Book cover for Horngren’s Cost Accounting

Horngren’s Cost Accounting

Srikant M. Datar, Madhav V. Rajan

ISBN #9780134475585

16th Edition

1,010 Questions

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58,980 Students Helped

Homework Questions

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Summary
Learning Objectives
Key Concepts
Example Problems
Explanations
Common Mistakes

Summary

This chapter provides a thorough overview of inventory management, focusing on comprehensive cost management strategies. It highlights the importance of six cost categories in managing inventory and explains tools like the EOQ model for balancing ordering and carrying costs. Special attention is given to safety stock and reorder points as mechanisms to mitigate stockout risks, while modern systems such as Just-in-Time (JIT) production, backflush costing, and lean accounting demonstrate simplified and efficient costing practices. The chapter also emphasizes the need to combine quantitative models with qualitative evaluations such as supplier reliability and performance standards to achieve optimal inventory decision-making.

Learning Objectives

1

Understand the comprehensive cost management of goods for sale by identifying and analyzing the six key cost categories that affect inventory decisions.

2

Apply the Economic Order Quantity (EOQ) model to balance ordering and carrying costs effectively.

3

Explain the role of safety stock and reorder points in mitigating stockout risks and ensuring smooth operations.

4

Compare traditional inventory and production systems with modern Just-in-Time (JIT) purchasing and production systems, including their use of backflush costing and lean accounting.

5

Evaluate both quantitative cost model parameters and qualitative factors, such as supplier reliability and performance evaluation criteria, when making inventory and production decisions.

Key Concepts

CONCEPT

DEFINITION

Inventory Management

The coordinated process of ordering, storing, and using a company’s inventory, including raw materials, components, and finished products, while minimizing associated costs.

Economic Order Quantity (EOQ) Model

A quantitative tool used to determine the optimal order size that minimizes the sum of ordering and carrying costs, often calculated using the formula EOQ = √(2DS/H), where D is demand, S is ordering cost, and H is carrying cost per unit.

Safety Stock

Additional quantity of inventory kept on hand to guard against uncertainties such as unexpected demand or delays in supply, thus mitigating the risk of stockouts.

Reorder Point

The inventory level at which a new order should be placed to replenish stock before it runs out, taking into account lead times and safety stock requirements.

Just-in-Time (JIT) Production

A strategy that minimizes inventory levels by receiving goods only when they are needed in the production process, thereby reducing storage costs and waste.

Backflush Costing

A simplified costing method used in low-inventory environments where costing adjustments are made after production is complete, rather than tracking costs through every stage of production.

Lean Accounting

An approach to accounting that supports lean production principles by simplifying cost tracking and eliminating unnecessary procedures inherent in traditional costing systems.

Supplier Evaluation

The process of assessing and selecting suppliers based on quantitative factors like cost and qualitative factors like reliability, delivery performance, and quality.

Enterprise Resource Planning (ERP) Systems

Integrated software platforms used by organizations to manage and automate many back office functions related to technology, services, and human resources, including inventory tracking and management.

Example Problems

Example 1

Why do better decisions regarding the purchasing and managing of goods for sale frequently cause dramatic percentage increases in net income?

Example 2

Name six cost categories that are important in managing goods for sale in a retail company.

Example 3

What assumptions are made when using the simplest version of the economic-order-quantity (E00) decision model?

Example 4

Give examples of costs included in annual carrying costs of inventory when using the EOQ decision model.

Example 5

Give three examples of opportunity costs that typically are not recorded in accounting systems, although they are relevant when using the EOQ model in the presence of demand uncertainty.
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Step-by-Step Explanations

QUESTION

How do you calculate the EOQ to determine the optimal order size?

STEP-BY-STEP ANSWER:

Step 1: Identify the annual demand (D) for the product.
Step 2: Determine the ordering cost (S), which is the cost incurred each time an order is placed.
Step 3: Determine the carrying (holding) cost (H) per unit per year.
Step 4: Use the EOQ formula: EOQ = √(2DS/H).
Step 5: Calculate the square root value to obtain the optimal order quantity.
Final Answer:

Economic Order Quantity (EOQ) Model

QUESTION

How is safety stock determined, and why is it important?

STEP-BY-STEP ANSWER:

Step 1: Analyze historical demand and lead time variability to understand the range of uncertainties.
Step 2: Establish a desired service level (probability of not facing a stockout).
Step 3: Calculate safety stock using statistical methods (e.g., standard deviation of demand during lead time multiplied by a safety factor based on the desired service level).
Step 4: Add the calculated safety stock to the reorder point to ensure continuous availability during fluctuations.
Step 5: Review and adjust the safety stock periodically based on changing demand and supply variability.
Final Answer:

Safety Stock

QUESTION

How does backflush costing simplify cost tracking in a JIT production system?

STEP-BY-STEP ANSWER:

Step 1: Recognize that minimal inventory is held, reducing the complexity of tracking costs at every stage.
Step 2: Record production outputs and then assign costs based on standard or predetermined cost rates.
Step 3: Eliminate the need for detailed cost tracking of individual components during the production process.
Step 4: Conduct periodic reconciliations to ensure that the costs flushed match actual production data and output.
Step 5: Use the streamlined costing information in management decisions, benefiting from reduced administrative overhead.
Final Answer:

Backflush Costing in JIT Environments

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Common Mistakes

  • Confusing ordering costs with carrying costs, leading to inaccurate EOQ calculations.
  • Failing to account for variability in demand when determining safety stock, which may result in frequent stockouts.
  • Assuming that quantitative models like EOQ are sufficient without considering qualitative factors such as supplier performance.
  • Misinterpreting backflush costing as a replacement for internal cost controls rather than a simplified tracking tool for low-inventory environments.
  • Overlooking the importance of aligning performance evaluations with inventory management practices, which can create conflicts in decision making.