Chapter 18 237

CHAPTER 18

INVENTORY AND PRODUCTION MANAGEMENT

QUESTIONS

1. The   three   costs   are   costs   of   ordering,   purchasing,   and   carrying   inventory.
These costs are presented in Exhibit 18.1 with examples.

2. A push system is a production control system in which work centers produce
inventory   in   excess   of   current   needs   because   of   lead   time   or   economic
production/order quantity requirements.

A pull system of production control is one in which parts are delivered/produced
only as needed by the work center for which they are intended. Theoretically,
there are no stockrooms where work centers “push” completed parts in excess of
the current needs of recipient work centers. JIT is a pull system.

3. Companies   must   be   aware   of   where   their   products   are   in   their   life   cycles
because,   in   addition   to   the   sales   effects,   the   life­cycle   stage   may   have   a
tremendous impact on costs and profits. Managing production activities and costs
requires   an   understanding   of   product   life   cycles   to   effectively   and   efficiently
engage   in   production   planning,   controlling,   problem   solving,   and   performance
evaluation.

4. Target   costing   is   a   method   of   determining   an   allowable   cost   of   making   a

product  by  subtracting   desired   profit  from  the  estimated   selling  price.   Once  a
product’s total life­cycle costs are projected, they can be compared to the target
cost to determine whether adjustments to the product design and manufacturing
process   are   necessary   before   product   engineers   release   the   final   design   and
specifications.

5. It is in the development stage that the production components and production
processes are determined. Accordingly, most production costs are set for a product
line’s life during the development stage. Costs are much less subject to influence
in later stages of the life cycle.

6. Kaizen   costing   is   an   approach   to   identify   ways   to   incrementally   improve

production   efficiency   and   reduce   the   costs   of   making   a   product.   A   major
distinction   between   kaizen   costing   and   target   costing   is   seen   in   the   life­cycle
stages in which each is used. Kaizen costing is used to reduce the cost of products
in later stages of the product life cycle. Target costing is applied in the product
development/design stage.

7. The primary goals of the JIT philosophy are
 eliminating any process that does not add value to the product;
 continuously improving production efficiency; and

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238 Chapter 18

 reducing total production cost rather than merely the cost of purchasing.

JIT attempts to achieve these goals by working to
 eliminate the acquisition/production of inventories in excess of current needs;
 reduce lead/setup times; and
 minimize product defects.

8. The   following   changes   are   needed   to   effectively   implement   JIT   in   a

production environment:
 The vendor selection process should reflect the following concerns in addition
to the invoice prices:
 consistent quality of materials/parts to minimize product defects;
 reliable delivery schedules with short lead times to allow for maintaining
little or no inventory and for flexibility and speed in setting up production
runs;
 maintenance of long­term relationships with fewer vendors to improve
communications, ensure quality and service, obtain quantity discounts,
and reduce operating costs;
 nearness to plant location to reduce lead times and shipping costs.

 Small quantities should be ordered to minimize inventory carrying costs.
 Product components and tools should be standardized to lower costs and
increase production efficiency.
 The   number   of   product   components   should   be   minimized   to   lower
costs and increase production efficiency.
 Products should be carefully designed to reduce subsequent change orders.
 Setup times should be shortened to allow for quicker, more flexible production.
 Production workers are used to continually ensure quality control to reduce
costs and approach zero defects.
 The plant layout should be designed in a manner that is conducive to the flow
of goods and organization of workers to minimize cycle time from material
input to finished product.
 Employee   suggestions   for   improving   production   should   be   sought;   these
individuals often have a wealth of information that goes untapped.
 Multiprocess handling should be used to improve worker flexibility and interest.

9. In an FMS, each employee is charged with operating or overseeing several
machines.   Although   the   automation   requires   fewer   workers   than   traditional
production systems, FMS requires its workers to have more training than those in
a traditional environment. Also, employees need to be given the authority and
responsibility to make decisions because the environment is too fast paced for
people “off the floor” to make certain production decisions.

10. The theory of constraints states that production cannot take place at a rate
faster than the slowest machine or person in the process. TOC can be used in
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accessible website, in whole or in part.
Chapter 18 239

either a manufacturing or service firm to focus management’s attention on the
elimination  of the bottlenecks  so that the best use of existing capacity can be
made.

11. Total ordering cost declines as order size increases. Carrying costs increase, in
total, as order size increases. At some point the two costs are equal, and it is at this
point that  the EOQ point is  located.  For amounts  greater  than the EOQ, total
carrying costs exceed total ordering costs.

