The following question-and-answer format summarizes the chapter’s learning objectives. Each decision presents a key question related to a learning objective. The guidelines are the answer to that question.
| Decision | Guidelines |
|---|---|
| The six categories are purchasing costs (costs of goods acquired from suppliers), ordering costs (costs of preparing a purchase order and receiving goods), carrying costs (costs of holding inventory of goods for sale), stockout costs (costs arising when a customer demands a unit of product and that unit is not on hand), costs of quality (prevention, appraisal, internal failure, and external failure costs), and shrinkage costs (the costs resulting from theft by outsiders, embezzlement by employees, misclassification or misplacement of inventory). |
| The economic-order-quantity (EOQ) decision model helps managers to calculate the optimal quantity of inventory to order by balancing ordering costs and carrying costs. The larger the order quantity, the higher the annual carrying costs and the lower the annual ordering costs. The EOQ model includes costs recorded in the financial accounting system as well as opportunity costs of carrying inventory that are not recorded in the financial accounting system. Managers choose a level of safety stock to minimize the stockout costs and the carrying costs of holding more inventory. |
| The cost of prediction errors when using the EOQ model is small. The square root in the EOQ model reduces the effect of estimation errors. To reduce the conflict between the EOQ decision model and the performance evaluation model, companies should include the opportunity cost of investment in inventory when evaluating managers. The opportunity cost of investment tied up in inventory is a key input in the EOQ decision model that is often ignored in the performance-evaluation model. |
| Just-in-time (JIT) purchasing is making purchases in small order quantities just as needed for production (or sales). JIT purchasing is a response to high carrying costs and low ordering costs. JIT purchasing increases the focus of companies and suppliers on quality and timely deliveries. Companies coordinate their activities and reduce inventories throughout the supply chain, from the initial sources of materials and services to the delivery of products to consumers. |
| Materials requirements planning (MRP) systems use a “pushthrough” approach whereby finished goods are manufactured on the basis of demand forecasts. Just-in-time (JIT) production systems use a “demand-pull” approach in which goods are manufactured only after receiving customer orders. |
| JIT production systems (a) organize production in manufacturing cells, (b) hire and train multiskilled workers, (c) emphasize total quality management, (d) reduce manufacturing lead time and setup time, and (e) build strong supplier relationships. The benefits of JIT production include lower costs and higher margins from better flow of information, higher quality, and faster delivery as well as simpler accounting systems. |
| Traditional inventory-costing systems use sequential tracking, in which recording of the journal entries occurs in the same order as actual purchases and progress in production. Most backflush costing systems do not record journal entries for the work-in-process stage of production. Some backflush costing systems also do not record entries for either the purchase of direct materials or the completion of finished goods. |
| Lean accounting assigns costs to value streams rather than to products. Non-value-added costs, unused capacity costs, and costs of direct materials inventory are not assigned to value streams to indicate how much current profitability could be improved. Moreover, costs that cannot be easily traced to value streams are not allocated but instead expensed. |