Chapter 20

1. Chapter 20 Managing inventory and quality

2. The importance of inventory management • Cope with uncertainties in customer demand and in production processes • Qualify for quantity discounts • Avoid future price increases in raw materials • Avoid the costs of placing numerous small orders with suppliers

3. Conventional approaches to inventory management • Focused on balancing • ordering costs • the incremental costs of placing an order for inventory • carrying costs • the costs of carrying inventory in stock • shortage costs (or out of stock costs)

4. Economic order quantity (EOQ) • The optimum order size for individual inventory items, to minimise the total ordering and carrying costs

5. Timing of orders under EOQ • Inventory reorder point (ROP) • the level of inventory on hand that triggers the placement of a new order (or setup) • safety stock • the extra inventory kept on hand to cover any above-average usage or demand

6. Assumptions underlying EOQ • Demand is known and constant • Incremental ordering costs are known, constant per order • Acquisition cost per unit is constant • Entire order is delivered at one time • Carrying costs are known, constant per unit • On average, one-half of order is in stock at any time

7. MRP • Material requirements planning (MRPI) • assists managers to estimate inventory requirements and to schedule production • Manufacturing resource planning (MRPII) • allows managers to link production planning to the overall planning function of the business • MRP is a push system

8. MRP terminology • Bill of materials • identifies all the materials, components and sub-assemblies required to make a product • Inventory master file • records the quantity of inventory on hand and movements in and out of stock • Master production schedule • identifies the quantity and timing of each item to be produced in each department

9. Benefits of MRP • Increased customer responsiveness • significantly more on-time deliveries • much less expediting • Increased labour productivity • Reduced inventory levels • reduced cost of holding inventory

10. Costs of MRP • Expensive to install • Requires extensive employee training and discipline • If bill of materials or inventory master files are inaccurate - system is unreliable

11. Just-in-time (JIT) inventory management • JIT inventory and production system is • a comprehensive system for controlling the flow of manufacturing in a multistage production environment • An underlying philosophy of simplifying the production process by removing non-value-added activities

12. Key features of JIT production • A pull method of co-ordinating production, uses kanbans • Simplified production processes • Purchase of materials, and manufacture of sub-assemblies and products in small lots • Quick and inexpensive setups of production machinery Cont.

13. Key features of JIT production • High-quality levels for raw materials, components and finished products • Effective preventative maintenance of equipment • Flexible work cells • to take advantage of group technology and remove bottlenecks

14. JIT purchasing • A few suppliers • Long-term contracts with suppliers • Materials and parts delivered in small lots as needed • Minimal inspection of delivered materials and parts • Grouped payments to each supplier

15. Costs of JIT • Substantial investment to change the production to minimise non-value-added activities • An increase in the risk of inventory shortages and the associated loss of production, expediting materials costs and loss of sales

16. Benefits of JIT • Savings in inventory-carrying costs • Lower insurance costs • Fewer losses due to spoilage, obsolescence and theft • No opportunity costs of high inventory • Elimination of non-value-added activities • Meets customers needs more effectively

17. JIT and backflush costing • Backflush costing • a simplified method of product costing under JIT • no raw material or WIP inventory account • raw material charged to raw and in process inventory (RIP) account used • conversion costs charged to finished goods inventory

18. Costs and benefits of backflush costing • Benefits of backflush costing • simpler and less expensive than conventional costing • Costs of backflush costing are • provides much less detail than conventional costing • Is the loss of detail overcome by cost savings?

19. Role of the management accountant in managing inventory • MPR: may maintain inventory master files and bills of material for all products • JIT • co-ordinate the flow of information to eliminate non-value activities • provide reports to appropriate levels of management

20. Managing quality • TQM is a management approach that focuses on meeting customer requirements by achieving continuous improvement in products or services • TQM is a broad philosophy with a number of features which are not included in JIT

21. Quality accreditation • Organisations may achieve quality accreditation by meeting a series of quality standards set out in the ISO 9000 series. • ISO 9000’s are • expensive to implement and maintain • may have little relevance to many small businesses and service organisations

22. Quality accreditation (QA) versus total quality management (TQM) • Organisations can have QA without TQM • TQM is a philosophy - QA is a documentation process • QA may encourage employees to think about quality

23. Features of TQM • TQM is holistic • Customer-driven • Involves empowerment • Has a process perspective • Is supported by a quality management system • Involves continuous improvement

24. Benefits and costs of TQM • Benefits • improved quality • shorter lead times • increased efficiency • improved customer satisfaction • TQM can be difficult and expensive to achieve because it may involve a change in organisational culture

25. Cost of quality reports • Quality of design • degree to which a product’s design specifications meet customers’ expectations • Quality of conformance • degree to which a product meets formal design specifications Cont.

26. Cost of quality reports • Costs incurred in ensuring that the organisation maintains a high level of quality in its products, and the costs that arise from having poor-quality products • Internal failure costs • incurred when defective products or services are detected before they leave the firm

27. Cost of quality reports • External failure costs • incurred as a result of defective products or services being delivered to customers • Appraisal costs • incurred to determine whether defects exist • Prevention costs • incurred to prevent internal or external failures and to minimise appraisal activities

28. Usefulness of cost of quality reports • Places a dollar figure on the costs of poor quality • Helps prioritise quality improvement programs • Helps managers monitor the effects of the ‘quality effort’ • Can help identify the optimal level of quality for the firm

29. Reasons for lack of use of cost of quality reports • Managers may believe costs outweigh the benefits • Information is difficult to extract from conventional costing systems • Many of the quality costs are spread across the organisation

30. Exhibit 20.3

31. Exhibit 20.4

32. Exhibit 20.6