12. Pareto inventory analysis requires that all inventory items be placed into one
of three classes: A, B, or C. The three categories are distinguished from each other
by their cost­to­volume ratio. High­value, low­volume items are placed in the A
category; at the other extreme, low­value, high­volume items are placed in the C
category. All other items are placed in category B. A red­line system or a two­bin
system is frequently used to control inventory levels of C items.

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240 Chapter 18

EXERCISES

13. a. Each student will have a different answer. No solution provided.
b. Each student will have a different answer. No solution provided.
c. The magnitude of inventory as a percentage of total assets will suggest
that   inventory  management   is  very  important   to  the  success  of  manufacturing
firms.

14. a. O
b. O
c. O
d. N/A (Purch.)
e. N
f. O
g. N/A (Purch.)
h. C
i. O
j. O
k. N
l. C
m. N/A (Purch.)
n. C
o. C
p. C
q. N
r. C

15. a. As technology changes, the relative costs of ordering and carrying inventory
change. The changes mentioned in this scenario would appear to lower the costs
of ordering inventory. Consequently, assuming the costs of carrying inventory
remain at their original level, the reduction in ordering costs would drive the
EOQ quantity down.

b. Each student will have a different answer, but the memo should make the points
listed in (a).

16. The   president   should   ask   for   a   formal   analysis   of   the   situation.   This   analysis
should address the costs and benefits of each alternative. Costs should include
purchase prices, warehousing costs (including insurance), personnel to operate the
warehouse and receive any necessary inventories during the period, the cost of
capital on the funds tied up in the parts, and penalties for canceling. The supply
director should comply with the president’s request by preparing and presenting
an objective report.

Often, when confronted by situations  such as this one, the only costs that are
considered are the direct costs (purchase price and penalties). Decision making of

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Chapter 18 241

this nature should be careful to reflect not only the directly visible costs but also
the “hidden costs” of purchase arrangements.

17. a. Restaurants that manage their food production on a push basis anticipate the
level   of   demand   and   prepare   food   before   customers   arrive   and   order.
Restaurants that manage their food production on a pull basis do not produce
any food until the customer orders.

b. Customers may prefer to dine at a restaurant that manages food production on a
push basis   if  they  are  time   constrained.  Because  the  food  has  already   been
produced before the customer arrives, the food can be served very quickly. An
illustration would be a restaurant that provides a buffet.

c. If quality and freshness are important to the customer, food prepared on a pull
basis will be preferred by the customer. Also, if a customer wants food prepared
to meet a dietary restriction, e.g., no salt, the customer will prefer that the food
production be pull based.

18. Each student will have a different answer. However, the reports should address the
following points. There are situations  in which JIT will not readily work. For
example, if vendors are unwilling to deliver inputs on a JIT basis, adopting JIT is
not   possible.   Also,   some   products   (such   as   those   that   are   not   available   from
repetitive manufacturing processes) are not suitable for JIT. For example, bridges,
office buildings, and other one­off types of products are not suitable candidates
for   JIT   manufacturing.   Other   instances   in   which   JIT   is   not   suitable   include
production environments in which demand is very seasonal. In such environments,
it may be more economical to produce at a balanced level on a year­around basis
rather than produce only seasonally.

19. Each student will have a different answer; however, the essence of the rebuttal
would be that profitability of the product recently introduced by 3G would vary
with the product life cycle. Further, because the product’s sales volume is likely to
be low in the year of introduction, first­year losses are not unexpected. One should
argue that the product should be dropped only if the total future life cycle sales are
expected to produce a loss rather than a profit.

20. Giles is correct. Relative to products with long life cycles, there is less opportunity
to   make   post­development   changes   to   production   processes   for   products   with
short life cycles to improve profitability. In general, the longer the life cycle, the
more opportunity there is to use kaizen costing techniques to improve efficiency.
For products with short life cycles, the bulk of life cycles sales will quickly be in
the past rather than in the future.

21. Life­cycle revenue:
Year 1 48,000  $19 $   912,000
Year 2 48,000  $20 960,000

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242 Chapter 18

Year 3 90,000  $16 1,440,000

Year 4       40,000  $12        480,000
Total  226,000 $3,792,000
Required profit 226,000 × $3.50             (791,000)
Selling & Administrative expenses             
   (200,000)
Total target cost $2,801,000

Target cost per unit: $2,801,000 ÷ 226,000 = $12.39

22. a.  Life­cycle revenues:
Year 1 4,000  $800 $   3,200,000
Year 2 3,600  $800      2,880,000
Year 3 4,700  $800      3,760,000
Year 4 5,000  $800      4,000,000
Year 5 1,500  $650         975,000
Year 6    
  1,000  $650           650,000
Totals  19,800 $ 15,465,000
Variable selling costs (19,800  $140)     (2,772,000)
Fixed selling and administrative     (3,700,000)
Required profit ($15,465,000  0.15)     
   (2,319,750)
Total target manufacturing cost $   6,673,250
Divided by number of units ÷ 19,800
Target manufacturing cost per unit $        337.03

      b. Total target manufacturing cost $   6,673,250
Year 1 mfg. cost (4,000  $430)     
   (1,720,000)
Total target manufacturing cost $   4,953,250

Target unit mfg. cost ($4,953,250 ÷ 15,800)              $313.50

c. The company’s engineers could redesign the product to
make it less costly to produce by reducing both material and conversion costs,
or redesign the process to reduce conversion costs. Also, they could use kaizen
costing techniques, which could lower costs after production has started.

