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chapter

27(12)
Cost Management for Just-in-Time Environments
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OPENING COMMENTS
Just-in-time was introduced briefly in Chapter 18(3). This chapter provides an opportunity to expand on that topic by applying the concepts of just-in-time to lead time, plant layout, employee empowerment, and supplier partnering. The chapter also presents the costs of quality and the differences between valueadded and non-value-added activities. Because these topics are receiving so much press, it would be relatively easy for your students to find newspaper or magazine articles discussing the many elements of just-in-time manufacturing. You may want to require your students to locate and summarize an article from a current periodical. As an alternative, you could offer bonus points to any student who is willing to make a two- to three-minute presentation to the class based on a just-in-time article found in The Wall Street Journal, in a local newspaper, or on the Internet. After studying this chapter, your students should be able to: 1. 2. 3. 4. Describe just-in-time manufacturing practices. Apply just-in-time practices to a nonmanufacturing setting. Describe the implications of just-in-time manufacturing on cost accounting and performance measurement. Describe and illustrate activity analysis for improving operations.

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STUDENT FAQS
Why is just-in-time manufacturing considered made-to-order, custom-order, short, or lean manufacturing? What is the difference between value-added lead time and non-value-added lead time in just-in-time manufacturing? Why does just-in-time emphasize product-oriented layout, whereas traditional manufacturing disregards setup time as an improvement priority? Why is all in-process work combined with raw materials to form a new account Raw and In-Process (RIP) Inventory under just-in-time manufacturing? What are the controlling costs of quality using activity analysis? Why are prevention and appraisal costs considered costs of controlling quality, whereas internal and external failure costs are costs of failing to control quality? What is the purpose of a Pareto chart of quality costs? Why is direct labor put into a cost account called Conversion Cost under just-in-time accounting?

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For Chapter 27(12) 27(12) Cost Management for Just-inTime Environments

IN-CLASS AND HOMEWORK ASSIGNMENT CHART


Number EO27(12)-1 EO27(12)-2 EO27(12)-3 EO27(12)-4 EO27(12)-5 EO27(12)-6 Objective 27(12)-1 27(12)-1 27(12)-1 27(12)-1 27(12)-1 27(12)-2 Description Difficulty Easy Easy Easy Easy Easy Easy Time 5 min 5 min 5 min 5 min 5 min 5 min AACSB Analytic Analytic Analytic Analytic Analytic Analytic IMA Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management SS GL

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Number EO27(12)-7 EO27(12)-8 EO27(12)-9 EO27(12)-10 EO27(12)-11 EO27(12)-12 EO27(12)-13 EO27(12)-14 EO27(12)-15 EO27(12)-16 EO27(12)-17 PE27(12)-1A PE27(12)-1B PE27(12)-2A PE27(12)-2B PE27(12)-3A PE27(12)-3B PE27(12)-4A PE27(12)-4B PE27(12)-5A PE27(12)-5B Ex27(12)-1 Ex27(12)-2 Ex27(12)-3 Ex27(12)-4 Ex27(12)-5 Ex27(12)-6 Ex27(12)-7 Ex27(12)-8 Ex27(12)-9 Ex27(12)-10 Ex27(12)-11 Ex27(12)-12 Ex27(12)-13

Objective 27(12)-2 27(12)-3 27(12)-3 27(12)-3 27(12)-3 27(12)-3 27(12)-4 27(12)-5 27(12)-5 27(12)-5 27(12)-5 27(12)-1 27(12)-1 27(12)-2 27(12)-2 27(12)-3 27(12)-3 27(12)-2, 27(12)-4 27(12)-2, 27(12)-4 27(12)-4 27(12)-4 27(12)-1 27(12)-1 27(12)-1 27(12)-1 27(12)-1 27(12)-1 27(12)-1 27(12)-1, 27(12)-2 27(12)-1 27(12)-1 27(12)-3 27(12)-3 27(12)-3

Description

Lead time Lead time Just-in-time features Just-in-time features Just-in-time journal entries Just-in-time journal entries Cost of quality report Cost of quality report Process activity analysis Process activity analysis Just-in-time principles Just-in-time as a strategy Just-in-time principles Lead time analysis Reduce setup time Calculate lead time Calculate lead time Lead time calculation doctor's office Supply chain management Employee involvement Lead time reductionservice company Just-in-time fast food restaurant Accounting issues in a just-in-time environment Just-in-time journal entries Just-in-time journal entries Just-in-time journal entries Pareto chart Cost of quality report Pareto chart for a service company Cost of quality and value-added/non-valueadded reports Process activity analysis

