1. Just-in-time processing is a philosophy that focuses on reducing time, cost, and poor quality within manufacturing processes. The result of these efforts is a reduction in inventory levels.
2. Move time and wait time in inventory are examples of non-value-added lead time.
3. A product-oriented layout can be designed to minimize materials movements and reduce (or
eliminate) setup time. As a result, a product-oriented layout should have a shorter lead time than a process-oriented layout.
4. Long setup times lead to large production runs (batch sizes) in order to amortize the cost of the setup. Large batch sizes result in larger inventories, which in turn lead to long wait times. Thus, long setup times can lead directly to long lead times.
5. Pull or “make to order” manufacturing requires the manufacturer to build product only as it is needed for actual customer orders. As a result, finished goods, work in process, and materials inventories are minimized. Make to order manufacturing requires a high degree of flexibility and insignificant setup costs.
6. Product defects can cause additional costs and unpredictability in the process in the form of scrap, rework, record keeping, and inspection. In addition, product defects can cause a process to shut down, because there is very little work in process inventory to keep the next (downstream) operations running. Thus, a just-in-time manufacturer would wish to eliminate the negative consequences of product defects.
7. With supply chain management, long-term relationships are established with suppliers and customers to improve quality, cost, and delivery. Traditional relationships are usually focused on reducing price through supplier or customer competitive bidding. Thus, the traditional supplier and customer relationship can be very short-term oriented (until a better “deal” comes along).
8. A just-in-time environment will result in fewer (or no) work in process control points. As a result, there are no in-process transactions into and out of work in process inventory locations throughout the process. The just-in-time cost accounting system, termed backflush accounting, “pulls” cost from completed production, rather than “pushes” through the plant, using materials requisitions or production orders.
9. The raw and in process inventory account combines the materials and work in process
inventories because the materials are often introduced directly into the process. Thus, the materials are not recorded in a separate materials account before being introduced to work in process because there is no materials inventory.
DISCUSSION QUESTIONS
10. Direct labor and indirect labor activities become combined in a just-in-time environment. Employees perform both direct and indirect labor tasks. In addition, direct labor can be a small part of the cost of producing product. As such, the direct labor is included as overall conversion cost (much like in a process cost system).
11. A Pareto chart shows the totals of a particular attribute for a number of categories. The categories are ranked and displayed left to right, so that the largest total is on the left and the smallest total is on the right. In this way, management can quickly identify important problems.
12. Non-value-added activities are activities that are viewed as unnecessary from the customer’s perspective. These activities are generally considered wasteful and are candidates for elimination through process improvements.
13. The cost of a process can be improved by improving processing methods or eliminating
PE 27–1A (FIN MAN); PE 12–1A (MAN)
a. Value-added lead time……… 28 min. (16 min. + 12 min.)
Non-value-added lead time:
Total within-batch wait time……… 1,092 (16 min. + 12 min.) × (40 – 1)
Move time……… 15
Total lead time……… 1,135 min.
28 min. 1,135 min.
PE 27–1B (FIN MAN); PE 12–1B (MAN)
a. Value-added lead time……… 19 min. (11 min. + 8 min.)
Non-value-added lead time:
Total within-batch wait time……… 1,881 (11 min. + 8 min.) × (100 – 1)
Move time……… 15
Total lead time……… 1,915 min.
19 min. 1,915 min.
PE 27–2A (FIN MAN); PE 12–2A (MAN)
b. Smaller batch sizes
c. Employee involvement
d. Less wasted movement of material and people
PE 27–2B (FIN MAN); PE 12–2B (MAN)
a. Production pace matches demand
d. Receive raw materials directly to manufacturing cells
b. Value-added ratio: = 1.0%
Value-added ratio:
a. Raw and In Process Inventory* 175,500
Accounts Payable 175,500
*$270 per unit × 650 units
b. Raw and In Process Inventory* 70,560
Conversion Costs 70,560
*[($819,000 ÷ 1,950 hours) × (16 min. ÷ 60 min.)] = $112 per unit; $112 × 630 units = $70,560
c. Finished Goods Inventory* 238,750
Raw and In Process Inventory 238,750
*($270 + $112) × 625 units
PE 27–3B (FIN MAN); PE 12–3B (MAN)
a. Raw and In Process Inventory* 68,250
Accounts Payable 68,250
*$65 per unit × 1,050 units
b. Raw and In Process Inventory* 12,000
Conversion Costs 12,000
*[($144,000 ÷ 1,800 hours) × (9 min. ÷ 60 min.)] = $12 per unit; $12 × 1,000 units = $12,000
c. Finished Goods Inventory* 75,460
Raw and In Process Inventory 75,460
Quality Cost Prevention……… $126,000 63% 12.6% Appraisal……… 30,000 15% 3.0% Internal failure……… 28,000 14% 2.8% External failure……… 16,000 8% 1.6% Total……… $200,000 100% 20.0%
PE 27–4B (FIN MAN); PE 12–4B (MAN)
Quality Cost Prevention……… $288,000 32% 9.6% Appraisal……… 108,000 12% 3.6% Internal failure……… 54,000 6% 1.8% External failure……… 450,000 50% 15.0% Total……… $900,000 100% 30.0%
PE 27–5A (FIN MAN); PE 12–5A (MAN)
Inspection activity before improvement: $360,000 ÷ 60,000 units = $6 per unit
Inspection activity after improvement:
Revised inspection cost……… (30% × 60,000 units) × $6 per unit = $108,000
Revised inspection cost per unit……… $108,000 ÷ 60,000 units = $1.80 per unit
PE 27–5B (FIN MAN); PE 12–5B (MAN)
Inspection activity before improvement: $68,000 ÷ 16,000 units = $4.25 per unit
Inspection activity after improvement:
Revised inspection cost……… 3,200 inspections × $4.25 per unit = $13,600
Revised inspection cost per unit……… $13,600 ÷ 16,000 units = $0.85 per unit
Quality Cost Classification Cost Sales
Sales
Total Quality Total
Cost of Quality Report
Cost of Quality Report
Percent of Percent of Percent of
Total Quality Cost Classification
Percent of Total Quality
Ex. 27–1 (FIN MAN); Ex. 12–1 (MAN)
The CEO must not have been listening very closely at the conference. Just-in-time is
not primarily an inventory reduction method. Just-in-time is a process improvement
philosophy that focuses on reducing time, cost, poor quality, and uncertainty from a process. Large inventories are merely a symptom of poorly designed processes. Thus, the CEO’s statement is naive. The company must first remove the reasons for inventory. These causes are poor quality, large setup times, unreliable equipment, poor employee relationships, poor layout design (process focus), and poor supplier relationships. When these are improved, then the inventory level can be reduced, lead times can be
shortened, and the company can begin pull manufacturing. If the employees follow the CEO’s orders without making the process improvements, the plant will likely suffer reduced productivity.
