Question

JIT purchasing, relevant benefits, relevant costs. (CMA, adapted) The Margro Corporation is an automotive supplier that uses automatic turning machines to manufacture precision parts from steel bars. Margro’s inventory of raw steel averages $600,000. John Dates, president of Margro, and Helen Gorman, Margro’s controller, are concerned about the costs of carrying inventory. The steel supplier is willing to supply steel in smaller lots at no additional charge. Gorman identifies the following effects of adopting a JIT inventory program to virtually eliminate steel inventory: 

• Without scheduling any overtime, lost sales due to stockouts would increase by 35,000 units per year However, by incurring overtime premiums of $40,000 per year, the increase in lost sales could be reduced to 20,000 units per year This would be the maximum amount of overtime that would be feasible for Margro. 
• Two warehouses currently used for steel bar storage would no longer be needed. Margro rents one warehouse from another company under a cancelable leasing arrangement at an annual cost of $60,000. The other warehouse is owned by Margro and contains 12,000 square feet Three-fourths of the space in the owned warehouse could be rented for $1.50 per square foot per year. Insurance and property tax costs totaling $14,000 per year would be eliminated.

Margro’s required rate of return on investment is 20% per year Margro’s budgeted income statement for the year ending December 31, 2008 (in thousands) is as follows:

1. Calculate the estimated dollar savings (loss) for the Margro Corporation that would result in 2008 from the adoption of JIT purchasing.

2. Identify and explain other factors that Margro should consider before deciding whether to adopt JIT purchasing.

 

Answer 1

JIT purchasing, relevant benefits, relevant costs.

1.         Solution Exhibit 20-31 presents the $37,500 cash savings that would result if Margro Corporation adopted the just-in-time inventory system in 2008. 

2.         Conditions that should exist in order for a company to successfully adopt just-in-time purchasing include the following:

•     Top management must be committed and provide the necessary leadership support to ensure a company-wide, coordinated effort.

•     A detailed system for integrating the sequential operations of the manufacturing process needs to be developed and implemented. Direct materials must arrive when needed for each subassembly so that the production process functions smoothly.

•     Accurate sales forecasts must be available for effective finished goods planning and production scheduling.

•     Products should be designed to maximize use of standardized parts to reduce manufacturing time and costs.

•     Reliable vendors who can deliver quality direct materials on time with minimum lead time must be obtained.

Solution Exhibit 20-31

Annual Relevant Costs of Current Purchasing Policy and JIT Purchasing Policy

for Margro Corporation

 

That the incremental costs of $40,000 in overtime premiums to make the additional 15,000 units are less than the contribution margin from losing these sales equal to $97,500 ($6.50  15,000). Margro would rather incur overtime than lose 15,000 units of sales.

That the incremental costs of $40,000 in overtime premiums to make the additional 15,000 units are less than the contribution margin from losing these sales equal to $97,500 ($6.50  15,000). Margro would rather incur overtime than lose 15,000 units of sales.