23. The   student’s   memo   should   address   the

following issues:
Target cost = $145 – $15 = $130.

a. Given that the target cost is $130 and the anticipated
actual first­year expected cost is $140, it is apparent that it will be impossible to
realize the required profit of $15 per unit unless changes are made.

b. There   are   two   major   courses   of   action.   First,

management should ask the product engineers  to review product design and
specifications  with the purpose of reducing expected average total life­cycle
cost   to   the   required   $130   target   cost.   Failing   success   in   this   endeavor,
management   could   consider   launching   the   product   with   the   objective   of

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Chapter 18 243

achieving   long­term   cost   reductions   through   kaizen   costing   techniques.   If

management is pessimistic about the company’s ability to achieve the required
long­term reductions in cost, the plans for the product should be abandoned.

24. Each  student will have a different  answer. No

solution provided.

25. a. (1) Direct Material Inventory 32,000
Accounts Payable 32,000

(2) Conversion Cost Control 64,000
Various accounts 64,000

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244 Chapter 18

(3) Work in Process Inventory  96,000
Direct Material Inventory 32,000
Conversion Cost Control 64,000

Finished Goods Inventory 96,000
Work in Process Inventory 96,000

(4) Accounts Receivable 158,000
Sales 158,000

Cost of Goods Sold 94,800
Finished Goods Inventory 94,800

a. (1) Cost of Goods Sold 96,000
Various accounts 96,000

(2) No entry

(3) Finished Goods Inventory 1,200
Cost of Goods Sold 1,200

26. a. Raw and In­Process Inventory 302,000
Accounts Payable 302,000

Conversion Cost Control 608,000
Various accounts 608,000

Raw and In­Process Inventory 600,000
Conversion Cost Control 600,000

Finished Goods Inventory 900,000
Raw and In­Process Inventory 900,000

Cost of Goods Sold 894,000
Finished Goods Inventory 894,000

Cost of Goods Sold 8,000
Conversion Cost Control 8,000

Accounts Receivable 1,490,000
Sales 1,490,000

          Alternatively, the following journal entries could be used: 

Raw and In­Process Inventory 2,000
Finished Goods Inventory 6,000
Cost of Goods Sold 902,000
Accounts Payable 302,000
Conversion Cost Control 608,000

Accounts Receivable 1,490,000
Sales 1,490,000

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Chapter 18 245

b. Raw and In­Process Finished Goods
302,000 900,000  900,000 894,000
600,000
      Bal. 2,000 Bal.       6,000

Cost of Goods Sold Conversion Cost Control
894,000 608,000 600,000
    8,000     8,000
  Bal.  902,000 Bal.              0

Accounts Payable Various accounts
302,000   608,000

Sales Accounts Receivable
  1,490,000  1,490,000

c. The remaining balance in Raw and In­Process Inventory
=
$902,000 – $900,000 = $2,000
The remaining balance in Finished Goods Inventory = 
($2 + $4)  1,000 = $6,000

27. a. Material usage variance:
Actual cost of material this month:
(A) 11,000 lbs.  $2.50 per lb. = $27,500
(B) 10,000 lbs.  $3.40 per lb. =   34,000
   $ 61,500
Current material standard:
(A) 3,000  2  $2.50 per lb. = $15,000
(B) 3,000  5  $3.40 per lb. =   51,000
        66,000
Material usage variance    $   4,500 F
Annual material standard:
(A) 3,000  3  $2.50 per lb. = $22,500
(B) 3,000  4  $3.40 per lb. =   40,800
   $ 63,300
Current standard      
  (66,000)
ECO variance    $   2,700 U

b. The effect of the engineering change was to change the
mix   of   material   inputs   by   decreasing   the   proportion   of   the   less   expensive
material, A. For July, this engineering change generated extra costs of $2,700.