In addition, the CEO has not provided the training or action plan for moving to just-in-time. The CEO has only commanded that it be done. This will create anxiety in the workforce, and it is not consistent with employee involvement.
Ex. 27–2 (FIN MAN); Ex. 12–2 (MAN)
This is an actual situation facing the U.S. apparel industry. Warren Featherbone and
other U.S.-based apparel manufacturers are discovering the strategic power of just-in-time. Rather than competing with the offshore manufacturers on price, these companies are providing smaller quantities with much faster delivery. The retailer is able to order and receive goods in smaller, more frequent batch sizes. As a result, the retailer is able to move with fashion trends much more quickly. For example, if a particular style is proving popular, the domestic manufacturer can immediately produce and deliver more of this item. The offshore operation manufactures in batch sizes that are too large and too far away to respond quickly. In addition, the retailer does not have to commit significant inventory to unknown fashion trends when purchasing from the local company. As a result, the retailer is able to avoid markdowns on slow-moving goods. Markdowns represent the second largest cost to retailing operations (next to cost of merchandise sold). The retailer must make large order commitments to the offshore manufacturer. If the product eventually proves to be disappointing in the market, the retailer has no choice but to incur severe markdowns to move the excess inventory. Because of significant benefits, the retailer will be willing to pay a higher cost for manufactured
Piecework compensation is a characteristic of a traditional manufacturing philosophy that is inconsistent with just-in-time. Under just-in-time, workers are viewed not just as laborers but as valuable assets of the company. The company wants workers to also bring their minds to the job. Thus, workers should be compensated for contributing to process improvements, for training themselves to work other jobs in the cell, and for managing themselves. This might involve an hourly rate system plus bonus incentives. Piecework payments would not pay workers for these contributions because the pay arrangement is a very simple “produce for pay” arrangement. Moreover, piecework encourages
workers to make product, regardless of whether there is demand for the product. Workers do not get paid for idle time, so they will continue to work and build inventory. However, under pull manufacturing, the cell will work only if there is demand. If there is no demand, the cell employees should work in other cells or work on improving themselves or the process. Piecework compensation is very inconsistent with this philosophy. Employees should not be penalized just because the cell is operating at a slower pace (or is shut down) due to decreases in demand. The employee has no control over the demand placed on the cell.
Management does not need to be concerned about proper motivation to work. Under pull manufacturing, the garment will be pulled through the cell. A slow employee will slow the whole output of the cell. The other employees will either help the slow employee or encourage the employee to catch up with the pace of the cell.
Ex. 27–4 (FIN MAN); Ex. 12–4 (MAN)
Management is incorrect in stating that the direct labor time is equal to the lead time. The lead time also includes the wait time and other non-value-added time required to make the product. The different batch sizes create within-batch wait time for each unit. Thus, the lion, which is made in batch sizes of 40 units, has assembly lead time of 480 minutes (40 units × 12 minutes per unit). Of this amount, only 12 minutes are value-added. The remaining 468 minutes (39 units × 12 min.) are non-value-added within-lot wait time. The bear has assembly lead time of 60 minutes (5 units × 12 minutes per unit). Of this amount, 12 minutes are value-added. The remaining 48 minutes (4 units × 12 min.) are non-value-added within-lot wait time.
a. Long setup times have two negative consequences. First, a long setup time consumes valuable machine capacity that could be used for productive purposes. Second, a long setup time results in large production batch sizes to recover the economic cost of the setup. As a result, a long setup will result in a large production batch, which increases work in process inventory, which increases lead time. Large work in process inventory commits working capital that could be used for other purposes. Long lead times reduce the company’s ability to respond to changes in customer demand.
b. One obvious improvement would be to limit the trips to the tool room to one
round trip, rather than two. However, even this could be improved upon by changing the location of the fixtures. Changing the location of the fixtures could significantly reduce the lathe setup time. Instead of using a tool room to control the fixtures, the appropriate fixtures for the lathe could be located at the lathe operation. In this case, the operator would not need to walk to a tool room and retrieve and replace fixtures (along with paperwork). Rather, the operator would have the tools required for a setup right at the lathe location. In this situation, the company would trade off somewhat less control over fixtures for faster setup time. Many companies are eliminating tool rooms for just this reason. These companies are finding that tool room control is not necessary if tools are stored at a designated location near the point of use (i.e., they won’t be lost or stolen if they have a visible storage point). An intermediate solution is to retain the tool room and have the operator make only one trip to the tool room to return the old fixture and retrieve the new one.
c. Turn off machine and remove fixture from lathe………… 10 minutes
Clean lathe……… 15 Install new fixture and turn on machine……… 10
Total setup time……… 35 minutes* * Plus time for replacing and retrieving a tool at a point of use.
