CPIM Module 5: Inventory/Days of Supply
Decoupling Inventory
An amount of inventory maintained between entities in a manufacturing or distribution network to create independence between processes or entities. The objective is to disconnect the rate of use from the rate of supply of the item.
Fixed overhead
Traditionally, all manufacturing costs—other than direct labor and direct materials—that continue even if products are not produced.
general and administrative expenses [G&A]
the category of expenses on an income statement that includes the costs of general managers, computer systems, research and development, etc
product cost
Cost allocated by some method to the products being produced. Initially recorded in asset (inventory) accounts, product costs become an expense (cost of sales) when the product is sold.
Work in Process (WIP)
A good or goods in various stages of completion throughout the plant, including all material from raw material that has been released for initial processing up to completely processed material awaiting final inspection and acceptance as finished goods inventory. Many accounting systems also include the value of semifinished stock and components in this category.
value added
1) In accounting, the addition of direct labor, direct material, and allocated overhead assigned at an operation. It is the cost roll-up as a part goes through a manufacturing process to finished inventory. 2) In current manufacturing terms, the actual increase of utility from the viewpoint of the customer as a part is transformed from raw material to finished inventory; the contribution made by an operation or a plant to the final usefulness and value of a product, as seen by the customer. The objective is to eliminate all non-value-added activities in producing and providing a good or service.
Safety Stock
1) In general, a quantity of stock planned to be in inventory to protect against fluctuations in demand or supply. 2) In the context of master production scheduling, the additional inventory and capacity planned as protection against forecast errors and short-term changes in the backlog.
days of supply
1) Inventory-on-hand metric converted from units to how long the units will last.
Variance
1) The difference between the expected (budgeted or planned) value and the actual. 2) In statistics, a measurement of dispersion of data.
profit margin
1) The difference between the sales and cost of goods sold for an organization, sometimes expressed as a percentage of sales. 2) In traditional accounting, the product selling price minus the direct material, direct labor, and allocated overhead for the product, sometimes expressed as a percentage of selling price.
Job costing
A cost accounting system in which costs are assigned to specific jobs. This system can be used with either actual or standard costs in the manufacturing of distinguishable units or lots of products.
hedge inventory
A form of inventory buildup to buffer against some event that may not happen. Planning involves speculation related to potential labor strikes, price increases, unsettled governments, and events that could severely impair a company's strategic initiatives. Risk and consequences are unusually high, and top management approval is often required.
b) 92 Rationale: The new level of safety stock is equal to the old level of safety stock multiplied by the square root of the new lead time divided by the old lead time—in this case, 85 times the square root of 7/6), or 85 times 1.08 = 92 (rounded).
A manufacturer is experiencing a delay in raw materials delivery; the materials will arrive a week later than expected. As a result, the manufacturer must adjust its level of safety stock. The company needs 85 units of safety stock to meet its customer service level. If the original lead time was six weeks, what is the new level of safety stock required? a) 85 b) 92 c) 98 d) 99
Cost of goods sold (COGS)
An accounting classification useful for determining the amount of direct materials, direct labor, and allocated overhead associated with the products sold during a given period of time.
liabilities
An accounting/financial term (balance sheet classification of accounts) representing debts or obligations owed by a company to creditors. May have a short-term time horizon, such as accounts payable, or a longer-term obligation, such as mortgage payable or bonds payable.
b) the resources owned by a company, whether tangible (cash, inventories) or intangible (patents, goodwill). Rationale: Assets are property owned by a person or company. They are regarded as having value and are available to meet debts.
Assets can be defined as: a) the costs related to problems found after the product reaches the customer. b) the resources owned by a company, whether tangible (cash, inventories) or intangible (patents, goodwill). c) the debts or obligations owed by a company to creditors. d) those items of cost related to the activities associated with the movement and storage of finished products.
c) It is not possible to manage the one without the other at any level Rationale: Inventory either results from or supports production, sales, marketing, and customer service. Yet it also represents costs. It is not possible to manage one without the other at any level.
At which level of production planning can one perform planning without also considering how to manage inventory? a) Material requirements planning b) Master planning and sales and operations planning c) It is not possible to manage the one without the other at any level d) Master scheduling
Inventory Management
the branch of business management concerned with planning and controlling inventories.
b) Ability to reduce safety stock levels Rationale: Drastically reducing lead times also allows organizations to reduce safety stocks because the lead time is shorter and therefore the demand during the lead time is less. Air transport also allows more production to be based on actual orders rather than forecasts and can enhance customer service.
Due to the 40-day lead time for container ship as opposed to a 2-day lead time for air, the much higher carrying cost for the water option for a given material makes air only slightly more expensive. What else might be considered that could further promote use of the air option? a) Ability to base more production on forecasts then actual orders b) Ability to reduce safety stock levels c) Ability to increase product quality d) Ability to ship more units per load
d) Cost of Goods Sold/Average Inventory Investment Rationale: Inventory Turnover = Cost of Goods Sold/Average Inventory Investment
How is inventory turnover calculated? a) Sales/Average Inventory Investment b) Sales/Inventory Investment c) Average Inventory/Standards Sales d) Cost of Goods Sold/Average Inventory Investment
d) $15 million Rationale: Annual Cost of Goods Sold = Inventory Turnover Ratio × Average Inventory in Dollars = 6 × $2.5 million = $15 million.