Difficulty Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy

Time 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 5 min 10 min 10 min 10 min 10 min 15 min 15 min 15 min 15 min 20 min 15 min 15 min 20 min 20 min

AACSB Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic

IMA Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management

SS

GL

Exl Exl Exl

Ex27(12)-14 Ex27(12)-15 Ex27(12)-16 Ex27(12)-17 Ex27(12)-18 Ex27(12)-19 Ex27(12)-20

27(12)-3 27(12)-3 27(12)-3 27(12)-4 27(12)-4 27(12)-2, 27(12)-4 27(12)-2, 27(12)-4 27(12)-4

Easy Easy Easy Moderate Moderate Moderate Moderate

20 min 15 min 15 min 20 min 20 min 30 min 30 min

Analytic Analytic Analytic Analytic Analytic Analytic Analytic

Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management Exl

Ex27(12)-21

Moderate

30 min

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Number Ex27(12)-22 Ex27(12)-23 Pr27(12)-1A Pr27(12)-2A Pr27(12)-3A Pr27(12)-4A

Objective 27(12)-2, 27(12)-4 27(12)-2, 27(12)-4 27(12)-1 27(12)-1 27(12)-3 27(12)-4, 27(12)-5 27(12)-1 27(12)-1 27(12)-3 27(12)-4, 27(12)-5 27(12)-2 27(12)-2 27(12)-3 27(12)-5

Description Process activity analysis Process activity analysis Just-in-time principles Lead time Just-in-time accounting Pareto chart and cost of quality report manufacturing-company Just-in-time principles Lead time Just-in-time accounting Pareto chart and cost of quality report municipality Ethics and professional conduct in business Just-in-time principles Just-in-time principles Value-added and nonvalue-added activity costs Lead time

Difficulty Moderate Moderate Moderate Moderate Difficult Difficult

Time 30 min 30 min 45 min 45 min 1 1/2 hr 1 1/2 hr 45 min 45 min 1 1/2 hr 1 1/2 hr 30 min 30 min 30 min 45 min

AACSB Analytic Analytic Analytic Analytic Analytic Analytic

IMA Cost Management Cost Management Cost Management Cost Management Cost Management Cost Management

SS Exl Exl

GL

Exl Exl

Pr27(12)-1B Pr27(12)-2B Pr27(12)-3B Pr27(12)-4B

Moderate Moderate Difficult Difficult

Analytic Analytic Analytic Analytic

Cost Management Cost Management Cost Management Cost Management

Exl Exl

SA27(12)-1 SA27(12)-2 SA27(12)-3 SA27(12)-4

Moderate Moderate Moderate Moderate

Ethics Analytic Analytic Analytic

Ethical Considerations Cost Management Cost Management Cost Management

SA27(12)-5

27(12)-1

Difficult

1 hr

Analytic

Cost Management

OBJECTIVE 1
Describe just-in-time manufacturing practices.

KEY TERMS
Electronic Data Interchange (EDI) Employee Involvement Enterprise Resource Planning (ERP) Just-in-Time Manufacturing Lead Time Non-Value-Added Lead Time Process-Oriented Layout Product-Oriented Layout Pull Manufacturing Push Manufacturing Radio Frequency Identification Devices (RFID) Six-Sigma Supply Chain Management Value-Added Lead Time Value-Added Ratio

SUGGESTED APPROACH
Just-in-time (JIT) processing is not just a method of reducing inventory. It is embraced as a philosophy that emphasizes eliminating waste from all processes. Inventory is simply a buffer that protects a process against unreliability (such as poor supplier delivery or machinery that breaks down frequently). Reducing inventory levels without correcting the problems that create unreliability will stop production. Constructing a reliable system will eliminate the need for an inventory buffer.

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Exhibit 1 in the text compares the principles of just-in-time manufacturing with a traditional manufacturing system. Review this chart with your class, explaining the concepts of lead time, production layout, and production scheduling. Follow this introduction with the in-class simulation provided below. Objective 1 also introduces the concepts of value-added and non-value-added lead time. Your students will find it helpful if you lead a discussion that distinguishes between value-added and non-value-added activities.

