Competition is fierce, especially in technology-related manufacturing, where overseas com- panies are producing high-quality goods at very low costs. As we saw in the discussion of activity-based costing, there is a never-ending quest to cut costs.
The cost of buying, storing, and moving inventory can be significant for companies.
To reduce inventory costs, many companies use a just-in-time (JIT) management system.
Companies with JIT management systems buy raw materials and complete finished goods just in time for delivery to customers.
In traditional manufacturing systems, raw materials are ordered in large quantities to obtain volume discounts and to have surplus raw materials on hand in case some of the raw materials turn out to be defective. Under the JIT management system, the manufacturer contracts with suppliers to deliver small quantities of raw materials as needed. Deliver- ies are small and frequent, and the suppliers must guarantee a close-to-zero defect rate.
Because of the zero defect rate and quick delivery, manufacturers can hold small amounts of raw materials in the warehouse and still be assured they won’t run out of raw materials and have to shut down production. For JIT management to work, relationships with sup- pliers of raw materials must be very reliable to ensure that the company has raw materials just when they are needed to manufacture products. Because products are made as ordered, finished goods inventories are kept to a minimal amount. This reduces the company’s cost to store and insure inventory. It also allows the company to minimize the resources it has invested in Raw Materials and Finished Goods Inventories. Lastly, because the inventories are low, the risk of the inventory becoming obsolete or unsalable is very small.
Production in JIT management systems is completed in self-contained work cells, as shown in Panel A of Exhibit 19-7. A work cell is an area where everything needed to com- plete a manufacturing process is readily available. Each work cell includes the machinery and labor resources to manufacture a product. Employees work in a team in the work cell and are empowered to complete the work without supervision. Workers complete a small batch of units and are responsible for inspecting for quality throughout the process. As the completed product moves out of the work cell, the suppliers deliver more raw materials to the work cell just in time to keep production moving along.
By contrast, traditional production systems (shown in Panel B of Exhibit 19-7) separate manufacturing into various processing departments that focus on a single activity.
Work in process must be moved from one department to another. More movements waste time, and wasted time is wasted money.
Under JIT management, customer demand, in the form of a customer’s order, trig- gers manufacturing. The sales order “pulls” materials, labor, and overhead into production.
This “demand-pull” system extends back to the suppliers of raw materials. As noted previ- ously, suppliers make frequent deliveries of defect-free materials just in time for production.
Purchasing raw materials to meet customers’ demands for final products reduces inventory.
Less inventory frees floor space (and resources) for more productive use. Thus, JIT man- agement systems help reduce waste. The traditional system requires more inventory and workers and costs more to operate than a JIT management system.
Learning Objective 5 Describe a just-in-time (JIT) management system and record its transactions
Just-in-Time (JIT) Management A cost management system in which
a company produces products just in time to satisfy needs. Suppliers deliver materials just in time to begin production, and finished units are completed just in time for delivery to the customer.
Exhibit19-7 | Production Flow Comparison: Just-in-Time Versus Traditional Production
Dept 2 Assembly
Worker
Assembly Supervisor Materials
Handler
WorkCell
All JIT workers perform materials handling, assembly, and quality control functions.
Quality Control Inspector Finished
Goods Inventory
Dept 1 Assembly
Worker
Dept 3 Assembly
Worker
Finished Goods Inventory MaterialsRaw
Inventory
PANEL B: Traditional Production System PANEL A: Just-in-Time Production System
Worker
MaterialsRaw Inventory
Materials Handler Worker Worker
Many companies credit JIT management for saving them millions of dollars. But JIT management systems are not without problems. With little or no inventory buffers, JIT management users lose sales when they cannot get materials on time or when poor- quality materials arrive just in time. There is no way to make up for lost time. As a result, as noted earlier, strong relationships with quality raw materials vendors are very important to successfully implement a JIT management system. Additionally, many JIT management companies still maintain small inventories of critical materials.
Just-in-Time Costing
JIT costing leads many companies to simplify their accounting. Just-in-time costing, also called backflush costing, seems to work backward. It starts with output that has been completed and then assigns manufacturing costs to units sold and to inventories. There are three major differences between JIT costing and traditional costing, as shown in Exhibit 19-8:
1. JIT costing does not track the cost of products from Raw Materials Inventory to Work- in-Process Inventory to Finished Goods Inventory. Instead, JIT costing waits until the units are completed to record the cost of production.
2. JIT costing combines Raw Materials Inventory and Work-in-Process Inventory accounts into a single account called Raw and In-Process Inventory.
3. Under the JIT philosophy, workers perform many tasks. Most companies using JIT combine direct labor and manufacturing overhead costs into a single account called Conversion Costs. The Conversion Costs account is a temporary account that works just like the Manufacturing Overhead account. Actual conversion costs accumulate as debits in the Conversion Costs account, and allocated conversion costs are credited to the account as units are completed. Accountants adjust any underallocated or overallo- cated conversion costs to Cost of Goods Sold at the end of the period, just as they do for underallocated or overallocated manufacturing overhead.
Just-in-Time Costing A costing system that starts with output completed and then assigns manufacturing costs to units sold and to inventories.
Raw and In-Process Inventory A combined account for Raw Materials Inventory and Work- in-Process Inventory used in JIT
management systems.
