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 1. 2. 3. 4. 5. Five assumptions made when using the simplest version of the EOQ model are: The same quantity is ordered at each reorder point. Demand, ordering costs, carrying costs, and the purchase-order lead time are certain. Purchasing cost per unit is unaffected by the quantity ordered. No stockouts occur. 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. Step 2: Compute the monetary outcome from the best action based on the incorrect amount of the predicted cost input. Step 3: Compute the difference between the monetary outcomes from Steps 1 and 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...
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