Value-Added Non-Value- Total
Time Added Time Time
Processing time……… 14 14
Within-batch wait time……… 616 616
Move time……… __ 5 5
Total……… 14 621 635
14 minutes 635 minutes
1Total process time per unit:
Milling……… 6 minutes
Finishing……… 8
Total……… 14 minutes
2Within-batch wait time:
Multiply the process time by the remaining units in the batch (waiting their turn)
14 minutes × (45 – 1 units) = 616 minutes
Value-Added Non-Value- Total
Time Added Time Time
Processing time……… 14 14
Within-batch wait time……… 42 42
Move time……… __ 0 0
Total……… 14 42 56
14 minutes 56 minutes
1Total process time per unit:
Milling……… 6 minutes
Finishing……… 8
Total……… 14 minutes
2Within-batch wait time:
Multiply the process time by the remaining units in the batch (waiting their turn)
14 minutes × (4 – 1 units) = 42 minutes
Traditional Philosophy
=
Value-added ratio: 2.2%, rounded
Just-in-Time Philosophy Value-added ratio: = 25.0% 1 2 1 2
Value-Added Non-Value- Total
Time Added Time Time
Processing time……… 30 30
Within-batch wait time……… 1,170 1,170
Move time……… __ 40 40
Total……… 30 1,210 1,240
30 minutes 1,240 minutes
1Total process time per unit:
Process Step 1……… 6 minutes Process Step 2……… 10
Process Step 3……… 6
Process Step 4……… 8
Total……… 30 minutes
2Within-batch wait time:
Multiply the process time by the remaining units in the batch (waiting their turn): 30 minutes × (40 – 1 units) = 1,170 minutes
3Move time:
5 moves (from raw materials to finished goods) × 8 minutes = 40 minutes
Value-Added Non-Value- Total
Time Added Time Time
Processing time……… 30 30
Within-batch wait time……… 120 120
Move time……… __ 10 10
Total……… 30 130 160
30 minutes 160 minutes
1Total process time per unit:
Process Step 1……… 6 minutes
Process Step 2……… 10
Proposed Approach
Value-added ratio: = 18.8%, rounded
Present Approach
=
Value-added ratio: 2.4%, rounded
1 2 1 2 3 3
a. and b.
Elapsed Time (a)
1:00 PM Arrives at doctor office
1:30 Waits in waiting room (5 × 6 min.) 30 min.
1:45 Waits in examining room 15
1:55 Nurse takes readings 10 min.
2:15 Waits in examining room 20
2:30 Doctor performs diagnosis 15
2:40 Waits to pay for services 10
2:45 Walks to pharmacy 5
3:15 Waits to fill prescription (6 × 5 min.) 30
3:20 Prescription is filled 5
3:35 Drives home 15
Total 50 min. 105 min.
Edwards arrives home at 3:35 p.m.
b. Of the total elapsed time of 155 minutes, 105 minutes is non-value-added time.
Value-Added Lead Time Total Lead Time
d. The doctor requires patients to wait in order to increase the productivity of the office.
The patients represent the “work in process inventory” of the office, while the
physician and nurses are the critical productive resources. The clinical staff remains productive because there is always a supply of patients to serve. The physician never loses productive minutes providing patient care by waiting for a patient. Unfortunately, the physician’s productivity comes at the cost of the patient. The patients must wait for the nurse and physician before being served.
Additional causes of patient waiting are due to variation in the patient service delivery process. If there are uncertainties or variation in service requirements, such as some patients needing more time with the doctor and others needing less, then the amount of “work in process” will tend to increase in order to buffer the “throughput” of the office. Likewise, doctors being called out for emergencies causes disruption in the patient flow in the office.
(50 min. + 105 min.) 50 min. = 32% Non-Value-Added Time Value-Added Time (b) Value-Added Ratio = c. = Activity
a. The Japanese supply chain model is one based on long-term arrangements and partnership. The Japanese automobile manufacturers want their
suppliers to be financially healthy because they rely on them for innovation. The Big Three automakers, in contrast, are only concerned about getting the best short-term price from their suppliers. The article seems to imply that the longer-term benefits from partnership are being ignored by the Big Three. As a result, they are willing to view their supplier relationships as
temporary―until the next best price comes along.
b. These suppliers support the Japanese system because it provides for
win-win opportunities, whereby the customer and the supplier can both be successful. The suppliers are concerned about their margins being squeezed down to the point that they will be unable to maintain financial viability and/or provide the level of supplier service that will be demanded in the long-term under the conventional Big Three supplier model. Suppliers are also concerned about the uncertainty of temporary or short-term
contracts. Such demand volatility can add risk and cost to the supplier’s business over time.
c. Supply chain management is often beneficial to the customer. However, the
customer may have to trade off between short-term and longer-term benefits. For example, supply chain management provides the supplier the financial incentives to invest in process and product innovation, invest in supply chain collaboration (such as EDI, RFID, and Internet collaboration), and to share best practices, such as just-in-time principles, across business entities. Such investments provide the customer access to new technologies, new ideas, more efficient processes, and ultimately lower costs and higher value for all parties involved in the supply chain.
Quickie’s team approaches are very different from using a manager to hire and evaluate employees. First, the input of many individuals goes into the hiring decision. In this way, the viewpoints of a variety of people are brought into the decision. Moreover, the new hire needs to “fit” with the culture of the team. Team-based hiring can produce a higher probability of having an effective team member by having a good fit. A possible concern is the team hiring only people that are like themselves. The peer evaluation may be more effective than the supervisor evaluation, since the team may be more familiar with the team member’s input to the goals of the team. In addition, it will be difficult to hide unwanted behavior from the team. Team members work with each other every day and may best be able to evaluate performance. A concern would arise if the team members are not trained in making evaluations. The process should be helpful and not threatening to the employee.
Team-based evaluation practices increase employee involvement. Employees have input into decisions that affect the team, rather than having these decisions handed down to them. This should increase the amount of empowerment and job satisfaction enjoyed by the team members.
Ex. 27–11 (FIN MAN); Ex. 12–11 (MAN)
Shield Insurance Company should adopt just-in-time principles in its claims payment operations. Management should first consider changing the layout for this process. Instead of processing the claims payments through three different departments that are organized by process, the company could design claims payment “cells” that are organized around different types of insurance
products or customers. For example, a cell could be created for all marine insurance. The cell would have data input, claims audit, and claims adjustment personnel all located together (co-located) to process marine insurance claims. This would reduce the move time between the departments considerably. In addition, the claims batches should be reduced. If the claims were processed one or two at a time in a product-focused cell, then payments might be possible on the same day that the claim is submitted, rather than 10 days later. Thus, as claims came into the cell, they would be worked on. This would be an example of “pull manufacturing (scheduling).” The cell is activated by work (demand for claim payments). The work is “pulled” through each process step in the cell until a check is delivered to the insurance customer. Claims payment software can also aid the process by transmitting claim information on electronic forms over an Intranet, rather than using paper forms.