28. a.     SP  AQ                    SP  SQ

(X) $0.02  220,000 = $4,400
    (Y) $0.05   31,000 =   1,550
       
$5,950
(X) $0.02  216,000 = $4,320
(Y) $0.05   32,000 =   1,600
$5,920
$30 U

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246 Chapter 18

   Material Usage Variance
   (Material X, $80 U; Material Y, $50 F)

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Chapter 18 247

b. Current SP  SQ        Annual SP  SQ
(X) $0.02  216,000 = $4,320 (X) $0.02  256,000 = $5,120
(Y) $0.05    32,000 =   1,600
   (Y) $0.05    16,000 =         800
          $5,920            $5,920
$0
ECO Variance
                                    (Material X, $800 F; Material Y, $800 U)

c. The company was fairly effective in managing costs. The engineering change
variance had no effect on costs, but relative to the current standard, actual usage
slightly exceeded the standard.

d. The   company   would   make   a   change   that   was   cost

neutral if the quality of the product would be improved. Thus, for no increase in
cost,   a   higher   quality   product   is   obtained,   which   could   result   in   greater
revenues.

29. JIT   requires   close   relations   and   communications   with   suppliers.

Preferably, there should be a few, well­cultivated suppliers who are “trained” to
know precisely the company’s inventory needs and who understand the critical
requirement of meeting the JIT operation schedule. Further, the suppliers should
be made aware that they will be dismissed for defective or inappropriate products
or   service   or   for   failure   to   meet   delivery   schedules.   All   of   the   above   require
continual close communications between the supplier and the JIT producer.

In   this   case,   Duggan   Mfg.   needs   to   consider   whether   some   or   all   of   the
responsibility   rests   with   the   company   itself.   Have   the   suppliers   been   properly
“trained”   and   made   precisely   aware   of   product   and   timing   needs?   Have   the
suppliers   been   chosen   with   the   expertise,   facilities,   and   delivery   capability   to
service Duggan’s requirements? Do Duggan’s personnel know exactly what the
needs are, and are those needs fairly stable? If, for example, Duggan has frequent
engineering   changes   because   of   inadequate   product   development,   supplier
compliance is hampered.

Finally, JIT systems cannot be fully and effectively implemented in a few months.
It usually takes considerably longer to make the system work well. Expectations
that JIT can have immediate perfect results are likely to lead to disappointment.

30. Each student will have a different answer. No solution provided.

31. a. Adoption of a FMS should reduce raw material, work in process, and finished
goods   inventories.   Because   an   FMS   allows   the   manufacturer   to   switch
production  among  products  quickly,  production  runs  can be shorter.  Shorter
production   runs   support   lower   levels   of   finished   goods   and   work   in   process
inventories. In turn, shorter production runs allow lower levels of materials to be
maintained.

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248 Chapter 18

b. The FMS should allow production employment levels
to drop. With an FMS, most production activities are performed by machine
and fewer production employees are needed to operate/monitor the machines.
Also, the production layout for a typical FMS allows one employee to operate
multiple machines. Accordingly, relative to a traditional production system, an
FMS should require a lower number of production employees.

c. In a traditional production system, employees typically
perform manual conversion operations or operate a single machine. In an FMS,
machines are computer controlled, and one employee typically operates several
machines.   Thus,   how   machines   are   operated   and   the   number   of   machines
operated by a single employee differ significantly between traditional and FMS
production. Accordingly, existing employees would need substantial training to
function in an FMS environment.

32. The first consideration would be to keep the two remaining polishing
machines operating at peak efficiency. To do so would require that all flatware
entering the polishing operation be defect free. Thus, one would want to be certain
that   there   is   a   quality   inspection   that   immediately   precedes   the   polishing
operation.   Further,   one   would   want   to   recommend   that   the   two   remaining
machines   be  properly  maintained  so that   no additional   breakdowns  will  occur
while the third machine is being repaired.

To gain additional capacity, one could rent a machine from a vendor, or outsource
some of the polishing to an outside firm.

33. No, Promotional Products did not complete the 180 units by 5:00 P.M.

          TIME OF AFTERNOON           
1–2 2–3   3–4     4–5 Total
Dept. 1 output 40 44 50 46 180
Dept. 2 output 40 44 45 45 174
Dept. 2 backlog   0   0   5   1
Cumulative
Dept. 2
backlog   0   0   5   6       6*

*The robot can be counted on to finish 45 units per hour.

Although Dept. 1 averaged 45 units per hour, it was late getting six units to Dept. 2 in
the last two hours. Since the robot was constrained to 45 units per hour, it could
not handle the extra five units given it between 3:00 and 4:00 and the extra one
unit given it between 4:00 and 5:00.

34. $16,700; at the EOQ, the total annual carrying costs will equal the total annual
ordering costs. That is, the EOQ model minimizes the sum of ordering and carrying
costs and the minimum cost occurs where total ordering costs and total carrying
costs are equal.