IN-CLASS SIMULATIONJust-in-Time Manufacturing


The instructors materials for Chapter 18(3) included instructions for conducting an in-class simulation demonstrating the effect of a demand-pull system with manufacturing cells. If you did not have time to run this simulation when introducing JIT in Chapter 18(3), consider doing it now. Even if you used the simulation in Chapter 18(3), you may want to repeat it. This JIT simulation provides a powerful example of the changes that occur when a manufacturer moves from a process-oriented push system to a productoriented pull system. For convenience, the instructions for this simulation will be repeated here. Just-in-time is essentially a pull system. Products are not made until they are needed by the customer, and component parts are not made until they are needed by the next stage of production. Just-in-time significantly reduces inventories, allowing manufacturers to reduce costs incurred in moving and storing inventory. Just-in-time also emphasizes quality. You can simulate the difference between the traditional push system and the pull system of just-in-time in your classroom. You will need scrap paper, four pens, a stapler, and six volunteers. Divide the scrap paper between two volunteers. Instruct one student to write an A on his or her pieces of paper, and ask the other to write a B. Use another volunteer as an expediter to collect the completed A and B papers and carry them to a fourth volunteer, who staples the papers together. The fifth volunteer picks up the stapled sets of paper and delivers them to the sixth volunteerthe customer. For the first simulation, instruct all volunteers to do their assigned tasks as quickly as possible. Tell them to assume they are being evaluated based on the quantity they produce. Allow them to work for 30 seconds, then stop the production line. Announce that the customer wants to change the color of the ink used to write the As and Bs, effective immediately. Therefore, any work in process will need to be scrapped. Count the scrapped sheets. Allow your students to work for another 30 seconds. Ask your customer to count the completed products he or she received. You may also want to ask a student with a stopwatch to measure cycle time by timing how long it took to get the first completed unit to the customer. Run this simulation a second time, but this time institute a pull system. Instruct all workers that they are not to make a new product (or component) until it is needed for the next stage of production. Also ask them to focus on quality, not quantity. In addition, change to a product-oriented layout by physically moving the students who are writing letters close enough to the student stapling the papers so that an expediter is not needed to move the papers from one station to the next. Allow your students to work for 30 seconds. At that time stop production, announce another ink color change, and collect any work in

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process as scrap. Start up the production line again for another 30 seconds. Ask your customer to count the completed products received and note the cycle time. You should find that the number of completed units is about the same under either system. However, the amount of scrap will be dramatically reduced under the just-in-time system. In addition, you may want to ask your customer to compare the quality of the output. It should be significantly higher under the second simulation.

GROUP LEARNING ACTIVITYResults of Just-in-Time Manufacturing Simulation


Divide your class into five groups. Ask each group to discuss the results of the manufacturing simulation, concentrating on one of the areas listed below. Group 1: Amount of Inventories Group 2: Lead Time Needed to Produce the Product Group 3: Production Layout Group 4: Work Schedulingwho/what determined when each worker performed a task Group 5: Quality In their discussion, your students should identify the changes that occurred between the two manufacturing systems. These group assignments are also listed on TM 27(12)-1. After a few minutes, ask each group to share its observations.

LECTURE AIDValue-Added vs. Non-Value-Added


Each activity performed by an organization creates cost. If the activity does not create any value for the customer, its cost represents wasted resources. The following questions can aid students in determining if an activity is value-added or non-value-added. 1. 2. 3. 4. 5. Given a choice, would the customer pay for this activity? If you quit performing this activity, would the customer care? If you quit performing this activity, would the output still meet customer requirements? Could you eliminate this activity if some other activity were done correctly or differently? Would re-engineering the system eliminate this activity?

A yes answer to questions 1 or 2 indicates a value-added activity. A yes answer to questions 3, 4, or 5 indicates a non-value-added activity.

GROUP LEARNING ACTIVITYValue-Added vs. Non-Value-Added


TM 27(12)-2 lists the activities used by a catalog sales company to process and ship a customer order. Divide your class into groups and ask them to classify each activity as value-added lead time or nonvalue-added lead time. Items 2, 4, 6, 8, and 9 are non-value-added.

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DEMONSTRATION PROBLEMWithin-Batch Wait Time