If the inventory turnover ratio is 6 times and the average inventory is $2.5 million, what is the annual cost of goods sold? a) $8.5 million b) $2.4 million c) $12.5 million d) $15 million
a) First in, first out Rationale: The first in, first out (FIFO) method of inventory valuation for accounting purposes assumes that the oldest inventory (first in) is the first to be used (first out). However, this does not necessarily affect the actual physical movement of items.
In which accounting method for valuing inventory is the oldest inventory the first to be used? a) First in, first out b) Last in, first out c) Average cost d) Standard cost
Pipeline stock
Inventory in the transportation network and the distribution system, including the flow through intermediate stocking points. The flow time through the pipeline has a major effect on the amount of inventory required in the pipeline. Time factors involve order transmission, order processing, scheduling, shipping, transportation, receiving, stocking, review time, and so forth.
Transit inventory
Inventory in transit between manufacturing and stocking locations.
a) distribution inventory Rationale: Distribution inventory typically includes spare parts and finished goods, located in the distribution system (e.g., in warehouses or in transit between warehouses and the consumer).
Inventory located in warehouses or in transit between warehouses and the consumer is called: a) distribution inventory b) work-in-process inventory. c) in-transit inventory. d) finished goods inventory.
a) 0.511 times Rationale: Inventory Turnover = Annual COGS/Average Inventory in Dollars. Average Inventory = (Inventory at Period Start + Inventory at Period End)/2. Since the inventory at the end of the last year will be the same as the inventory at the beginning of this year, it can be used when calculating average inventory. Average Inventory for this year: ($5,000,000 + $4,000,000)/2 = $4,500,000. Inventory Turnover = $2,300,000/$4,500,000 = 0.511 times.
Inventory on the balance sheet at the end of the last year was $5,000,000. Inventory at the end of this year was $4,000,000. Last year's annual cost of goods sold (COGS) was $3,000,000. This year's annual COGS was $2,300,000. What is this year's inventory turnover? a) 0.511 times b) 0.575 times c) 0.589 times d) 1.957 times
Fluctuation inventory
Inventory that is carried as a cushion to protect against forecast error.
Transportation inventory
Inventory that is in transit between locations.
Lot-size inventory
Inventory that results whenever quantity price discounts, shipping costs, setup costs, or similar considerations make it more economical to purchase or produce in larger lots than are needed for immediate purposes.
Inventory Buffer
Inventory used to protect the throughput of an operation or the schedule against the negative effects caused by delays in delivery, quality problems, delivery of an incorrect quantity, and so on.
Distribution inventory
Inventory, usually spare parts and finished goods, located in the distribution system (e.g., in warehouses or in transit between warehouses and the consumer).
Maintenance, repair, and operation (MRO) supplies
Items used in support of general operations and maintenance such as maintenance supplies, spare parts, and consumables used in the manufacturing process and supporting operations.
Direct labor
Labor that is specifically applied to the good being manufactured or used in the performance of the service.
d) Lowest days of supply Rationale: Providing high levels of inventory to maximize customer order fill rates conflicts with achieving low levels of inventory.
Maintaining high stock levels of products for sale conflicts with which of the following objectives? a) Lowest production costs b) Lowest distribution costs c) Best customer service d) Lowest days of supply
In-transit inventory
Material moving between two or more locations, usually separated geographically; for example, finished goods being shipped from a plant to a distribution center.
Direct material
Material that becomes a part of the final product in measurable quantities.
d) $400,000 Rationale: Assets = Liabilities + Owners' Equity. Rearranging this question, you get: Owners' Equity = Assets -Liabilities = $1,000,000 - $600,000 = $400,000.
On a balance sheet, assets are $1 million. If liabilities are $600,000, what is owners' equity? a) $1,600,000 b) Not enough information was provided to answer the question. c) $600,000 d) $400,000
c) $1,300,000 Rationale: Increasing revenue by $1,000,000 would increase the cost of goods sold to $1,700,000 (overhead does not increase), resulting in gross profit of $1,300,000.
On the basis of the information below, increasing revenue by $1,000,000 would result in what amount for gross profit? Revenue (sales) = $2,000,000 Cost of Goods Sold: Direct Material = $600,000 Direct Labor = $200,000 Overhead (constant) = $500,000 Gross Profit = $700,000 a) $1,000,000 b) $1,050,000 c) $1,300,000 d) $1,700,000
Cycle stock
One of the two main conceptual components of any item inventory, the cycle stock is the most active component. The cycle stock depletes gradually as customer orders are received and is replenished cyclically when supplier orders are received. The other conceptual component of the item inventory is the safety stock, which is a cushion of protection against uncertainty in the demand or in the replenishment lead time.
average inventory
One-half the average lot size plus the safety stock, when demand and lot sizes are expected to be relatively uniform over time. The average can be calculated as an average of several inventory observations taken over several historical time periods; for example, 12-month ending inventories may be averaged. When demand and lot sizes are not uniform, the stock level versus time can be graphed to determine the average.
