Introduction
Chapter 21
Accounting, time and efficiency
1 2
Describe a just‐in‐time (JIT) production system
3 4
• Stock management is a pivotal part of profit planning for
manufacturing and merchandising companies.
• In this chapter, we look at just-in-time production and purchasing
issues and we consider how some firms manage efficiency issues
and profit pursuits when faced with different constraints.
Just-in-time systems
• Just‐in‐time (JIT) refers to a system in which materials arrive exactly as 
they are needed. 
• Just‐in‐time production is a mechanism in which each component on a 
production line is produced immediately as needed by the next step in 
the production line. 
• Just‐in‐time (JIT) production systems take a ‘demand pull’ approach in 
which goods are only manufactured to satisfy customer orders.
• Demand triggers each step of the production process, starting with 
customer demand for a finished product at the end of the process, to the 
demand for direct materials at the beginning of the process.
 Major features of a JIT system Financial benefits of JIT
• JIT production systems aim simultaneously to meet customer demand in 
– Lower investment in stocks
a timely way...
– Reduction in carrying and handling costs of stocks
– with high‐quality products; and
– Reduction in risk of obsolescence of stocks
– at the lowest possible total cost. 
– Lower investment in plant space for stocks and production
• The five major features of a JIT system are:
– Reductions in set‐up costs and total manufacturing costs
1 Organising production in manufacturing cells (κύτταρα)
– Reduction in costs of waste and spoilage as a result of improved quality
2 Hiring and retaining multi‐skilled workers
– Higher revenues as a result of responding faster to customers
3 Emphasising total quality management
– Reductions in paperwork.
4 Reducing manufacturing lead time and set‐up time
5 Building strong supplier relationships.

5 6

ΚΟΣΤΟΛΌΓΗΣΗ ΑΝΤΊΘΕΤΗΣ ΡΟΉΣ

Product‐costing benefits of JIT

– Reductions in overhead costs

– Facilitation of the direct tracing of some costs that were formerly
classified as overhead
– Costs of set-up, minor maintenance and quality inspection
becoming easily traced, direct costs
Journal entries for backflush‐costing systems

7 8
 Backflush costing Backflush costing (Continued)

• A unique production system such as JIT often leads to its own unique costing  • Backflush costing describes a costing system that delays recording some or 
system. all of the journal entries relating to the cycle from purchase of direct 
• Organising manufacturing in cells, reducing defects and manufacturing lead  materials to the sale of finished goods.
time and ensuring timely delivery of materials enables purchasing,  • Where journal entries for one or more stages in the cycle are omitted, the 
production and sales to occur in quick succession with minimal stocks. journal entries for a subsequent stage use normal or standard costs to work 
• Traditional normal and standard costing systems use sequential tracking. backwards to flush out the costs in the cycle for which journal entries were 
not made.
• Sequential tracking is any product‐costing method where recording of the 
journal entries occurs in the same order as actual purchases and progress in 
production.

9 10

Trigger points Trigger points (Continued)

• The term trigger point refers to a stage in a cycle going from purchase of direct 
materials to sale of finished goods at which journal entries are made in the  • Stage A: Purchase of direct materials
accounting system. • Stage B: Production resulting in work-in-progress
• A sequential tracking costing system would have four trigger points,  • Stage C: Completion of a finished unit or product
corresponding to separate journal entries being made at different stages.
• Stage D: Sale of finished goods

11 12
 Trigger points (Continued) Trigger points (Continued)

Assume trigger points A, C and D. • What is the journal entry when trigger point A occurs?
Stock: Raw and in-progress control XX
This company would have two stock accounts: Accounts payable control XX
Type Account title To record direct material purchased during the period.
1. Combined materials and Stock: Raw and
materials in work-in-stock in-progress control
2. Finished goods Finished goods control

13 14

Trigger points (Continued) Trigger points (Continued)

• What is the journal entry to record conversion • What is the journal entry when trigger point C
costs? occurs?
Conversion costs control XX Finished goods control XX
Various accounts XX Stock: Raw and in-progress control XX
To record the incurrence of conversion costs during Conversion costs allocated XX
the accounting period. To record the cost of goods completed during the
• Underallocated or overallocated conversion accounting period.
costs are written off to cost of goods sold.

15 16
 Trigger points (Continued) Trigger points (Continued)

• What is the journal entry when trigger point D occurs? • Assume trigger points A and D.
Cost of goods sold XX • This company would have one stock account:
Finished goods control XX Type Account title
To record the cost of goods sold during the accounting period. Combines direct materials Stock
stock and any direct control
materials in work-in-progress
and finished goods stocks

17 18

Trigger points (Continued) Trigger points (Continued)

• What is the journal entry when trigger point A • What is the journal entry to record conversion costs?
occurs? Conversion costs control XX
Stock: Raw and Various accounts XX
in-progress control XX
• To record the incurrence of conversion costs during the accounting
Accounts payable control XX
period.
To record direct material purchased during
the period. • Same as the A, C and D example.
• Same as the A, C and D example.

