CHAPTER 20
INVENTORY MANAGEMENT, JUST-IN-TIME,
AND SIMPLIFIED COSTING METHODS
20-1 Cost of goods sold (in retail organizations) or direct materials costs (in organizations with
a manufacturing function) as a percentage of sales frequently exceeds net income as a percentage
of sales by many orders of magnitude. In the Kroger grocery store example cited in the text, cost
of goods sold to sales is 76.8%, and net income to sales is 0.1%. Thus, a 10% reduction in the
ratio of cost of goods sold to sales (76.8 to 69.1% equal to 7.7%) without any other changes can
result in a 7800% increase in net income to sales (0.1% plus 7.7% equal to 7.8%).
20-2 Six cost categories important in managing goods for sale in a retail organization are the
following:
1. purchasing costs;
2. ordering costs;
3. carrying costs;
4. stockout costs;
5. costs of quality; and
6. shrinkage costs
20-3 Five assumptions made when using the simplest version of the EOQ model are:
1. The same quantity is ordered at each reorder point.
2. Demand, ordering costs, carrying costs, and the purchase-order lead time are certain.
3. Purchasing cost per unit is unaffected by the quantity ordered.
4. No stockouts occur.
5. Costs of quality and shrinkage costs are considered only to the extent that these costs affect
ordering costs or carrying costs.
20-4 Costs included in the carrying costs of inventory are incremental costs for such items as
insurance, rent, obsolescence, spoilage, and breakage plus the opportunity cost of capital (or
required return on investment).
20-5 Examples of opportunity costs relevant to the EOQ decision model but typically not
recorded in accounting systems are the following:
1. the return forgone by investing capital in inventory;
2. lost contribution margin on existing sales when a stockout occurs; and
3. lost contribution margin on potential future sales that will not be made to disgruntled
customers.
20-6  | The steps in computing the costs of a prediction error when using the EOQ decision
model are:
Step 1:  | Compute the monetary outcome from the best action that could be taken, given
the actual amount of the cost input.
Compute the monetary outcome from the best action based on the incorrect
amount of the predicted cost input.
Compute the difference between the monetary outcomes from Steps 1 and 2.
Step 2:
Step 3:
20-2
20-7 Goal congruence issues arise when there is an inconsistency between the EOQ decision
model and the model used for evaluating the performance of the person implementing the model.
For example, if opportunity costs are ignored in performance evaluation, the manager may be
induced to purchase in a quantity larger than the EOQ model indicates is optimal.
20-8 Just-in-time (JIT) purchasing is the purchase of materials (or goods) so that they are
delivered just as needed for production (or sales). Benefits include lower inventory holdings
(reduced warehouse space required and less money tied up in inventory) and less risk of
inventory obsolescence and spoilage.
20-9  | Factors causing reductions in the cost to place purchase orders of materials are:
  | Companies are establishing long-run purchasing agreements that define price and
quality terms over an extended period. Companies are using electronic links, such as the Internet, to place purchase orders.
 Companies are increasing the use of purchase-order cards.
20-10 Disagree. Choosing the supplier who offers the lowest price will not necessarily result in
the lowest total purchase cost to the buyer. This is because the price or purchase cost of the
goods is only one—and perhaps, most obvious—element of cost associated with purchasing and
managing inventories. Other relevant cost items are ordering costs, carrying costs, stockout costs,
quality costs, and shrinkage costs. A low-cost supplier may well impose conditions on the
buyer—such as poor quality, or frequent stockouts, or excessively high inventories—that result
in high total costs of purchase. Buyers must examine all the elements of costs relevant to
inventory management, not just the purchase price.
20-11 Supply-chain analysis describes the flow of goods, services, and information from the
initial sources of materials and services to the delivery of products to consumers, regardless of
whether those activities occur in the same company or in other companies. Sharing of
information across companies enables a reduction in inventory levels at all stages, fewer
stockouts at the retail level, reduced manufacture of product not subsequently demanded by
retailers, and a reduction in expedited manufacturing orders.
20-12 Just-in-time (JIT) production is a “demand-pull” manufacturing system that has the
following features:
 Organize production in manufacturing cells,
 Hire and retain workers who are multi-skilled,
 Aggressively pursue total quality management (TQM) to eliminate defects,
 Place emphasis on reducing both setup time and manufacturing cycle time, and
 Carefully select suppliers who are capable of delivering quality materials in a timely
manner.
20-13 Traditional normal and standard costing systems use sequential tracking, in which journal
entries are recorded in the same order as actual purchases and progress in production, typically at
four different trigger points in the process.
Backflush costing omits recording some of the journal entries relating to the cycle from
purchase of direct materials to sale of finished goods, i.e., it has fewer trigger points at which
journal entries are made. When journal entries for one or more stages in the cycle are omitted,
20-3
the journal entries for a subsequent stage use normal or standard costs to work backward to
“flush out” the costs in the cycle for which journal entries were not made.
20-14 Versions of backflush costing differ in the number and placement of trigger points at
which journal entries are made in the accounting system:
Number of
Journal Entry
Trigger Points | Location in Cycle Where
Journal Entries Made
Version 1  | 3  | Stage A. Purchase of direct materials and incurring of
conversion costs
Stage C. Completion of good finished units of product
Stage D. Sale of finished goods
Version 2  | 2  | Stage A. Purchase of direct materials and incurring of
conversion costs
Stage D. Sale of finished goods
Version 3  | 2  | Stage C. Completion of good finished units of product
Stage D. Sale of finished goods20-15 Traditional accounting systems cost individual products, and separate product costs from
selling, general, and administrative costs. Lean accounting costs the entire value stream instead
of individual products. Rework costs, unused capacity costs, and common costs that cannot be
reasonably assigned to value streams are excluded from value stream costs. In addition, many
lean accounting systems expense material costs the period they are purchased, rather than storing
them on the balance sheet until the products using the material are sold.
20-16 (20 min.) Economic order quantity for retailer.
1. D = 10,000 jerseys per year, P = $200, C = $7 per jersey per year
7
2 10,000 $200
C
2 DP
EOQ     = 755.93  756 jerseys
2. Number of orders per year =
EOQ
D
=
756
10,000
= 13.22  14 orders
3.
working day
Demand each
=
Number