Note to Instructors: Insurance companies, such as Aetna and Mutual Benefit
Life, are actually employing just-in-time principles in their claims payment and insurance application processes.
a. The present Grill Rite service delivery system is an example of a push system. Special orders are “pushed” through the system. The order is placed at the beginning of the process and the hamburger is cooked, dressed, and then delivered to the “inventory” of finished hamburgers placed under the hot lamps. Customers are sold burgers from this finished goods inventory. Under this system, the customer wait time would be small only if the customer ordered a “standard” burger from the inventory. If the customer placed a special order, then he or she would have to wait for the complete cook and dress cycle to be completed.
b. A new system could be designed so that a custom order is introduced after cooking
the burger, rather than prior to cooking. In this way, hamburgers are made to order without the use of finished goods inventory. Under this process, assume a customer ordered a hamburger with ketchup and pickles only. The order would be received at the dressing station. Here, a food preparer would take a hamburger off the grill and place ketchup and pickles on the burger using materials at the dressing station (termed point-of-use materials). The hamburger that is pulled from the grill would create a signal (the space on the grill) for a new hamburger to be placed on the grill. In this way, hamburgers that are cooking do not have orders assigned to them. Rather, they are available to be pulled by the food preparer to satisfy customer orders. Under this system, the lead time for cooking the hamburger is eliminated from the customer wait time. The customer has only to wait for the burger to be dressed. The
attractiveness of this approach is that customers can have the burgers “their way” without using finished goods inventory to provide fast response.
A variation on this answer is to have plain hamburgers pulled directly off the grill by the customer order (as above) but place the dressing stations among the customers (similar to Fuddruckers). In this way, the customers dress their own burgers after purchasing them.
Note to Instructors: You may recognize that the first system described in this exercise is
similar to the method invented by McDonald’s, while Wendy’s used the second method. McDonald’s recently indicated that it was switching its method to work more like Wendy’s because of its superior service characteristics. You might also note that Dell’s
manufacturing strategy is very similar to Wendy’s. It produces computers to order using pull signals. This allows Dell to build the computer to a user specification yet still deliver it within a matter of days.
The production manager probably has some good points. If the accounting system does not change when an organization embraces a just-in-time strategy, then there will likely be complaints. A conventional accounting system needs to have a strong accounting control orientation. Under just-in-time, the accounting system can be designed with much wider transaction control intervals. The company could have a very wide
transaction interval—such as between purchased parts transacted in and finished goods transacted out. Thus, many transactions into and out of intermediate work in process inventory locations would not be needed. In addition, a raw and in process inventory
account would allow the company to eliminate separate raw materials release transactions. Eliminating accounting controls would be foolhardy unless the company has strong visible controls. Otherwise, there is simply too much room for waste and very large unexplained cost variances. Under just-in-time, visible controls such as the amount of inventory, production line stoppages, statistical control charts, or emergency lights replace accounting controls.
The direct labor reporting can be eliminated. Under JIT accounting, the direct labor employees are assigned to production cells. Their wages are treated as part of the cell’s conversion costs and are not separately traced or reported. The traditional financial measures should be supplemented with nonfinancial measures, such as schedule attainment, lead time, quality, machine uptime (availability), safety, and setup time. The nonfinancial measures can be collected and reported immediately without the need for additional effort to translate the numbers into financial terms. In addition, cost of quality or value-added/non-value-added activity analyses can provide financial information that can be used by the production department manager.
$550,000 2,000 hours
12 minutes 60 minutes = $55 per unit
c. 1. Raw and In Process Inventory*
Accounts Payable 128,000
*800 units × $160 per unit
2. Raw and In Process Inventory*
Conversion Costs 44,000
*800 units × $55 per unit
3. Finished Goods Inventory*
Raw and In Process Inventory 172,000
*800 units × ($160 + $55) = $172,000
4. Accounts Receivable*
Sales 249,600
*$780 units × $320 per unit
Cost of Goods Sold*
Finished Goods Inventory 167,700
*780 units × ($160 + $55)
167,700 249,600 $275 per hour
b. Budgeted Cell Conversion
Cost per Unit = × $275 per hour
a. Budgeted Cell Conversion
Cost Rate = =
172,000 128,000
$168,000 2,100 hours
12 minutes 60 minutes = $16 per unit
c. 1. Raw and In Process Inventory*
Accounts Payable 31,500
*900 units × $35 per unit
2. Raw and In Process Inventory*
Conversion Costs 14,400
*900 units × $16 per unit
3. Finished Goods Inventory*
Raw and In Process Inventory 44,880
*880 units × ($35 + $16)
4. Accounts Receivable*
Sales 90,300
*860 units × $105 per unit
Cost of Goods Sold*
Finished Goods Inventory 43,860
*860 units × ($35 + $16)
43,860 90,300 $80 per hour
b. Budgeted Cell Conversion
Cost per Unit = × $80 per hour
a. Budgeted Cell Conversion
Cost Rate = =
44,880 31,500
a. 1. Raw and In Process Inventory* 80,600
Accounts Payable 80,600
*620 units × $130 per unit
2. Raw and In Process Inventory* 66,000
Conversion Costs 66,000
*[($66,000 ÷ 200 hours) × (20 min. ÷ 60 min.)]
= $110 per unit; $110 per unit × 600 units = $66,000
3. Finished Goods Inventory* 141,600
Raw and In Process Inventory 141,600
*($130 + $110) × 590 units
4. Sales* 244,375
Accounts Receivable 244,375
*$425 per unit × 575 units
Cost of Goods Sold* 138,000
Finished Goods Inventory 138,000
*($130 + $110) × 575 units
b. Raw and In Process Inventory, ending balance1………$5,000
Finished Goods Inventory, ending balance2………$3,600
1
$80,600 + $66,000 – $141,600, or
Materials [130 per unit × (620 units – 600 units)]……… $2,600 Production [($130 + $110) × (600 units – 590 units)]……… 2,400 Total……… $5,000
2$141,600 − $138,000 = $3,600, or
Pareto Chart of Quality Activities
0 50000 100000 150000 200000 250000 War ranty cl aim s Corre ct sh ipme nt e rrors Disp osing scr ap Fina l insp ection Proce ssing custo mer r eturn s Emer gency equip men t main tena nce Emplo yee tr aining Scra p re portin g Inspe cting inco ming ma teria ls Preve ntive equ ipm ent m ainte nance Supp lier de velop men t D o llarsa. Quality Cost Prevention $ 72,000 9% 1.8% Appraisal 120,000 15% 3.0% Internal failure 208,000 26% 5.2% External failure 400,000 50% 10.0% Total $800,000 100% 20.0% 1 $72,000 ÷ $800,000 2$72,000 ÷ $4,000,000
The following classifications were used to develop the cost of quality report:
Quality Activities
Correct shipment errors……… Disposing of scrap……… Emergency equipment maintenance……… Employee training……… Final inspection……… Inspecting incoming materials……… Preventive equipment maintenance……… Processing customer returns……… Scrap reporting……… Supplier development……… Warranty claims……… Total………
b. The majority of the company’s quality efforts are in correcting quality problems.