19 20
 Trigger points (Continued) Trigger points (Continued)

• What is the journal entry to record the cost of goods completed during  • What is the journal entry when trigger point D

the accounting period (trigger point C)? occurs?
No journal entry. Cost of goods sold XX
Stock control XX
Conversion costs allocated XX
To record the cost of goods sold during the
accounting period.

21 22

Trigger points (Continued) Trigger points (Continued)

• Assume trigger points C and D. • What is the journal entry to record

• What is the journal entry when trigger point A occurs? conversion costs?
No journal entry. • Conversion costs control XX
Various accounts XX
To record the occurrence of conversion costs
during the accounting period.
• Same as the A, C and D example.

23 24
 Trigger points (Continued) Trigger points (Continued)

• What is the journal entry to record the cost of • What is the journal entry when trigger point
goods completed during the accounting period D occurs?
(trigger point C)? Cost of goods sold XX
Finished goods control XX Finished goods control XX
Accounts payable control XX To record the cost of goods sold during the
Conversion costs allocated XX accounting period.
To record the cost of goods completed during
the accounting period.

25 26

Managing goods for sale in

retail organisations

• Cost associated with goods for sale: Explain the economic order
– Purchasing costs quantity (EOQ) decision model and how it
– Ordering costs balances ordering costs and carrying costs
– Carrying costs
– Stockout costs
– Quality costs

27 28
 Assumptions of the Economic order quantity decision
Economic order quantity decision model model
• The economic order quantity (EOQ) is a decision model that calculates the  1 The same fixed quantity is ordered at each reorder point.
optimal quantity of stock to order under a restrictive set of assumptions. 2 Demand, ordering costs and carrying costs  are known with certainty.
• The simplest version of this model incorporates only ordering costs and  3 Purchase‐order lead time – the time between placing of an order and its 
carrying costs into the calculations. delivery – is also known with certainty.
4 Purchasing costs per unit are unaffected by the quantity ordered.
5 No stockouts occur. One justification for this assumption is that the costs 
of a stockout can be prohibitively high.
6 In deciding the size of the purchase order, managers consider the costs of 
quality only to the extent that these costs affect ordering costs or carrying 
costs.

29 30

Economic order quantity decision model Economic order quantity decision model

• The EOQ minimises the relevant ordering costs and carrying costs. • Annual demand is 12.844 packages, at the rate of 247 packages per 

• Relevant total costs = Relevant ordering costs + Relevant carrying costs. week.
• Little Video store sells packages of blank video tapes. • Little Video requires a 15% annual return on investment.  
• Little Video purchases packages of video tapes from White Oaks, Inc., at  • The purchase‐order lead time is two weeks.
£15/package. • What is the economic order quantity?

31 32
 Economic order quantity decision model Economic order quantity decision model

Additional data of Little Video: The formula for the EOQ model is:
Relevant ordering costs per
purchase order £209 2 DP
EOQ =
Relevant carrying costs per C
package per year: D = Demand in units for a specified time period
Required annual return P = Relevant ordering costs per purchase order
on investment (15% × £15) £2.25 C = Relevant carrying costs of one unit in
Relevant other costs 3.25 stock for the time period used for D.
£5.50

33 34

Economic order quantity decision model Economic order quantity decision model

2 12.844 £209
EOQ = £5,50
• What are the relevant total costs?
The formula for annual relevant costs (TRC) is: TRC =
Annual relevant ordering costs +     Annual relevant 
EOQ = 976.144 EOQ = 988 carrying costs                   
D Q DP QC
• Little Video should purchase 988 tape packages per order
( ) ( )
TRC = Q × P +  2 × C =
Q
+                       
2
to minimise total ordering and carrying costs. • Q can be any order quantity, not just the EOQ.

35 36
 Economic order quantity decision model Economic order quantity decision model

• When Q = 988 units, • How many deliveries should occur each time
• TRC = 12.844 × £209 + 988 × £5.50 period?
988 2 The number of deliveries each time period is:
TRC = £5.434 D 12.844
= = 13 deliveries
EOQ 988

37 38

Economic order quantity decision model

10,000

8,000
Annual relevant
total costs
Explain the reorder point and safety stocks
Relevant total costs (£)

6,000
5,434

4,000 Annual relevant

ordering costs
Annual relevant
carrying costs
2,000

600 988 1,200 1,800 2,400

Order quantity (units) EOQ

39 40
 Reorder point Reorder point (Continued)

• The reorder point is the quantity level of the stock on hand that • What is the reorder point for Little Video?
triggers a new order. – Economic order quantity = 988 packages          
• The reorder point is simplest to compute when both demand and – Number of units sold/week = 247 packages
purchase-order lead time are known with certainty.
– Purchase‐order lead time = 2 weeks
• Reorder point = Number of units sold
• Reorder point = 247 × 2 = 494 packages
per unit of time × Purchase-order lead time
• Little Video will order 988 packages of tapes each time its stock 
falls to 494 packages.

