Questions for Writing and Discussion

Chapter 14 Managerial Accounting

1. What are the ordering costs? Provide examples.

Answer
Ordering costs are the costs of placing and receiving an order. Examples include clerical
costs, documents, insurance, and unloading.
2. What are setup costs? Illustrate with examples.
Answer
Setup costs are the costs of preparing equipment and facilities so that they can be used for
producing a product or component. Examples include wages of idled production workers,
lost income, and the costs of test runs.
3. What are the carrying costs? Illustrate with examples.
Answer
Carrying costs are the costs of maintaining inventory. Examples include insurance, taxes,
handling costs, and the opportunity cost of capital tied up in inventory.
4. What are stockout costs?
Answer
Stockout costs are the costs of insufficient inventory (e.g., lost sales and interrupted
production).
5. Explain why, in the traditional view of inventory, carrying costs increase as ordering
costs decrease.
Answer
As ordering costs decrease, fewer and larger orders must be placed. This, in turn,
increases the units in inventory and, thus, increases carrying costs.
6. Discuss the traditional reasons for carrying inventory.
Answer
Reasons for carrying inventory include the following: (a) to balance setup and to carry
costs; (b) to satisfy customer demand; (c) to avoid shutting down manufacturing
facilities; (d) to take advantage of discounts; and (e) to hedge against future price
increases.
7. What is the economic order quantity?
Answer
The economic order quantity is the amount that should be ordered to minimize the sum of
ordering and carrying costs.
8. Suppose that a material has a lead time of days and that the average usage of the material
is 12 units per day. What is the r What is the cause stock if the maximum usage is 15
units per day safety stock?
Answer
Reorder point = 3 × 12 = 36 units; Safety stock = 3(15 – 12) = 9 units
9. Explain how safety stock is used to deal with demand uncertainty.
Answer
Safety stock is the difference between maximum and average demand multiplied by the
lead time. By reordering whenever the inventory level hits the safety stock point, a
company is ensured of always having sufficient inventory to meet demand.
10. What approach does JIT take to minimize total inventory costs?
Answer
JIT minimizes carrying costs by driving inventories to insignificant levels. Ordering
costs are minimized by entering into long-term contracts with suppliers (or going se tup
times to zero).
11. What is JIT manufacturing? List five ways in which JIT manufacturing differs from
traditional manufacturing.
Answer
JIT manufacturing is a demand-pull approach to manufacturing. It differs from traditional
manufacturing by significantly reducing reliance on inventories, forming manufacturing
cells, using interdisciplinary labor, decentralizing services, and adopting a total quality
management philosophy.
12. What are manufacturing cells? Explain how they differ from production departments
Answer
Manufacturing cells are collections of machines and labor dedicated to producing a single
product or subassembly. Each cell is capable of performing a variety of operations. This
 differs from the departmental organization, where a collection of the same machines is
used to achieve the same process on multiple products.
13. Explain why some indirect manufacturing costs in traditional manufacturing become
direct costs in JIT manufacturing. Give some examples of expenses that change in this
way.
Answer
By forming manufacturing cells dedicated to a single product, all costs associated with
the enclosure are traceable to the product. Machinery and services that formerly belonged
to several products now belong only to a single product. For example, depreciation,
material handling, and maintenance become direct product costs.
14. Explain how long-term contractual relationships with suppliers can reduce the acquisition
cost of materials.
Answer
JIT hedges against future price increases and obtains lower input prices (usually better
than quantity discounts) by using long-term contractual relationships with suppliers.
Suppliers are willing to give these breaks to reduce the uncertainty in demand for their
products.
15. What is EDI, and what relationship does it have to continuous replenishment?
Answer
EDI, or electronic data interchange, allows suppliers to access a buyer’s database.
Information on the buyer’s database is used to determine when supplies should be
delivered. When supplies arrive, their receipt is noted electronically, and payment is
initiated. No paperwork is involved. Continuous replenishment is when suppliers are
responsible for replenishing the buyer’s inventory stock. EDI facilitates this by providing
information (electronically) needed by the supplier to make replenishment decisions.
16. One reason for inventory is to prevent shutdowns. How does the JIT approach to an
inventory management deal with this potential problem?
Answer
Shutdowns in a JIT environment are avoided by practicing total preventive maintenance
474 and total quality control and by developing close relationships with suppliers to
 ensure on-time delivery of materials. Internally, a Kanban system provides a timely flow
of materials and components.
17. Explain how the Kanban system helps reduce inventories.
Answer
The Kanban system ensures that parts or materials are available when needed (just in
time). The flow of materials is controlled through markers or cards that signal the
production of the necessary quantities at the time.
18. What is a constraint? An internal constraint? An external constraint?
Answer
Constraints represent limited resources or demand. Internal constraints are limiting
factors found within the firm. External constraints are limiting factors imposed on the
firm from external sources.
19. What are loose constraints? Binding constraints?
Answer
Loose constraints are those where the product mix chosen does not consume all the
available resources. A binding rule is where the product mix uses all the limited
resources.
20. Define and discuss the three measures of organizational performance used by the theory
of constraints.
Answer
The theory of constraints uses three measures of organizational performance:
throughput—the rate at which an organization generates money; inventory—the money
an organization spends in turning materials into throughput; and operating expenses—the
money the organization spends in turning lists into throughput. The objective is to
maximize throughput and minimize inventory and operating costs.
21. Explain how lowering inventory produces better products, lower prices, and better
responsiveness to customer needs.
Answer
Lower inventories mean that a company must pay attention to higher quality—it cannot
afford to have production go down because of defective parts or products. It also means
that improvements can reach the customer sooner. Lower inventories mean less space,
 less overtime, and less equipment— in short, lower production costs and, thus, lower
prices are possible. Lower inventories also mean (usually) shorter lead times and a better
ability to respond to customer requests.
22. What five steps TOC uses to improve organizational performance?
Answer
Following are the five steps that TOC uses to improve organizational performance: (1)
identify constraints, (2) exploit binding constraints, (3) subordinate everything else to
decisions made in Step 2, (4) elevate binding constraints, and (5) repeat process.
23. What is a drum-buffer-rope system?
Answer
The drum is the binding constraint that sets the production rate in the factory. The rope
means that the release of materials to the first process is tied to the speed of the drummer
constraint. The buffer is an amount of inventory placed in front of the drummer process
to protect throughput.