This is evident by the high percentage of quality costs associated with internal and external failure (76% of total quality costs). The highest cost activities are warranty claims, which indicates significant field failures for the product. Emergency
Quality Cost Activity Cost Classification
Percent of Total Sales Quality Cost Classification
ACTIVE MEMORIES INC. Cost of Quality Report
Cost Summary Internal failure 80,000 40,000 Percent of Total Quality Cost $120,000 88,000 80,000 40,000 80,000 40,000 16,000 Appraisal Appraisal Prevention External failure $800,000 200,000 External failure Internal failure Internal failure Prevention External failure 16,000 Prevention 2 1
Pareto Chart of Quality Activities
0 20,000 40,000 60,000 80,000 100,000 120,000 140,000 Replace old technology cable with higher quality cable Replace old technology signal switches with higher quality switches Cable signal testing Re-install service (installed incorrectly the first time) Billing error correction Train employees Repair satellite equipment Respond to customer home repair requests Repair underground cable connections DollarsDiscussion in 2pp
ends with JR
agreeing that "ing"
ending should be
added to all
instances
highlighted.
Maintains
consistency with
text exercise.
Please revise.
a. Prevention $260,000 52% 13.0% Appraisal 70,000 14% 3.5% Internal failure 30,000 6% 1.5% External failure 140,000 28% 7.0% Total $500,000 100% 25.0% 1$260,000 ÷ 500,000 2$260,000 ÷ $2,000,000 b. Value-added 66% Non-value-added 34% Total 100%
The following classifications were used to develop the reports:
Activity Cost
Billing error correction……… $ 50,000
Cable signal testing……… 70,000
Reinstalling service (installed
incorrectly the first time)……… 55,000
Repairing satellite equipment………… 30,000
Repairing underground cable
connections to the customer……… 15,000
Replacing old technology cable
with higher quality cable……… 120,000
Replacing old technology signal
Quality Cost Non-value-added Value-added Value-added Non-value-added Non-value-added DIGITAL LIGHT INC.
Cost of Quality Report
Cost Summary Percent of External failure* Prevention Non-value-added Internal failure VA/NVA Category
Value-Added/Non-Value-Added Activity Analysis
Quality Cost Classification
Amount
DIGITAL LIGHT INC.
Quality Activities External failure Appraisal External failure Classification Percent of Total Sales 170,000 $500,000 Percent Quality Cost Total Quality Cost $330,000 2 1
c. The reports indicate that Digital Light Inc.’s total costs of quality are 25% of total sales. In addition, 52% of the activity cost goes toward prevention activities. As a result, Digital Light is able to avoid high internal and external failure activities. Only 34% of the activities are non-value-added, compared to 66% that are value-added.
Although there is some room for improvement, the company appears to be effectively managing its quality activities.
b. In this improvement scenario there will 237,000 (300,000 – 63,000) additional cans processed through the packaging operation. The same number of cans still will be processed by the mixing and filling activities.
Additional cost to packaging activity from improved process:
Packaging activity cost per can1………
×Number of additional cans from
improvement effort……… cans
Additional packaging activity cost………
1
c. Expected activity cost per can after improvement:
The activity cost per can of the new process is improved because the number of cans completed through the mixing and filling process increased by 237,000 cans at a small additional cost of $4,740 in the packaging activity. The mixing and filling activity costs do not change because the improvement only impacts the number of cans processed after the filling activity, not prior to this activity. This solution simplifies by assuming the refrigeration did not require additional activity cost. While not analyzed in this exercise, there are additional savings from less waste of materials from fewer kicks.
a. Activity Cost per Can =
$600,000 + $4,740 =
Activity Cost per Can =
$0.020 per can
Activity Cost per Can =
Number of Completed Cans Activity Cost per Can
6,000,000 cans
Packaging Activity Cost per Can =
Packaging Activity Cost Number of Completed Cans
=
Packaging Activity Cost per Can =
$120,000 6,000,000 cans = $ 4,740 Activity Cost $600,000 $0.10 per can $0.097 per can 6,237,000 cans 237,000 $ 0.020 Activity Cost
Number of Completed Cans
a. Cost Receiving claim……… $ 80,000 20% Adjusting claim……… 240,000 60% Paying claim……… 80,000 20% Total……… $400,000 100%
The “adjusting claim” activity is the most significant activity in this process.
b. Average process cost per paid claim:
$400,000 4,000 claims
c. Activity Cost Activity Cost
Prior to After
Activity Improvement Improvement
Receiving claim……… $ 80,000 $ 92,000 Adjusting claim……… 240,000 72,000 Paying claim……… 80,000 80,000 Total……… $400,000 $244,000 * $80,000 × 115% **$240,000 × (100% – 70%)
Note: Sometimes an activity cost within a process will need to increase in order
to realize additional benefits in another part of a process, as illustrated here.
d. Average process cost per paid claim:
$244,000 4,000 claims
Percent of
= $100 per paid claim
Activity Total Process
$156,000
= $61 per paid claim
Activity Cost (Cost) Savings $ (12,000) 168,000 0 * **
a.
