Learning Objectives
1. What value chain relationships are important to organizations?
2. What costs are associated with buying, producing, and carrying inventory?
3. How do push and pull systems control production?
4. Why do product life cycles affect profitability?
5. What is target costing, and how does it influence production cost management?
systems?
7. What are flexible manufacturing systems?
8. Why are lean enterprises important in today’s business environment?
9. How can the theory of constraints help in determining production flow?
10. (Appendix) How are economic order quantity, order point, and safety stock determined and used?
INVENTORY AND PRODUCTION
MANAGEMENT
CHAPTER
18
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Terminology
Autonomation: the use of equipment that has been preprogrammed to sense certain conditions
Backflush costing: a streamlined cost accounting method that speeds up, simplifies, and minimizes
Bottleneck: a point at which the processing levels are sufficiently slow to cause the other processing
Computer-integrated manufacturing (CIM): the integration of two or more flexible manufacturing
Constraint: anything that confines or limits the ability of a person or machine to perform a project or
function
Flexible manufacturing system (FMS): a production system involving a network of robots and material
conveyance devices monitored and controlled by computers that allows for rapid production and
responsiveness to changes in production needs
Focused factory arrangement: an arrangement in which a vendor (which may be an external party or an
Internet business model: a business model that involves (1) few physical assets, (2) little management
hierarchy, and (3) a direct pipeline to customers
Just-in-time (JIT): a philosophy about when to do something; the “when” is as needed and the
“something” is a production, purchasing, or delivery activity
Lead time: the days between the placement of an order to the time the goods arrive for usage or are
produced by the company
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Lean manufacturing: approach in which the manufacturer makes only those items demanded by
customers and attempts to make those items without waste
Product life cycle: a model depicting the stages through which a product class (not each product)
passes from the time that an idea is conceived until production is discontinued
Push system: the traditional production system in which work centers buy or produce inventory that is
not currently needed because of lead time or economic production/order requirements; it requires that
excess inventory be stored until needed
Red-line system: an inventory ordering system in which a red line is painted on the inventory container
at a point deemed to be the reorder point
Target costing: a method of determining what the maximum cost of a product should be based on the
product’s estimated selling price less the desired profit and selling and administrative costs
Theory of constraints (TOC): a method of analyzing the bottlenecks (constraints) that keep a system
from achieving higher performance since production cannot take place at a rate faster than the slowest
machine or person in the process
Value engineering: a disciplined search for various feasible combinations of resources and methods that
will increase product functionality and reduce costs
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Lecture Outline
LO.1: What value chain relationships are important to organizations?
A. Introduction
1. Manufacturing and retail firms face two significant challenges in managing inventory.
investment a company makes.
3. This chapter deals with ways companies minimize their monetary commitments to inventory while
still satisfying customer demands.
safety stock, and Pareto inventory analysis.
B. Important Relationships in the Value Chain
1. Every company has upstream suppliers and downstream customers, which together comprise a
supply or value chain.
2. By building improved cooperation, communication, and integration, the entities within the value
throughput, and cost efficiency.
4. Products and services can be provided faster and with fewer defects, and activities can be
a. improved communication of requirements and specifications;
b. greater clarity in requests for products or services;
5. If employees perceive their internal suppliers and customers as extensions of themselves and
work to exploit the previous opportunities, teamwork will be significantly enhanced.
Chapter 18: Inventory and Production Management IM 5
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publicly accessible website, in whole or in part.
a. Improved teamwork helps companies in their implementation of pull systems, which are part
of a just-in–time work environment. Increased productivity benefits all company stakeholders
by:
i. reducing investment in inventory;
ii. improving cash-to-cash cycle time;
1. Organizations can increase their profit margins by reducing or minimizing inventory investments,
2. Efficient inventory management relies mostly on cost-minimization strategies.
inventory:
i. purchasing/production;
ii. ordering/setup; and
iii. carrying/not carrying goods in stock.
allowed, plus shipping charges.
