Cost Accounting (14th Edition)

712 CHAPTER 20 INVENTORY MANAGEMENT, JUST-IN-TIME, AND SIMPLIFIED COSTING METHODS
Exhibit 20-5
Annual Relevant Costs of Current Purchasing Policy and JIT Purchasing Policy for CD World
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
A B C D E F G H I J
Relevant Costs Under
Current Purchasing Policy
JIT Purchasing Policy
Relevant Items
Relevant
Cost
Per Unit
Quantity
Per
Year
Total
Costs
Relevant
Cost
Per Unit
Quantity
Per Year
(1)
(2)
(3)
(4) =
(2) × (3) (5)
(6)
(7) =
(5) × (6)
Purchasing costs $14.00 per unit
13,000
$ 182,000 $14.02 per
unit
13,000
$ 182,260
Ordering costs 2.00 p er order
13
26 2.00 per order
130
260
Opportunity carrying costs 2.10 a per unit of average inventory 500 b 1,050 2.10 a per unit of average inventory 50 c
105
per year
per year
Other carrying costs (insurance,
materials handling, and so on)
3.10
per unit of average
inventory per year
500 b 1,550 3.10 per unit of average
inventory per year
Stockout costs 4.00 per unit
0 0
4.00 per unit
150
Total annual relevant costs $ 184,626
Annual difference in favor of JIT
purchasing
a Purchasing cost per unit × 0.15 per year
b
Order quantity ÷ 2 = 1,000 ÷ 2 = 500 units
c
Order quantity ÷ 2 = 100 ÷ 2 = 50 units
$1,246
50 c
Total
Costs
155
600
$183,380
CD World has recently established an Internet business-to-business purchase-order
link with Sontek. CD World triggers a purchase order for compact disks by a single computer
entry. Payments are made electronically for batches of deliveries, rather than for each
individual delivery. These changes reduce the ordering cost from $200 to only $2 per purchase
order! CD World will use the Internet purchase-order link whether or not it shifts to
JIT purchasing. CD World is negotiating to have Sontek deliver 100 packages of disks
130 times per year (5 times every 2 weeks), instead of delivering 1,000 packages 13 times
per year, as shown in Exhibit 20-1. Sontek is willing to make these frequent deliveries, but
it would add $0.02 to the price per package. As before, CD World’s required rate of return
on investment is 15% and the annual relevant carrying cost of insurance, materials handling,
shrinkage, breakage, and the like is $3.10 per package per year.
Also assume that CD World incurs no stockout costs under its current purchasing
policy, because demand and purchase-order lead times during each four-week period are
known with certainty. CD World is concerned that lower inventory levels from implementing
JIT purchasing will lead to more stockouts, because demand variations and
delays in supplying disks are more likely in the short time intervals between orders delivered
under JIT purchasing. Sontek has flexible manufacturing processes that enable it to
respond rapidly to changing demand patterns. Nevertheless, CD World expects to incur
stockout costs on 150 compact disk packages per year under the JIT purchasing policy.
When a stockout occurs, CD World must rush-order compact disk packages from another
supplier at an additional cost of $4 per package. Should CD World implement the JIT
purchasing option of 130 deliveries per year? Exhibit 20-5 compares CD World’s relevant
total costs under the current purchasing policy and the JIT policy, and it shows net cost
savings of $1,246 per year by shifting to a JIT purchasing policy.
Supplier Evaluation and Relevant Costs of Quality and
Timely Deliveries
Companies that implement JIT purchasing choose their suppliers carefully and develop
long-term supplier relationships. Some suppliers are better positioned than others to support
JIT purchasing. For example, Frito-Lay, a supplier of potato chips and other snack
foods, has a corporate strategy that emphasizes service, consistency, freshness, and quality
of the delivered products. As a result, the company makes deliveries to retail outlets
more frequently than many of its competitors.