Cost
Preparing materials request……… $ 36,000 9%
Requesting, receiving, and selecting
vendor bids……… 100,000 25%
Preparing purchase order……… 20,000 5%
Preparing receiving ticket……… 24,000 6%
Matching M/R, R/T, and invoice……… 48,000 12%
Correcting reconciliation differences……… 140,000 35%
Preparing and delivering vendor payment……… 32,000 8%
Total process activity cost……… $400,000 100%
“Requesting, receiving, and selecting vendor bids” and “correcting reconciliation differences” total 60% of the total process cost. This indicates that these two activities are good candidates for improvement efforts.
b. Average process cost per payment:
$400,000 20,000 payments
c. Activity Cost Activity Cost
Prior to After
Activity Improvement Improvement
Preparing materials request……… $ 36,000 $ 36,000
Requesting, receiving, and
selecting vendor bids……… 100,000 25,000
Preparing purchase order……… 20,000 20,000
Preparing receiving ticket……… 24,000 24,000
Matching M/R, R/T, and invoice………… 48,000 48,000
Correcting reconciliation
differences……… 140,000 35,000
Preparing and delivering
vendor payment……… 32,000 32,000
Total process activity cost……… $400,000 $220,000
* $100,000 × (100% – 75%) ** $180,000 Savings Activity Cost $ — — 75,000 — Percent of = $20 per payment
Activity Total Process
— — 105,000 * ** —
Prob. 27–1A (FIN MAN); Prob. 12–1A (MAN)
1. Brite Lite’s purchasing policy is very short-sighted. It does not involve developing
partnerships with suppliers. Brite Lite should consider changing its arm’s length policy and work on building a long-term supply chain strategy with its suppliers. With a supply chain strategy, Brite Lite can begin to consider more than just the price of its glass. It can work with the supplier on quality, responsive delivery, electronic data interchange invoicing, supplier raw materials logistical support, sharing of research and development efforts, and sharing of production schedules, to name a few. The arm’s length approach is more costly in the long run, even if it squeezes the last penny out of each supplier. The arm’s length approach reduces the possibility of working on issues that go across organizational boundaries (such as electronic data interchange, sharing demand forecasts, or more frequent just-in-time deliveries), which hold the promise of reducing the total delivered cost.
2. The hidden costs beyond the price include the costs associated with the higher
inventory required by Mid-State’s delivery schedule. These inventory costs include additional space, handling, obsolescence, financing, and materials management costs. These costs were not considered because they are not obvious. They are also difficult to determine. The price is obvious, so it is easy to build a purchasing policy around “getting the best price.” This policy ignores the additional internal costs of the higher inventory imposed by Mid-State’s delivery schedule. These are costs incurred by other parts of the organization, not purchasing. In a functional organization, purchasing would respond by saying that the additional internal inventory costs are not its problem. Those are costs incurred in another manager’s responsibility center. Of course, this is part of the problem of such simple “low-price bid” policies.
3. If the financing costs are 10%, then the additional cost of the inventory could be
determined as follows:
At the beginning of July, the new shipment of 45,000 pounds arrives. Assuming that the glass supply runs out by the end of the quarter, the average inventory for the quarter is:
Beginning of July……… 45,000
End of September……… 0
Total……… 45,000 2 Average pounds in inventory for the quarter……… 22,500
The inventory carrying cost can be estimated as follows:
Average pounds in inventory for the quarter……… 22,500
×Price per pound……… $28
Total inventory investment……… $630,000
Interest rate per quarter (10% ÷ 4)……… 2.5%
Inventory financing cost per quarter……… $ 15,750
Inventory financing cost per quarter……… $ 15,750
÷Number of pounds ordered for the quarter……… 45,000 lbs.
Additional cost per pound (rounded)……… $ 0.35 /lb.
The financing cost is 2.5% of the average quarterly inventory value, or $15,750 per
quarter. This translates into an additional 35¢ per pound ($15,750 ÷ 45,000 lbs.) purchased during the quarter. Thus, just considering the financing cost by itself makes Cleveland Glass the “real” low-cost bidder.
Note to Instructors: As a point of comparison, the financing cost for Cleveland Glass’
daily deliveries is less than a cent per pound ($14,100 × 2.5% = $352.50; $352.50 ÷
45,000 lbs. = $0.0078), because the average daily inventory investment would be only $14,100 [500 lbs. × $28.2]. (This calculation would be half this amount if it was assumed the average daily inventory was half the daily shipment, or 250 pounds [500 pounds per day ÷2]).
1. Value-added time:
Assembly of PC board……… 5 min.
Stereo assembly……… 18
Time to inspect one unit……… 9
Pack and label……… 8
Total……… 40 min.
Non-value-added time: Wait time:
Within-batch wait time—PC board assembly
(59 × 5 min.)……… 295 min.
Within-batch wait time—final assembly
(59 × 18 min.)……… 1,062
Within-batch wait time—testing (59 × 9 min.)……… 531
Within-batch wait time—shipping (59 × 8 min.)……… 472
Test setup……… 30
Total wait time……… 2,390 min. Move time:
Move from PC board assembly to final assembly……… 10 min.
Move from final assembly to testing……… 20
Total move time……… 30
Total non-value-added time……… 2,420 min.
Total lead time (40 min. + 2,420 min.)……… 2,460 min.
40 min. 2,460 min.
2. The existing process is very wasteful. The company could improve the process by
changing the layout from a process orientation to a product orientation. Each stereo model could be formed into a production cell. Each cell would have PC board assembly, final assembly, and testing next to each other. In this way, the batch sizes could be reduced significantly. Workers could practice one-at-a-time processing and merely pass a single completed assembly through the cell. The work content would need to be made more balanced before implementing this solution. As a result, the move time and within-batch wait time would be eliminated. The company could also initiate total quality principles. Moving toward zero defects would allow the company to reduce testing activities (and time), and as a result, the setup time for the test area might be eliminated or reduced.
Value-Added Ratio = Value-Added Lead Time
Total Lead Time
$756,000 2,400 hours
= $105 per unit
3. a. Raw and In Process Inventory*
Accounts Payable 730,000
*7,300 units × $100 per unit
b. Raw and In Process Inventory*
Conversion Costs 756,000
*7,200 units × $105 per unit
c. Finished Goods Inventory*
Raw and In Process Inventory 1,465,750
*7,150 units × ($100 + $105)
d. Accounts Receivable*
Sales 2,800,000
*7,000 units × $400 per unit
Cost of Goods Sold*
Finished Goods Inventory 1,435,000
*7,000 units × ($100 + $105)
4. Raw and In Process Inventory:
$730,000 + $756,000 – $1,465,750 = $20,250 Finished Goods Inventory:
$1,465,750 – $1,435,000 = $30,750 or (7,150 units – 7,000 units) × ($100 + $105) = $30,750 1,435,000 2,800,000 $315 per hour
2. Budgeted Cell Conversion
Cost per Unit =
1. Budgeted Cell Conversion
Cost Rate = =
$315 per hr. × (20 min. ÷ 60 min.)