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accessible website, in whole or in part.
Chapter 18 249

35. Storage $0.240

Handling 0.280
Insurance 0.440
Opportunity cost ($6.80 × 0.08)   0.544
  
Carrying cost $1.504

(Production labor cost is omitted.)
36. EOQ (Face cream) = √ (2QO ÷ C)
 = √ [(2  2,000  12.00) ÷ 2.00]
 = √ (24,000)
 = 155 (rounded)

EOQ (Lotion) = √ [2  1,000  40) ÷ 1.45]
                              = √ (55,172)
= 235 (rounded)

EOQ (Powder) = √ [(2 × 900 × 15) ÷ 1.25]
 = √ (21,600)
 = 147 (rounded)

37. EOQ = √ (2QO ÷ C)
 (EOQ)2 = 2QO ÷ C
(C × EOQ ) ÷ (2 × O) = Q
2

 Q = [0.35 × (1,600)2] ÷ (2  140)
= 896,000 ÷ 280
= 3,200 units

38. EPR = √ (2QS ÷ C)
= √ [(2  3,600  600) ÷ 2]
= √ (2,160,000)
= 1,470 units (rounded)

39. a. EPR = √ [(2  15,000  400) ÷ 2.50]
= √ (4,800,000)
= 2,191 units (rounded)

Avg. inventory = 2,191 ÷ 2 = 1,095.5 units
Number of orders per year = 15,000 ÷ 2,191 = 7 (rounded)
Carrying cost (1,095.5  $2.50) $2,738.75
Setup cost (7 × $400)                              2,800.00
Total cost $5,538.75

b. EPR = √ [(2  15,000  100) ÷ 10]
= √ (300,000) 
= 548 units (rounded)

Avg. inventory = 548 ÷ 2 = 274 units (rounded)
Number of orders per year = 15,000 ÷ 548 = 28 (rounded)
Carrying cost (274  $10) $2,740
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accessible website, in whole or in part.
250 Chapter 18

Setup cost (28  $100)                            2,800
Total cost $5,540

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accessible website, in whole or in part.
Chapter 18 251

PROBLEMS

40. a. Because it is presumably less costly to produce pork and eggs using traditional
methods, the cost to produce the pork and eggs is likely to be higher using the
more humane methods. Assuming the suppliers are able to pass their higher
costs on to Burger King, the prices Burger King pays for eggs and pork will
increase.

b. The Burger King policy is likely to be supported by some Burger King patrons
and opposed by others. Those who support the policy are likely to be willing to
pay higher prices for Burger King food, knowing that the higher prices allow
animals to be treated more humanely. However, other customers will be critical
of   the   higher   prices   based   on   the   argument   that   those   customers   had   no
objection to the former methods of producing eggs or pork. Such customers will
argue they are paying higher prices for food so Burger King can appease animal
rights activists.

c. The key ethical issue is the extent to which Burger King imposes unreimbursed
costs on its suppliers because of its new policy. It is ethically questionable for
Burger   King   to   demand   that   its   existing   suppliers   absorb   all   of   the   costs
associated   with   the   more   humane   methods   of   producing   pork   and   eggs.
Alternatively, a more ethical implementation of the new policy would require
that   Burger   King   reimburse   a   significant   portion   of   the   additional   costs   of
complying with its new supplier standards.

41. a. A key consideration would be to minimize the probability of having obsolete
products   and   product   components   on   hand.   With   the   rapid   rate   of   product
obsolescence,   the   firm   would   only   want   to   produce   to   satisfy   immediate
demand;   no   stockpiling   would   occur.  Also,   the   firm   would   want   to   have   a
production  system that  could be quickly  adapted  from the production  of one
product to another.

b. The   firm   would   want   to  use  a  pull­based  inventory  control   system.  Such  a
system would avoid the accumulation of materials and components that might
be rendered obsolete or unusable due to technical innovations within the firm
and by competitors.

c. It   would   have  the   effect   of  reducing   the  EPR.  The   EPR  would  be  reduced
because of the high carrying cost of inventory. Inventory carrying costs would
be high because included in the inventory carrying costs would be a component
to account for the cost of product obsolescence.
    (CMA adapted)

42. a. The controller would want to isolate just the variable costs—those costs that
vary with the number of orders processed. In this case, the relevant costs would
include the $0.90 of department supplies and $6.06 for phone expense.

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accessible website, in whole or in part.
252 Chapter 18

b. Similar to the ordering costs, the controller would only want to include those
costs that vary with the number of units stored. The variable costs include $0.15
for inventory insurance and $0.16 for obsolescence.