41 42

Reorder point (Continued) Safety stock

This exhibit
988
assumes that
demand and • Safety stock is stock held at all times regardless of the quantity of
Reorder Reorder purchase-
point point order lead stock ordered using the EOQ model.
time are
494
certain:
• Safety stock is used as a buffer against unexpected increases in
demand or lead time and unavailability of stock from suppliers.
Demand =
247 tape
packages/
week
Weeks 1 2 3 4 5 6 7 8
Purchase-
Lead time
order lead
2 weeks
time = 2
weeks.

43 44
 Safety stock (Continued)

• Little Video’s expected demand is 247  packages per week.
• Management feels that a maximum demand of 350 packages per week  Compare EOQ and JIT purchasing models
may occur.
• Management decides that the costs of stockouts are prohibitive.
• How much safety stock should be carried?
• 350 maximum demand − 247 expected demand = 103 excess demand 
per week
• 103 packages × 2 weeks lead time = 206 packages of safety stock.

45 46

JIT purchasing and EOQ

JIT purchasing and EOQ model parameters
model parameters
• The cost of placing a purchase order (parameter P in the EOQ model) is also 
• Companies moving towards JIT purchasing argue that the cost of carrying  being re‐evaluated.
stocks (parameter C in the EOQ model) has been dramatically  • Three factors are causing sizable reduction in the cost of placing a purchase 
underestimated in the past. order (P).
• This cost includes storage costs, spoilage, obsolescence and opportunity  1 Companies are increasingly establishing long‐run purchasing arrangements.
costs such as investment tied up in stock. 2 Companies are using electronic link, such as the Internet, to place purchase orders.
3 Companies are increasing the use of purchase order cards (similar to consumer credit 
cards like Visa and Master Card).
• Both increases in the carrying cost (C) and decreases in the ordering cost per 
purchase order (P) result in smaller EOQ amounts.

47 48
 Relevant costs of JIT
purchasing

• When comparing two or more purchasing policies the analysis should

Determine the relevant benefits include only the relevant costs – those costs that differ between
and relevant costs in JIT alternatives.
purchasing and JIT production • The difference between two incremental costs is the relevant savings
from choosing a given purchasing policy.

49 50

Cost of a prediction error Just-in-time (JIT) purchasing

– Step 1: Calculate the monetary outcome from the best action that could  – JIT purchasing – the purchase of goods or materials such that a

have been taken, given the actual amount of the cost input delivery immediately precedes demand or use.
– Step 2: Calculate the monetary outcome from the best action based on  – Requires organisations to restructure their relationship with suppliers
the incorrect amount of the predicted cost input and place smaller and more frequent purchase orders.
– Step 3: Calculate the difference between the monetary outcomes from 
steps 1 and 2

51 52
 Supplier evaluation Supplier evaluation (Continued)

• The timely delivery of quality products is particularly crucial in JIT • What are some examples of relevant costs?
purchasing environments. – Purchasing costs
• Defective goods and late deliveries often result in contribution – Ordering costs
margin that is lost on current and future sales. – Inspection costs
• Companies that implement JIT purchasing choose their suppliers – Stockout costs
carefully. – Customer returns costs
– Outlay carrying costs

53 54

Performance measures and control in JIT production JIT’s effect on costing systems
• To manage and reduce stocks, the management accountant must design 
performance measures to control and evaluate JIT production.
• In reducing the need for materials handling, warehousing and incoming
• What information may management accountants use?
– Personal observation by production line workers and managers.
inspection, JIT systems reduce overhead costs.
– Financial performance measures, such as stock turnover ratios. • JIT systems also facilitate the direct tracing of some costs that were
• What are non‐financial performance measures of time, stock and quality? formerly classified as overhead.
– Manufacturing lead time.
– Units produced per hour.
– Days’ stock on hand. 
– Total set‐up time for machines/total manufacturing time.
– Number of units requiring rework or scrap/total number of units started and completed.

55 56
 Theory of constraints

• The theory of constraints (TOC) describes methods to maximise operating 

Define the three main measurements in the profit when faced with some bottleneck and some non‐bottleneck operations. 
theory of constraints It defines three measurements:
1 Throughput contribution
2 Investments (stock)
3 Operating costs

57 58

Theory of constraints Bottlenecks

• The three main measurements in the theory of constraints are: The theory of constraints emphasises the management of bottlenecks as the 
1 Throughput contribution equal to sales revenue minus direct materials costs. key to improving the performance of the production system as a whole.
2 Investments equal the sum of materials costs of direct materials stock, work‐in‐ • Step 1: Recognise that the bottleneck resource determines throughput 
progress stock, finished goods stock, R&D costs and costs of equipment and  contribution of the plant as a whole.
buildings. • Step 2: Search and find the bottleneck resource by identifying resources with 
3 Operating costs equal to all operating costs (other than direct materials)  large quantities of stock waiting to be worked on.
incurred to earn throughput contribution. • Step 3: Keep bottleneck operation busy and subordinate all non‐bottleneck 
• The objective of TOC is to increase throughput contribution while decreasing  resources to the bottleneck resource.
investments and operating costs. • Step 4: Take actions to increase bottleneck efficiency and capacity by 
• TOC considers a short‐run time horizon and assumes operating costs to be  calculating throughput capacity and identifying any relevant/irrelevant costs.
fixed costs.

59 60