730,000
756,000
5. JIT accounting is different from traditional accounting in a number of respects. Most importantly, JIT accounting is simplified and uses minimal control. As a result, the number of transactions are reduced, and the control intervals between adjacent work in process transaction points are widened. In many JIT operations, there are no separate materials or work in process inventories. Rather, purchased materials are charged to an account that combines raw materials and work in process, termed the “raw and in process inventory” account. Direct labor is frequently eliminated as a cost category and is instead included as a conversion cost of the cell. The cell conversion cost is applied to the raw and in process inventory account. Indirect labor can frequently be assigned to a production cell. As a result, these costs do not need to be allocated, since they are included directly in the cell’s conversion cost. Often, nonfinancial performance measures, such as lead time or quality measures, are used to monitor performance.
Prob. 27–4A (FIN MAN); Prob. 12–4A (MAN) 1.
Pareto Chart-Quality Activities
10000 20000 30000 40000 50000 60000 70000 80000 90000 Dollars
The following classifications are used in answering (2) and (3):
Activity Cost
Correcting errors identified
by election commission………… $ 84,000
Correcting jams……… 66,000
Correcting scan errors……… 33,000
Loading……… 15,000
Logging-in control codes
(for later reconciliation)………… 12,000
Program scanner……… 21,000
Rerunning job due to scan
reading errors……… 18,000
Scanning……… 30,000
Verifying scan accuracy via
reconciling totals……… 12,000
Verifying scanner accuracy
with test run……… 9,000
Total……… $300,000
2. Percent of total activity cost for each quality cost (and nonquality cost) classification:
Prevention……… 3%
Appraisal……… 8%
Internal failure……… 39%
External failure……… 28%
Not a cost of quality……… 22%
Total……… 100% Value-added
Value-added Value-added Not a quality cost
Prevention Appraisal Internal failure Appraisal Non-value-added External failure Internal failure Internal failure Not a quality cost
Activity Classification Classification
Value-Added/
Quality Cost Classification
Not a quality cost
Cost of Quality Non-Value-Added
Non-value-added Value-added Value-added Non-value-added Non-value-added Value-added 84,000 66,000 Percent of Total Department Cost Activity Cost $300,000 $ 9,000 24,000 117,000
3. Percentages of total activity cost that are value- and non-value-added:
Value-added……… 33% Non-value-added……… 67% 100%
4. The department has 67% of its total costs as non-value-added. This is a very
significant amount. Internal failure represents 39% of the total costs. This represents significant opportunity for cost savings. In addition, the external failure costs of 28% of the total may understate the true damage caused by external failure. The potential dissatisfaction and political ill will are not accounted for in this analysis.
Percent of Total Department Cost Activity Cost $300,000 201,000 $ 99,000
1. HD Hogg’s purchasing policy is very short-sighted. It does not involve developing partnerships with suppliers. HD Hogg should consider changing its arm’s length policy and work on building a long-term supply chain strategy with its suppliers. With a supply chain strategy, HD Hogg can begin to
consider more than just the price of its frames. It can work with the supplier on quality, responsive delivery, electronic data interchange invoicing, supplier raw materials logistical support, sharing of research and development efforts, and sharing of production schedules, to name a few. The arm’s length
approach is more costly in the long run, even if it squeezes the last penny out of each supplier. The arm’s length approach reduces the possibility of working on issues that go across organizational boundaries (such as electronic data interchange, sharing forecast information, or more frequent just-in-time deliveries), which hold the promise of reducing the total delivered cost.
2. The hidden costs beyond the price include the costs associated with the
higher inventory required by Iron Horse Frames’ delivery schedule. These inventory costs include additional space, handling, obsolescence, financing, and materials management costs. These costs were not considered because they are not obvious. They are also difficult to determine. The price is obvious, so it is easy to build a purchasing policy around “getting the best price.” This policy ignores the additional internal costs of the higher inventory imposed by Iron Horse Frames’ delivery schedule. These are costs incurred by other parts of the organization, not purchasing. In a functional organization, purchasing would respond by saying that the additional internal inventory costs are not its problem. Those are costs incurred in another manager’s responsibility center. Of course, this is part of the problem of such simple “low-price bid” policies.
3. If the financing costs are 12%, then the additional cost of the inventory could be determined as follows:
At the beginning of July, the new shipment of 4,500 frames arrives. Assuming that the frame supply runs out by the end of the quarter, the average inventory for the quarter is:
Beginning of July……… 4,500
End of September……… 0
Total……… 4,500
2
Average frames in inventory for the quarter……… 2,250
The inventory carrying cost can be estimated as follows:
Average frames in inventory for the quarter……… 2,250
×Price per frame……… $300
Total inventory investment……… $675,000
Interest rate per quarter (12% ÷ 4)……… 3%
Inventory financing cost per quarter……… $ 20,250
Inventory financing cost per quarter……… $ 20,250
÷Number of frames ordered for the quarter……… 4,500 frames
Additional cost per frame……… $ 4.50 per frame
The financing cost is 3% of the average quarterly inventory value, or $20,250 per
quarter. This translates into an additional $4.50 per frame ($20,250 ÷ 4,500 frames) purchased during the quarter. Thus, just considering the financing cost by itself makes Famous Frames the “real” low-cost bidder.
Note to Instructors: As a point of comparison, the financing cost for Famous Frames’
daily deliveries is 10¢ per frame ($15,050 × 3% = $451.50; $451.50 ÷ 4,500 frames =
$0.10), because the average daily inventory investment would be only $15,050 [(50 frames per day) × $301]. (This calculation would be half this amount if it was assumed the average daily inventory was half the daily shipment, or 25 frames [50 frames per day ÷ 2]).
÷
1. Value-added time:
Stamping……… 5 min.
Appliance assembly……… 22
Time to test one unit……… 8
Pack and shipment labeling……… 15
Total……… 50 min. Non-value-added time: Wait time: Within-batch wait time—stamping (39 × 5 min.)……… 195 min. Within-batch wait time—final assembly (39 × 22 min.)……… 858
Within-batch wait time—testing (39 × 8 min.)……… 312
Within-batch wait time—shipping (39 × 15 min.)……… 585
Stamping setup……… 60
Total wait time……… 2,010 min. Move time: Move from stamping to final assembly……… 10 min. Move from final assembly to testing……… 25
Total move time……… 35 min.
