92. The executive vice president of Robotics, Inc.

, is concerned because the cost of

materials has not been in line with the budget for several periods, even after
implementing an EOQ model. The company has the normal direct material variance
computations of price and efficiency at the end of each month. The price variance
of the direct materials used is usually near expectations. The vice president does not
understand how the budget differences are always larger than the material price
variances.

Required:
What explanation can you give for the evaluation problems presented?

Answer:
An EOQ model does not solve all inventory related problems. The first problem is
the timing of material price variance computations. They should be at the time of
purchase, not at the time of usage. By changing when the variance is computed, the
responsibility is placed where it should be, in purchasing, not in production. Also,
the timing of when materials are used could explain the difference between the
budget variances and the material price variances. Materials may be purchased in
one period and not used until another period. Also, material usage may include
items purchased during several previous periods.

Difficulty: 2 Objective: 3
Terms to Learn: inventory management, economic order quantity (EOQ)

93. The manufacturing manager of New Technology Company is concerned about the
company's newest plant. When the plant began operations three years ago, it had the
best of everything. It had modern equipment, well-trained employees, engineered
work and assembly stations, and a controlled environment. During the first two
years, the evaluation results were very good with almost all cost variances being
favorable. However, recently, things have turned negative.

In recent months, everything seems to be operating in a crisis management mode.

Although most cost variances remain favorable, the plant's segment contribution is
declining and customers are complaining about poor quality and slow delivery.
everal customers have suggested that they may take their business elsewhere if
things do not improve.

The shop floor is in continual turmoil. In-process inventory is everywhere,

production employees have difficulty finding jobs that need to be worked on, and
scheduling has requested a larger computer to keep track of work in process.

The vice president of sales does not know where to begin with solving the
customers' problems. It seems that everyone is working very hard and the plant has
the best facilities and trained employees in the industry.

Required:

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What is the nature of the plant's problems? What recommendation would you make
to help improve the situation?

Answer:
The basic problem appears to be too much work-in-process inventory and a lack of
control over the flow of this inventory. Since the plant had two good years of
production, it may be that increased demands are pushing the plant near its capacity
and management has lost control of how to manage a near-capacity situation.
Although the employees are well trained and skilled in what they do, that is not
enough to ensure the production process runs smoothly. All activities must be
organized to be efficient.

A beginning recommendation is to implement a materials required planning system

where each workstation controls what it produces, and pushes it to the next
workstation. This can be accomplished by tighter controls over the scheduling of
production units by workstation. This would be incorporated with a master
production schedule, bill of materials, and timely inventory system.

Difficulty: 2 Objective: 4
Terms to Learn: inventory management, material requirements planning (MRP)

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94. What is a supply chain, and what are the benefits of a supply chain analysis?
Provide an example of these benefits.

Answer:
The supply chain describes the flow of goods, services, and information from the
initial sources of materials and services to the delivery of products to customers,
regardless of whether these activities occur in the same organization or in other
organizations. Utilizing supply chain analysis allows companies to coordinate their
activities and reduce inventories throughout the supply chain. An example of the
benefits of supply chain analysis might be the emergence of supplier or vendor-
managed inventories such as the relationship between Procter & Gamble and
Walmart.

Difficulty: 2 Objective: 4
Terms to Learn: inventory management

95. Kretzinger Company makes extensive use of financial performance reports for each
of its departments. Although most departments have been reporting favorable cost
variances with the company's current inventory system, management is concerned
about the overall performance of the purchasing department. For example, the
following information is for the purchasing of materials for a product the company
has been manufacturing for several years:

Purchase Year Quantity Used Average Price Variance

Inventory
20X1 40,000 8,000 $ 1,000 F
20X2 60,000 15,000 10,000 F
20X3 60,000 20,000 12,000 F
20X4 50,000 12,500 20,000 U
20X5 54,000 18,000 8,000 F
20X6 58,000 23,200 9,500 F

Required:
a. Compute the inventory turnover for each year. Can any conclusions be drawn
for a yearly comparison of the purchase price variance and the inventory
turnover?

b. Identify problems likely to be caused by evaluating purchasing only on the

basis of the purchase price variance.

c. What recommendations will improve the evaluation process?

