 – 0.18) = $287 000

c$150 000  (1 – 0.45) = $82 500

d$4 × 45 000 units = $200 000

2. Other nonfinancial and qualitative factors that Harris 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 standardised 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.

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.

Question 7:

Supply chain effects on total relevant inventory costs

Peach Computer Co. outsources the production of motherboards for its
computers. It is currently deciding which of two suppliers to use: Alpha or
Beta. Due to differences in the product failure rates in the two companies, 5%
of motherboards purchased from Alpha will be inspected and 25% of
motherboards purchased from Beta will be inspected. The following data refer
to costs associated with Alpha and Beta:

Alpha Beta
5
Number of orders per year 50 0
10 10
Annual motherboards demanded 000 000
$1 $10
Price per motherboard 08 5
$ $1
Ordering cost per order 13 0

Inspection cost per unit $6 $6

100 100
Average inventory level units units
10
Expected number of stockouts 0 300
Stockout cost (cost of rush order) per $
stockout 4 $6
Units returned by customers for replacing
motherboards 50 500
Cost of replacing each motherboard $30 $30
 1
Required annual return on investment 0% 10%
Other carrying cost per unit per year $3.50 $3.50

Required
1. What is the relevant cost of purchasing from Alpha and Beta?
2. What factors (other than cost) should Peach consider?

Solution:
Supply chain effects on total relevant inventory costs
1. The relevant costs of purchasing from Alpha and Beta are:

Cost Category Alpha Beta

Purchase costs
10 000 boards × $108 per $1 080 1 050 000
board 000
10 000 boards × $105 per
board
Ordering costs
50 orders × $13 per order 650
50 orders × $10 per order 500
Inspection costs
10 000 boards × 5% × $6 per 3000
board 15 000
10 000 boards × 25% × $6 per
board
Required annual return on
investment
100 boards × $108 per board × 1
10% 080 1 050
100 boards × $105 per board ×
10%
Stockout costs
100 boards × $4 per board 400
300 boards × $6 per board 1 800
Return costs
50 boards × $30 per board 1500
500 boards × $30 per board 15 000
 Other carrying costs
100 boards × $3.50 per board 350 350
per year
100 boards × $3.50 per board
per year
Total Cost $1 086 $1 083 700
980

2. While Beta will save Peach $3 280 ($1 086 980 − $1 083 700 Peach
may still choose to use Alpha for the following reasons:
a. With ten times the number of returns, Beta will probably have a
negative effect on Peach’s reputation.
b. With Beta’s higher stock-outs, Peach’s reputation for availability
and on time delivery will be effected.
c. The increased number of inspections may necessitate the hiring of
additional personnel and the need for additional factory space and
equipment.