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accessible website, in whole or in part.
Chapter 18 253

43. a. The company produces only two products, so the production setting is likely
to 
be relatively simple. Because a significant portion of its sales are seasonal, the
company may choose to use a traditional push system. Using a push system, the
company   could   level   production   volume   throughout   the   year.   Alternatively,
with a pull system, the firm would produce at low volumes during part of the
year and very high volumes during part of the year. It would be very difficult to
maintain  level employment  and full  employment  of the production  facilities
using a pull system.

b. The  significant  variety  of  products  produced  along  with  the  high  unit  costs
argues   for  a   pull   system.   Using  a   traditional   push   system,   to  accommodate
significant   product   variety,   the   firm   would   have   to   carry   large   inventories.
Because   unit   costs   are   high,   the   carrying   costs   would   also   be   high.
Alternatively, with a pull system, units could be produced in small lots, which
would   facilitate   maintenance   of   low   inventories   and   low   carrying   costs   of
inventories.

c. Because the products have a short life cycle, there is significant risk associated
with carrying large inventories; therefore, the firm would prefer not to use a
push system that tends to require higher inventory levels than a pull system. A
pull system would allow the firm to maintain low inventories while meeting
sales demand. 

d. Firms seek to avoid the risk of carrying large stocks of products subject to
obsolescence, spoilage, or other risk factors. A pull system allows firms to meet
demand while maintaining smaller inventory levels; accordingly, a pull system
would be preferred in this case.

e. Because   the   products   have   long   life   cycles,   the   risk   of   maintaining   larger
inventories is minimal. Also, because the product mix is limited, there are only
small gains available to the quick setups and short production runs available
with a pull system. In this case, the production efficiencies associated with the
long production runs characteristic of a push system are likely to outweigh the
risks and costs of carrying the associated higher inventory levels.

44. a.  Successfully  using JIT to manage  inventory  requires  that  a firm  be able  to

quickly produce the quantity and mix of products ordered by its  customers.
However, this becomes more difficult as distance grows between the firm and
its suppliers or its customers. The logistical challenges of moving component
parts or finished goods thousands of miles is daunting.

b. Because of the difficulty of predicting the product mix, Koss was forced to
maintain excessive inventories of component parts (these inventories were not
managed on a JIT basis). Alternatively, by maintaining a reasonable level of
finished goods, Koss was able to dramatically reduce inventories of component
parts.

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accessible website, in whole or in part.
254 Chapter 18

c. A stock outage of a component part creates a problem with a longer lead time to
a solution. In the event of a finished goods outage, the lead time includes only
the time  to manufacture  another unit of product. However, in the case of a
component   stockout  that  results  in  a  finished  goods  stockout,  the  lead   time
includes the manufacturing time plus the time to order, ship, and receive the
required component. Thus, while Koss was managing finished goods on a JIT
basis, the firm maintained excessive inventories of component parts to avoid a
stockout   that   would   have   a   potentially   long   lead   time   for   a   solution.   Koss
decided   this   approach   was   inferior   to   the   alternative   of   holding   a   modest
inventory of finished goods that could be replenished from a modest stock of
component parts.

45. a. Because   the   new   product   is   described   as   “innovative,”   the   CFO   would   be
concerned about an introductory price that is lower than the life cycle average
price. In the usual circumstance, the highest price of the life cycle would occur
at the time the product is introduced because the product will be perceived by
the market to be “more different” from competing products at that time relative
to   later   in   the   product   life   cycle.   Thus,   the   CFO’s   expectation   is   that   the
introductory price should be significantly higher than $60.

b. This is a significant factor and would influence a price recommendation. If the
price is set high, volume of sales will suffer. If the price is set too low, volume
will increase, but unit contribution margin will be sacrificed. The goal is to set a
price that maximizes life cycle contribution margin.

c. Because the profit on electronic products tends to be highest in the early years
of the life cycle, it would be preferable to realize as much life cycle volume as
early as possible. Accordingly, the fact that Years 3 and 4 account for more life
cycle volume than Years 1 and 2 would cause the CFO concern.

46. a.   Yes.   The   royalties   realized   from   game   sales   will   vary   with   the   number   of
PlayStations sold. Thus, if the volume of PlayStation sales is sensitive to price,
a lower price should result in the sale of more units and more games as well.

b. Setting the price at $599 should result in significantly more sales early
in the product life cycle as well as for the total life cycle. The lower sales price
will make the product more attractive relative to competitors, which will not
only increase unit sales but may even discourage competitors from launching
products that are direct competitors  of the PlayStation because of the losses
those firms would likely sustain in trying to match Sony’s price.

c. The  practice   is  more  beneficial   if the   product  life  cycle   is  long.  A

longer life cycle would allow Sony to practice  kaizen costing techniques  to
reduce the cost of production relative to the sales price. Also, a longer life cycle
would allow the firm to earn more royalties on the sale of software.