Conversion Costs Account A temporary account used in JIT management systems to accumulate direct labor and manufacturing overhead costs and then allocate the costs as units are completed.
Exhibit19-8 | Comparison of Traditional and Just-in-Time Costing
Production activity
Inventory accounts
Manufacturing costs
Records the costs of products as they move through the manufacturing process
Raw Materials Inventory Work-in-Process Inventory Finished Goods Inventory Direct materials
Direct labor
Manufacturing overhead Traditional
Records the costs of products when units are completed
Raw and In-Process Inventory Finished Goods Inventory Direct materials
Conversion costs Just-in-Time
Recording Transactions in JIT
To illustrate JIT costing, we’ll continue with our Smart Touch Learning example. Smart Touch Learning purchases raw materials to be used in the production of touch screen tab- let computers. These costs are recorded in the Raw and In-Process Inventory account. All other manufacturing costs—including labor, various indirect materials, and overhead—are indirect costs of converting the raw materials into finished goods (tablet computers). All these indirect costs are accumulated in the Conversion Costs account.
As noted previously, JIT does not use a separate Work-in-Process Inventory account.
Instead, it uses only two inventory accounts:
• Raw and In-Process Inventory, which combines raw materials with work in process
• Finished Goods Inventory
Assume that on January 1, Smart Touch Learning had a beginning balance of $20,000 in Raw and In-Process Inventory and a beginning balance of $15,000 in Finished Goods Inventory. During the year, the company uses JIT costing to record the following summary transactions:
Transaction 1
Smart Touch Learning purchased $305,000 of raw materials on account.
Accounts Payable Raw and In-Process Inventory Trans. 1
Accounts and Explanation Date
305,000
305,000 Debit Credit
Transaction 2
Smart Touch Learning incurred $255,000 for labor and overhead.
Wages Payable, Accumulated Depreciation, etc.
Conversion Costs Trans. 2
Accounts and Explanation Date
255,000
255,000 Debit Credit
Transaction 3
Smart Touch Learning completed 2,000 standard model tablets that it moved to Finished Goods Inventory. Recall that the standard (expected) cost of each standard model tablet is
$276.75, as calculated using ABC ($150.00 direct materials + $126.75 conversion costs).
The debit (increase) to Finished Goods Inventory is at standard cost of $553,500 (2,000 completed standard model tablets * $276.75 per tablet). There is no separate Work- in-Process Inventory account in JIT costing, so Smart Touch Learning credits the following:
• Raw and In-Process Inventory is credited for the direct materials, $300,000 (2,000 completed standard model tablets * $150.00 standard direct material cost per tablet).
• Conversion Costs is credited for the direct labor and indirect costs allocated to the finished tablets, $253,500 (2,000 completed standard model tablets * $126.75 standard conversion cost per tablet).
This is the key to JIT costing. The system does not track costs as the tablets move through manufacturing. Instead, completion of the tablets triggers the accounting system to go back and move costs from Raw and In-Process Inventory (credit), allocate Conversion Costs (credit), and attach those costs to the finished products (debit).
= A/Pc R&IPc
Lc
Ac E
Wages Payablec
Lc Accum.
Depreciationc AT
Conversion Costsc
ET
=
Transaction 4
Smart Touch Learning sold 1,900 tablets on account for $500 each, for a total of $950,000.
The cost of goods sold is $525,825 (1,900 tablets * $276.75). The journal entries are:
Sales Revenue
Cost of Goods Sold
Finished Goods Inventory Accounts Receivable Trans. 4
525,825 Accounts and Explanation
Date
950,000
525,825 950,000
Debit Credit
Exhibit 19-9 shows Smart Touch Learning’s relevant accounts. Combining the Raw Materials Inventory account with the Work-in-Process Inventory account to form the single Raw and In-Process Inventory account eliminates detail and saves time and costs.
= Sales
Revenuec A/Rc
Ac L Ec
= L
COGSc FGT
AT ET
Exhibit19-9 | Smart Touch Learning’s JIT Costing Accounts
Bal.
Trans. 1
25,000 20,000 305,000 Bal.
Trans. 3 300,000
Raw and In-Process Inventory
Bal.
Trans. 3
42,675 15,000 553,500 Bal.
Trans. 4 525,825
Finished Goods Inventory
BALANCE SHEET INCOME STATEMENT
525,825 Trans. 4
Cost of Goods Sold
Unadj. Bal.
255,000 1,500
Trans. 2 253,500 Trans. 3 Conversion Costs
Adjustment
You can see from Exhibit 19-9 that conversion costs are underallocated by $1,500 (actual costs of $255,000 - allocated costs of $253,500). Underallocated and overallo- cated Conversion Costs are treated just like underallocated and overallocated Manufactur- ing Overhead. The Conversion Costs account is adjusted so that it has a zero balance, and the amount underallocated is transferred to Cost of Goods Sold, as follows:
Conversion Costs Cost of Goods Sold Adj.
Accounts and Explanation Date
1,500
1,500 Debit Credit
In the final analysis, Cost of Goods Sold for the year is $527,325, as shown in the T-account in Exhibit 19-10.
= L
COGSc Conversion
CostsT
A EcT