Any student who has ever waited in line at your colleges registration or financial aid offices will agree that wait time is non-value-added. To illustrate within-batch wait time, make a comparison to a hypothetical doctors office. Assume that a doctor spends, on average, 10 minutes with each patient. Of course, some patients require more time and others require less. Some patients arrive early for their appointment and some arrive late. To allow the doctor to see the most patients and eliminate down-time, three patients are scheduled during every thirty-minute interval. For example, three patients are scheduled at 9:00 and three more are scheduled at 9:30. In effect, the doctor has a batch of three patients at a time. The last patient to be seen in each batch has 20 minutes of non-value-added wait time (assuming the doctor is on schedule) and 10 minutes of value-added time with the doctor. This may be efficient from the doctors point of view, but it is not efficient from the patients perspective. The patients lead time is increased because of the batch concept. If the doctor moved to a one-piece flow concept and scheduled one patient every 10 minutes, theoretically, the wait time would be eliminated. Now, lets move to a manufacturing example. Assume a product is produced in batches of 20 units at a time. Each unit takes 5 minutes of processing time. It will take 100 minutes (20 units 5 minutes each) to process the entire batch. Each unit will be waiting during the time the other 19 units are being worked on. Therefore, the within-batch wait time is calculated as follows: Within-batch wait time = Processing time (Number of units in batch 1) = 5 minutes (20 1) = 5 minutes 19 = 95 minutes The lead time can be analyzed as follows: Lead Time % of Total Value-added lead time (processing time) 5 minutes 5% Non-value-added lead time (within-batch wait time) 95 minutes 95% Total 100 minutes 100%

OBJECTIVE 2
Apply just-in-time practices to a nonmanufacturing setting.

SUGGESTED APPROACH
Review Exhibits 5 and 6 with your class, explaining how just-in-time principles can be applied in a nonmanufacturing setting, such as the hospital used in these exhibits. You may want to have students apply JIT to a different nonmanufacturing process with which they may be familiar, such as the college or university in which they are enrolled. Ask them to identify the process and the product of the process and to draw a rough sketch of a JIT layout for that process.

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GROUP LEARNING ACTIVITYValue-Added vs. Non-Value-Added


Use TM 27(12)-2. Divide your student into groups and ask them to evaluate the process describe and make recommendation on how JIT practices could be used to improve processes both for customers and the catalog sales company.

OBJECTIVE 3
Describe the implications of a just-in-time manufacturing on cost accounting and performance measurement.

KEY TERMS
Backflush Accounting Conversion Costs Nonfinancial Measure Raw and In Process (RIP) Inventory

SUGGESTED APPROACH
The implementation of a JIT system will require modifications to an organizations cost accounting system. Use the lecture aids and demonstration problems that follow to illustrate these changes.

LECTURE AIDAccounting in a JIT System


Remind your students of the following characteristics found in cost accounting systems used by JIT manufacturers. 1. Raw and In-Process (RIP) Inventory: One of the ways JIT seeks to reduce inventories is by using supplier partnering. Materials are delivered in small batches and taken directly into production without any receiving inspection. As a result, there is no pick transaction where materials are taken out of Materials Inventory and moved to Work in Process. Therefore, these accounts are combined into Raw and In-Process (RIP) Inventory. Conversion Costs: Since workers are cross-trained to perform both direct labor and indirect labor functions (such as maintenance or quality inspection), it becomes increasingly difficult to separate direct labor and overhead costs. Therefore, it may be necessary to develop a conversion cost rate that applies both direct labor and overhead costs to the product. Direct Tracing of Overhead: Since production layouts are organized into specific product cells, it is easier to trace overhead costs to products. For example, if you have three machines each making three different products, the depreciation for the machines must be added up and divided among the three products. If the layout is changed so that each machine makes only one product, you know exactly how much depreciation needs to be assigned to each product.

2.

3.

DEMONSTRATION PROBLEMAccounting in a JIT System


To simplify the accounting under JIT to a principles level, the text only illustrates scenarios where there is no variance between actual and budgeted manufacturing costs.

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Assume that LeForge Industries manufactures ceramic bakeware in a JIT System. The materials cost to make one of LeForges baking dishes is $2. The budgeted labor and overhead costs for 100,000 production hours are $400,000. Each dish requires 0.75 hours of processing time. During February, 11,000 baking dishes were produced. First of all, point out that the conversion cost per unit is $3. This may be calculated as follows:
Budgeted Conversion Cost Rate $400,000 $4 per production hour 100,000

Conversion Cost per Unit $4 per hour 0.75 hours per unit $3

Next, illustrate the journal entries. The purchase of the materials to make the 11,000 dishes would be recorded directly into Raw and In-Process Inventory, as follows: Raw and In-Process Inventory Accounts Payable 22,000 22,000

After recording materials, LeForge would need to determine the amount of conversion costs that should be applied to the 11,000 dishes. LeForges conversion cost is $3 per unit; therefore, $33,000 of conversion costs would be applied into Raw and In-Process Inventory. Raw and In-Process Inventory Conversion Costs 33,000 33,000

You may want to mention that actual conversion costs (such as wages paid to factory workers, supplies used, depreciation on factory equipment, etc.) would be debited to the conversion costs account as they are incurred. The 11,000 completed units are transferred to finished goods based on their production cost, which includes $2 per unit for materials and $3 per unit for conversion costs. Finished Goods Inventory Raw and In-Process Inventory 55,000 55,000

Assume 10,700 of the units completed were sold to customers at a sales price of $9 per unit. Shipping the dishes to customers would be recorded with the following entries: Accounts Receivable Sales Cost of Goods Sold Finished Goods Inventory 96,300 96,300 53,500 53,500

This leaves $1,500 (300 units $5/unit) in the finished goods inventory account.