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accessible website, in whole or in part.
Chapter 18 255

47. a.  Revenues
Year 1 100,000  $2.50 $    250,000
Year 2 250,000  $2.40 600,000
Year 3 350,000  $2.30 805,000
Year 4 500,000  $2.10 1,050,000
Year 5 600,000  $2.00 1,200,000
Year 6 450,000  $2.00 900,000
Year 7 200,000  $1.90 380,000
Year 8       
   130,000  $1.90         247,000
Totals   2,580,000 $ 5,432,000
Profit margin        
  (1,358,000)
Target cost $ 4,074,000

Unit target cost $4,074,000 ÷ 2,580,000 = $1.58

b. Total production cost estimate:
Fixed costs ($200,000  8) $1,600,000
Variable costs ($2.60  2,580,000)    
  6,708,000
Total $8,308,000

The comparison of the estimated production costs to the target production cost
is very unfavorable. Note that the expected, actual variable costs substantially
exceed the target cost. Hence, it is highly likely that the company will need to
redesign the product to bring actual cost into alignment with the target cost.
Kaizen methods alone cannot feasibly close the cost gap.

c. Because   the   target   and   expected   costs   are   far   apart,   the   company
should   strongly   consider   deferring   production   until   the   product   can   be
redesigned to reduce expected production costs.  

48. Using the data given, the target cost of production can be computed:
Estimated sales price  $215
Projected profit per unit           (35)
Projected selling & administrative costs           
  (40)
Target cost of production $140
Estimated cost of production:
Direct material $  70
Direct labor 40
Variable overhead 15
Fixed costs [($360,000  5) ÷ 180,000]       10
Total estimated actual cost $135

After integrating the marketing and engineering information, it is clear that the
prospects are favorable for launching a product that will generate more than the
expected level of gross margin. The expected cost of production is slightly below
the target cost of production. The gap between the two numbers should represent
additional profit.

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accessible website, in whole or in part.
256 Chapter 18

49. a. D
b. U
c. T
d. D, T
e. T
f. T
g. D
h. T
i. T
j. D, T 

50. a. Conversion Cost Control 40,000
Various accounts 40,000

Finished Goods Inventory 64,000
Accounts Payable 24,000
Conversion Cost Control 40,000

Accounts Receivable 116,000
Sales 116,000

Cost of Goods Sold 62,000
Finished Goods Inventory 62,000

b. Raw and In­Process Inventory 24,000
Accounts Payable 24,000

Conversion Cost Control 40,000
Various accounts 40,000

Cost of Goods Sold 62,000
Finished Goods Inventory 2,000
Raw and In­Process Inventory 24,000
Conversion Cost Control 40,000

Accounts Receivable 116,000
Sales 116,000

c. Cost of Goods Sold 62,000
Finished Goods Inventory 2,000
Accounts Payable 24,000
Various accounts 40,000

Accounts Receivable 116,000
Sales 116,000

d. Conversion Cost Control 40,000
Various accounts 40,000

Cost of Goods Sold 64,000

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accessible website, in whole or in part.
Chapter 18 257

Accounts Payable 24,000
Conversion Cost Control 40,000

Finished Goods Inventory 2,000
Cost of Goods Sold 2,000

Accounts Receivable 116,000
Sales 116,000

51. a. (1) Raw and In­Process Inventory 24,904,000
Material Price Variance 480
Accounts Payable 24,904,480

(2) Conversion Cost Control 3,000,000
Accumulated Depreciation 600,000
Cash 2,200,000
Accounts Payable 200,000

(3) Raw and In­Process Inventory 2,912,000
Conversion Cost Control 
(20,800  $140) 2,912,000

(4) No entry

(5) Conversion Cost Control 14,442,000
Accumulated Depreciation 4,000,000
Cash 9,325,000
Accounts Payable 1,117,000

(6) Raw and In­Process Inventory 14,448,000
Conversion Cost Control
(103,200  $140) 14,448,000

b. 103,200 rolls  0.4 = 41,280 yds.; 41,280  $2 = $82,560 increase

c. Material Quantity Engineering Change Variance  82,560
 Raw and In­Process Inventory           82,560

d. 103,200  (5 ÷ 240)  $140 = $301,000 saved

e. Conversion Cost Control                                    301,000
   Machine Hrs. Eng. Change Variance                                    301,000

f. Actual conversion cost ($3,000,000 + $14,442,000) $ 17,442,000
Machine hours engineering change           301,000
Revised conversion cost $ 17,743,000
Applied conversion cost ($2,912,000 + $14,448,000)        (17,360,000)
Underapplied $      383,000

g. Increase in material cost per roll (0.4  $2) $ 0.80
Decrease in conversion cost per roll [(5 ÷ 60)  $35]                  
  (2.92)

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accessible website, in whole or in part.
258 Chapter 18

Net decrease in cost per roll                $(2.12)

Yes, the changes are cost beneficial.