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Answer:
a.
Year Quantity used Average Turnover
inventory
20X1 40,000 divided by 8,000 5.0
20X2 60,000 divided by 15,000 4.0
20X3 60,000 divided by 20,000 3.0
20X4 50,000 divided by 12,500 4.0
20X5 54,000 divided by 18,000 3.0
20X6 58,000 divided by 23,200 2.5

Favorable purchase prices appear to be associated with decreases in inventory

turnover and increases in average inventory levels. Decreases in inventory
turnover are a possible signal of the buildup of excess inventory. Excess
inventory will reduce return on investment of the company and the above
information indicates a need for a just-in-time inventory system.

b. To achieve quantity discounts and favorable materials price variances,

purchasing may be ordering excess inventory, thereby increasing subsequent
storage, obsolescence, and handling costs. To obtain a low price, purchasing
may be ordering from a supplier whose goods have inferior quality which
may, in turn, lead to increased inspection, rework, and, perhaps, dissatisfied
customers.

c. It appears that two items may help improve the situation. First, consider the
change to a just-in-time inventory system that would greatly improve the
inventory turnover and reduce the amount of inventory carried. Second,
additional measures should be used in the evaluation of the purchasing
department. Either different financial measures should be used or the addition
of nonfinancial measures should be implemented.

Difficulty: 3 Objective: 5
Terms to Learn: inventory management, just-in-time (JIT) production

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96. Minnesota Ore Company mines iron ore for production into various metal products.
During recent years, the company has had large fluctuations in its inventories of
metal ingots. Much of the volatility of the inventory levels is due to the variability
of demand by the company's largest customers, automobile manufacturers. For
large orders, the company has the technology to quickly shift production from one
product to another.

Required:
Explain how the company can improve its inventory control system and give the
advantages of whatever you recommend.

Answer:
The company can probably benefit from changing to a just-in-time system for
inventory control. This would allow the company to be responsive to actual needs
rather than finished goods inventory building. The advantages would be:

1. Lower inventory requirements;

2. Reductions in carrying and handling costs of inventories;
3. Reduction in risks of obsolete inventories;
4. Reduction in total manufacturing costs; and
5. Reductions in paperwork.

Difficulty: 2 Objective: 5
Terms to Learn: inventory management, just-in-time (JIT) production

97. What are five features of a just-in-time manufacturing system?

Answer:
A just-in-time (JIT) system has many positive features. It organizes production in
manufacturing cell groups which allow for all equipment used for a given product
to be grouped together. This reduces material handling costs and sequences the
production process. A second feature of a JIT system is that workers are trained to
be multiskilled. They are trained to operate various machines as well as to do light
maintenance and repairs on the machines. A third feature of JIT is that it
aggressively works to eliminate defects. Because there is a tight link between the
steps, defects are quickly noticed in the next step and addressed before large
numbers of units become backlogged. A fourth feature of a JIT system is that it
reduces setup time and manufacturing lead time. Reduced setup costs make it more
practical to produce smaller batches and react faster to changes in customer
demand. A fifth feature of a JIT system is the firm only uses suppliers who are
capable of meeting delivery demands in a timely fashion. This also causes an
increase in the quality of the goods being received by the firm.

Difficulty: 2 Objective: 6
Terms to Learn: just-in-time (JIT) production

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98. Backflush costing does not strictly adhere to generally accepted accounting
principles. Explain why. Also, describe the types of businesses that might use
backflush costing.

Answer:
The principal reason why backflush costing does not strictly adhere to GAAP is that
the work-in-process accounts are not recognized in the accounting records. Work in
process consists of unfinished goods. Substantial business resources were dedicated
to their production, and should be recognized in the accounts as an asset. This
approach to costing is usually used by companies that adopt JIT production
methods. While not totally devoid of inventories, such companies seek to minimize
inventories thus minimizing the problems associated with no work-in-process
accounts.

The type of business which would use backflush costing would be firms that use
JIT production, have fast manufacturing lead times, or have very stable inventory
levels from period to period. For these companies, backflush costing will report cost
numbers similar to what a sequential costing approach would report.

Difficulty: 3 Objective: 8
Terms to Learn: backflush costing

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