4. Production cost for a manufacturer refers to the costs associated with purchasing direct materials,
paying for direct labor, and absorbing variable and fixed overhead.
a. Fixed manufacturing overhead is the least susceptible to cost minimization in the short run
except in the case where management is able to somewhat control it by managing production
LO.3: How do push and pull systems control production?
D. Inventory and Production Management Philosophies
1. The two theoretical approaches to producing inventory are push systems and pull systems.
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a. A push system is the traditional production system in which work centers may produce
b. A pull system is a production system dictated by product sales and demand; it is a system in
LO.4: Why do product life cycles affect profitability?
E. Understanding and Managing Production Activities and Costs
1. Product life cycles
a. The product life cycle is a model depicting the stages through which a product class (not
necessarily each product) passes.
b. The five specific product life cycle stages are:
i. development (which includes design);
iii. growth;
iv. maturity; and
Sales begin to stabilize or slowly decline and firms often compete on the basis of
v. decline.
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c. Text Exhibit 18.4 (p. 731) illustrates a conventional sales trend line as the product class
passes through each life cycle stage.
2. Lifecycle and target costing
a. General
i. The development stage is fundamentally ignored by the standard financial accounting
model.
ii. Effective development efforts are critical to a product’s profitability, even though
v. One technology that is increasingly used in the design stage is virtual reality.
Virtual reality is an artificial, computer-generated environment in which the user has
prototype rather than a real prototype.
vi. Once a product or service idea is formulated, the market is typically researched to
determine the features that customers desire.
vii. After a product is designed, the producing firm has traditionally determined product cost
and set a selling price based on that cost.
b. Target costing
i. Target costing is a technique that is used to determine what the cost of a product should
ii. It is used to estimate an allowable product cost by applying market research to estimate
cost:
TC = ESP – APM – S&A
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where TC = target cost
ESP = estimated selling price
APM = acceptable profit margin
of using different input resources, manufacturing processes, and design
specifications. They assist in determining how adjustments can be made.
A less-than-desired profit margin can be accepted.
The company can decide that it does not want to enter this particular product market
necessary modeling effort.
viii. In designing a product to meet an allowable cost, engineers strive to eliminate all
nonessential activities from the production process.
Properly designed products should require only minimal engineering change orders
(EOCs) after being released to production.
currently ordered can be made obsolete.
ix. Target costing requires a shift in the way managers think about the relationships among
cost, selling price, and profitability.
The traditional attitude has been that a product is developed, production cost is
and/or improve the production process after manufacturing activities have begun.
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to lower costs or improve quality.
LO.6: What is the just–in-time philosophy and what modifications does JIT require in accounting
systems?
F. Just-in-Time Systems
goals:
a. eliminating any production process or operation that does not add value to the
product/service;
b. continuously improving production/performance efficiency; and
c. reducing the total cost of production/performance while increasing quality.
during a manufacturing process.
b. A just-in-time (JIT) manufacturing system is a production system that attempts to acquire
components and produce inventory only as needed, to minimize product defects, and to
reduce lead/setup times for acquisition and production.
4. Production has traditionally been dictated by the need to smooth operating activities over time.
5. Management’s preoccupation with spreading overhead over a maximum number of units of
a. Text Exhibit 18.8 (p. 737) depicts these inefficiencies or problems as “rocks” in a stream of
“water” that represents inventory.
G. Changes Needed to Implement JIT Manufacturing
1. General
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b. Certain modifications must be made to supplier relationships, distribution, product design,
product processing, and plant layout.
products and services.
2. Supplier relationships and distribution
a. The optimal JIT situation would be to have only one vendor for any given item, but that would
“partners” in the process.
c. Vendor certification is becoming increasingly popular. Factors commonly considered in
improve quality and reduce costs.
i. Such partnerships permit members of the supply chain to eliminate redundancies in
3. Product design
a. Products must be designed to use the fewest number of parts and the parts need to be
standardized to the extent possible.
affected.
c. Good product design should address all concerns of the intended consumers including the
d. The environmental impact is likely to become a much more significant concern in coming
those emissions.
4. Product processing