52. a. Whether this is an ethical practice depends on the rationale for the oil and gas
industry to adopt JIT. Assuming the industry has migrated to JIT because JIT
reduces   long­run  costs   of   producing   petroleum   products,   there   is   no  ethical
issue. Alternatively,  if the industry has embraced  JIT because JIT mandates
lean   inventories,  and  in  turn,  lean  inventories,   allow   the  industry  to  exploit
supply chain shocks (e.g., hurricanes), by increasing prices, then the practice is
ethically questionable.

b. The theory of constraints focuses managerial attention on maximizing the return
a firm realizes on a constrained resource. If oil and gas products are treated as
the constrained resource, management would focus on finding ways to generate
the maximum output from the supply of oil and gas inputs available.

c. Firms that are heavily dependent on oil and gas inputs could do any of the
following:
(1) develop alternative and multiple sources of supply;
(2) develop forward contracts for required supplies of oil and gas products;
(3) diversify outputs so that some outputs are less energy intensive; or
(4) acquire alternative energy sources such as wind, solar, and ethanol.

d. It is certainly true that (collectively) the U.S. government makes more profit per
gallon of gasoline sold than do the oil and gas companies. Assuming a gas tax is
an ethical source of government support, it can be argued that this is an ethical
tax   because   those   who   use   the   most   energy   (and   are   contributing   most
significantly to energy shortages) bear the greatest tax. Further, the higher the
tax rate, the greater is the negative impact on demand for energy and the lower
is   energy   consumption.   One   could   argue   that   the   tax   would   be   made   more
ethical if those who are at the greatest disadvantage because of high energy
prices (e.g., poor and elderly) received energy cost subsidies from the energy
taxes collected by government.

53. a. EOQ = √ [(2  7,000  32.00) ÷ 0.50]
 = √ (896,000)
 = 947 pounds (rounded)

b. Average daily usage = 7,000 ÷ 365 = 19.18 lbs.
Order point = [19.18  (12 + 7)] = 364 lbs. (rounded)

54. a. EPR = √ (2QS ÷ C)
= √ [(2  30,000  $50) ÷ $0.25]
= √ (12,000,000)
= 3,464 pounds (rounded)

b. Number of runs = 30,000 ÷ 3,464 = 9 runs (rounded)

c. EOQ (seed) = √ (2QO ÷ C)
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly
accessible website, in whole or in part.
Chapter 18 259

= √ [(2  30,000  2  2  $4.25) ÷ $0.01]
= √ (102,000,000)
= 10,100 seeds (rounded)

EOQ (fertilizer) = √  [(2  30,000  0.25  $8.80) ÷ $0.05]
 = √ (2,640,000)
 = 1,625 pounds of fertilizer (rounded)

d. Seed orders = (30,000  2  2) ÷ 10,100 = 12 orders (rounded)
Fertilizer orders = (30,000  0.25) ÷ 1,625 = 5 orders (rounded)

e. Total cost:
Average inventory:
Onions: 3,464 ÷ 2 = 1,732 lbs.
Seeds: 10,100 ÷ 2 = 5,050 seeds
Fertilizer: 1,625 ÷ 2 = 812.5 lbs.
Carrying costs:
Onions: 1,732  $0.25 $433.00
Seeds: 5,050  $0.01      50.50
Fertilizer: 812.50  $0.05        40.63 $   524.13
Ordering costs:
Seeds: 12  $4.25 $   51.00
Fertilizer: 5  $8.80        44.00        95.00
Setup costs:
Onions: 9  $50.00        450.00
Total cost $1,069.13

f. The growing of onions is very similar in most respects to a
factory production setting. However, the length of time from the beginning of
the process to the end of the process is likely to be much longer and therefore
requires   more  careful  planning.  An  incorrect  estimate  of  demand  cannot   be
remedied in any time shorter than the growing cycle of the onion plant. Also,
weather   and   local   growing   conditions   may   be   additional   constraints   on   the
production decision. Further, the yield is likely to vary much more for onions
than other production processes because some of the critical inputs are beyond
the control of managers (sunshine and rain, for example).

g. Yes, there are some inconsistencies. Because the growing of
onions is a cyclical event, as opposed to a continuous event, there should be a
very close relationship between the required quantities of onions, fertilizer, and
seeds. Inventories should be minimal and be ordered in quantities that match
input requirements for each growing cycle. The EOQ quantities differ from the
cycle quantities.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly
accessible website, in whole or in part.