Total non-value-added time……… 2,045 min.
Total lead time (50 min. + 2,045 min.)……… 2,095 min.
50 min. 2,095 min.
2. The existing process is very wasteful. The company could improve the process
by changing the layout from a process orientation to a product orientation. Each appliance model could be formed into a production cell. Each cell would have stamping, final assembly, testing, and shipping next to each other. In this way, the batch sizes could be reduced significantly. Workers could practice one-at-a-time processing and merely pass a single completed assembly through the cell. As a result, the move time and within-batch wait time would be eliminated. The company could also initiate total quality principles. Moving toward zero defects would allow the company to reduce inspecting activities. A product-dedicated flow would also eliminate the need to perform stamping machine setups, since all the stampings would be the same for a given product model.
Value-Added Ratio = Value-Added Lead Time
Total Lead Time
$189,000 2,100 hours
= $18 per unit
3. a. Raw and In Process Inventory*
Accounts Payable 1,979,500
*10,700 units × $185 per unit
b. Raw and In Process Inventory*
Conversion Costs 189,000
*10,500 units × $18 per unit
c. Finished Goods Inventory*
Raw and In Process Inventory 2,070,600
*10,200 units × ($185 + $18)
d. Accounts Receivable*
Sales 5,000,000
*10,000 units × $500 per unit
Cost of Goods Sold*
Finished Goods Inventory 2,030,000
*10,000 units × ($185 + $18)
4. Raw and In Process Inventory:
$1,979,500 + $189,000 – $2,070,600 = $97,900 Finished Goods Inventory:
$2,070,600 – $2,030,000 = $40,600 or (10,200 units – 10,000 units) × ($185 + $18) = $40,600 2,030,000 5,000,000 $90 per hour 2. Budgeted Conversion
Cost per Unit =
1. Budgeted Cell Conversion
Cost Rate = =
$90 per hr. × (12 min. ÷ 60 min.)
1,979,500
189,000
5. JIT accounting is different from traditional accounting in a number of respects. Most importantly, JIT accounting is simplified and uses minimal control. As a result, the number of transactions is reduced, and the control intervals between adjacent work in process transaction points are widened. In many JIT operations, there are no separate materials or work in process inventories. Rather, purchased materials are charged to an account that combines raw materials and work in process, termed the “raw and in process inventory” account. Direct labor is frequently eliminated as a cost category and is instead included as a conversion cost of the cell. The cell conversion cost is also applied to the raw and in process inventory account. Indirect labor can frequently be assigned to a production cell. As a result, these costs do not need to be allocated, since they are included directly in the cell’s conversion cost. Often, nonfinancial performance measures, such as lead time or quality measures, are used to monitor performance.
1.
Pareto Chart of Activities
0 20000 40000 60000 80000 100000 120000 Produce product Dispose scrap Inspect work i n process te pr oduct ion late production Final inspect ion ive m achi ne maintenance cust omer qu ality complaint s erials with poo r quali ty Correct invoice error s Inspect incoming m ater ials Dollars
The following classifications are used in answering (2) and (3):
Activity Cost
Correcting invoice errors……… $7,500 Disposing of incoming
materials with poor quality…… 15,000
Disposing of scrap……… 27,500
Expediting late production…… 22,500
Final inspection……… 20,000
Inspecting incoming
materials……… 5,000
Inspecting work in process…… 25,000
Preventive machine maintenance……… 15,000 Producing product……… 97,500 Responding to customer quality complaints……… 15,000 Total……… $250,000
2. Percent of total activity cost for each quality cost (and nonquality cost)
classification:
Prevention……… 6%
Appraisal……… 20%
Internal failure……… 26%
External failure……… 9%
Not a cost of quality……… 39%
Total……… 100% Appraisal
External failure Not a quality cost
Value-added Value-added
Non-value-added Value-added Value-added
Quality Cost Classification
Appraisal
Cost of Quality Non-Value-Added
Non-value-added Value-added Activity External failure Internal failure Classification Classification Value-Added/ Non-value-added Non-value-added Non-value-added Internal failure Prevention Internal failure Appraisal $250,000 $ 15,000 50,000 65,000 22,500 97,500 Percent of Total Department Cost Activity Cost
3. Percentages of total activity cost that are value- and non-value-added:
Value-added……… 65% Non-value-added……… 35% 100%
4. The company has 65% of its total costs as value-added. However, there is still room
for significant improvement. Internal failure represents 26% of the total costs. This represents significant opportunity for cost savings. In addition, the external failure costs of 9% of the total may understate the true damage caused by external failure. The potential dissatisfaction, ill will, and lost future sales are not accounted for in this analysis. Percent of Total Department Cost Activity Cost $250,000 87,500 $162,500
CP 27–1 (FIN MAN); CP 12–1 (MAN)
The controller should confront the plant manager. The plant manager is attempting to skew the sampling results by giving the sampled items special treatment. The original intent of the sampling plan is to represent the average performance of the manufacturing process. Thus, the tagged items should receive no better treatment than the average product being produced. The plant manager’s memo will cause the lead times reported to central
management to be much better than they actually are. Thus, it is possible that salespersons and marketing personnel will begin to make shipping commitments to customers based on the reported lead times. Since the plant is unable to perform for all products at the reported levels, customers may be left angry when the commitments are not met.
The controller should first insist that the plant manager issue a new memo to all employees, reversing the first memo. The controller should help the plant manager see that skewing the results will provide only a short-term benefit. Eventually, this action will come back to haunt them as the real performance of the plant becomes evident to customers and top management. Top management will be very displeased with a deliberate attempt on the part of the plant manager to “cook the numbers.” If the plant manager fails to agree to this, the controller may need to report this incident to the company’s chief financial officer.
It would be unethical for the controller to fail to address this issue. The Standards of
Ethical Conduct for Practitioners of Management Accounting and Financial Management
states that the management accountant must communicate information fairly and objectively and disclose all fully relevant information that could reasonably be expected to influence the intended user’s understanding of the information.