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CLASS DISCUSSIONNonfinancial Measures


Nonfinancial measures are performance measures that are not stated in terms of dollars but are quantifiable, such as lead time, number of defects, or percentage of orders delivered on-time. These measures are very important to the long-term success of an organization. Ask your students to develop nonfinancial measures for a pizza-delivery business. Remind them that measures related to the amount of sales or keeping costs within budget are financial measures. You may want to suggest that they first identify critical success factors for a pizza-delivery business and then identify ways to measure if the business is improving in these areas. It may be helpful to allow your students to discuss their ideas in small groups before opening the floor for a full-class discussion. Possible responses: Expect a variety of responses here but students should focus on delivery time, number of deliveries per round trip, wait time in store, efficiency of routing, waste due to lost sales, to name a few.

OBJECTIVE 4
Describe and illustrate activity analysis for improving operations.

KEY TERMS
Activity Analysis Appraisal Costs Cost of Quality Report Costs of Quality External Failure Costs Internal Failure Costs Non-Value-Added Activity Pareto Chart Prevention Costs Process Value-Added Activity

SUGGESTED APPROACH
TM 27(12)-3 lists the four categories of quality costs (prevention, appraisal, internal failure, and external failure). Review these terms with your class. Display TM 27(12)-4, which presents a Pareto chart showing costs related to quality at Sycamore Manufacturing. Emphasize that a Pareto chart is simply a bar chart with amounts ranked from the largest on the left to the smallest on the right. Ask your students to classify each of the costs as a prevention, appraisal, internal failure, or external failure cost. Next, ask them to produce a cost of quality report using the format shown in Exhibit 10 in the text. A solution is presented on TM 27(12)-5.

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CLASS DISCUSSIONValue-Added and Non-Value-Added Activities


Display TM 27(12)-4, which lists the quality costs for Sycamore Manufacturing. Each of these qualityrelated activities can be labeled as value-added or non-value-added. Ask your students to categorize the quality costs. The text identifies prevention and appraisal as value-added activities. Internal and external failures are considered non-value-added. Some consultants in the quality area encourage companies to think of inspection (an appraisal cost) as non-value-added. Their philosophy is that quality should be designed into the production process rather than relying on inspection. You can probably spark a lively debate on this topic. Ask your students to assume they have taken their tax information to an accountant in order to have their tax return prepared. The accountant will assign the tax return to one of her staff to do the actual preparation work. After the return is completed, the accountant will review it for accuracy. Ask your students if the review is value-added or non-valueadded. Most will consider the review value-added. Next, explain that they will be billed $40 per hour for the time the staff member spent preparing the return and $80 per hour for the time the accountant reviewed the return. Do they want to pay for this review? Is it really value-added? What could be done to eliminate the need for a review? Close by reminding students that labeling an activity as non-value-added is a signal that the activity should be eliminated if possible. If the activity cannot be eliminated, the goal is to reduce the cost of the activity and/or the time spent on the activity. Managers will not always agree on whether an activity is value-added or non-value-added. Possible response: Activities 1, 2, and 4 could be considered non-value added activities.

CLASS DISCUSSIONActivity Analysis for a Process


TM 27(12)-6 presents cost information about the process of receiving raw materials at Logan Manufacturing. This TM lists the steps in the process, the cost of each step, the cost of each step as a percentage of the total, and the cost to process each raw material shipment. Ask your students to comment on how management at Logan Manufacturing could use this data to improve operations. Your students should point out that inspecting raw materials is the largest cost; therefore, it would draw the most management attention. Hopefully, this data would motivate management to seek ways to reduce or eliminate the need for inspecting raw materials through supplier partnering. The data also give management a means to quantify the cost savings of any process improvements. For example, if supplier partnering and confidence in the quality of raw materials allow the company to cut inspections in half, Logan will save $25,500 per year or $42.50 per shipment. Point out that gathering the data presented in TM 27(12)-6 is not an easy task. Costs are usually recorded in accounting records by department. There may be a general ledger account showing the total wages expense for quality inspectors, but if inspectors review raw materials and finished products, the total wages must be allocated between the different types of inspections.