Raw Material
Purchased items or extracted materials that are converted via the manufacturing process into components and products.
a) Variability of demand Rationale: Safety stock, also known as fluctuation inventory, exists primarily to accommodate variations in demand. The other answer choices might have an indirect influence on safety stock decisions, but none of them provides the best answer.
Safety stock depends on which of the following? a) Variability of demand b) Risk of obsolescence c) Ordering cost d) Inventory carrying cost
Overhead
The costs incurred in the operation of a business that cannot be directly related to the individual goods or services produced. These costs, such as light, heat, supervision, and maintenance, are grouped in several pools and distributed to units of goods or services by some standard allocation method such as direct labor hours, direct labor dollars, or direct materials dollars.
Gross margin
The difference between total revenue and the cost of goods sold.
cash flow
The net flow of dollars into or out of the proposed project. The algebraic sum, in any time period, of all cash receipts, expenses, and investments. Also called cash proceeds or cash generated.
inventory turnover
The number of times that an inventory cycles, or "turns over," during the year. A frequently used method is to divide the annual cost of sales by the average inventory level.
Standard costs
The target costs of an operation, process, or product including direct material, direct labor, and overhead charges.
d) 31.2 days Rationale: Days of Supply = Inventory on Hand/Average Daily Usage. To determine average daily usage, divide the annual usage by 365: 58,500/365 = 160.274. Days of Supply = 5,000/160.274 = 31.197, rounded to 31.2 days.
There are currently 5,000 hydraulic door closers in stock, and analysts project that there will be sales of 58,500 this year. If this turns out to be true, how many days of supply are currently on hand? a) 11.7 days b) 21.3 days c) 36.7 days d) 31.2 days
Finished goods inventory
Those items on which all manufacturing operations, including final test, have been completed. These products are available for shipment to the customer as either end items or repair parts.
Inventory
Those stocks or items used to support production (raw materials and work-in-process items), supporting activities (maintenance, repair, and operating supplies), and customer service (finished goods and spare parts).
d) Activities associated with the movement of material, usually finished goods or service parts, from the manufacturer to the customer Rationale: Distribution is the action or process of supplying goods to stores and other businesses that sell to consumers.
What does the term "distribution" refer to? a) Art and science of obtaining, producing, and distributing material and product in the proper place and in proper quantities b) General flow of merchants shipping between two departure/terminal areas c) Action of transporting someone or something or the process of being transported d) Activities associated with the movement of material, usually finished goods or service parts, from the manufacturer to the customer
c) Amount of direct materials, direct labor, and allocated overhead associated with products sold during a given period of time Rationale: The cost of goods sold determines the amount of direct materials, direct labor, and allocated overhead associated with the products sold.
What is the cost of goods sold? a) Accounting classification used on an asset sheet to reflect inventory value b) Actual cost of the operation of a unit assigned the responsibility of developing and producing a specific product c) Amount of direct materials, direct labor, and allocated overhead associated with products sold during a given period of time d) Computation used to calculate retail costs for the sale of a product
b) Lot-size inventory Rationale: Lot-size inventory is defined as materials, either purchased or manufactured, ordered in quantities greater than needed for immediate purposes for economic or other reasons. Fluctuation inventories (safety stock) are carried to protect against forecast. Transportation inventory is in transit. Scheduled receipts are quantities of items expected to be received, or arrive, on scheduled due dates.
What is the name for inventories that are purchased or manufactured in greater quantities than are immediately in demand? a) Transportation inventory b) Lot-size inventory c) Scheduled receipts d) Fluctuation inventory
a) Standard costs Rationale: Standard costs are the target costs of an operation, process, or product including direct material, direct labor, and overhead charges.
What is the term for the target costs of an operation, process, or product including direct material, direct labor, and overhead charges? a) Standard costs b) Average costs c) First in, first out d) Last in, first out
c) Fluctuation inventory Rationale: Fluctuation inventory, also known as inventory buffer, is carried as a cushion to protect against forecast error.
What type of inventory is held due to the unpredictable nature of supply, demand, or lead time? a) Hedge inventory b) Demand inventory c) Fluctuation inventory d) Anticipation inventory
a) Average cost Rationale: Average cost per unit is based on estimating total cost, including allocated overhead, to produce a batch of goods divided by the total number of units produced.
Which accounting method for valuing inventory estimates total cost, including allocated overhead, to produce a batch of goods divided by the total number of units produced? a) Average cost b) Standard cost c) First in, first out d) Last in, first out
a) General and administrative expenses Rationale: General and administrative expenses are the expenses required to administer a business. They are not related to the construction or sale of goods or services.
Which category of expenses on an income statement includes the costs of general managers, computer systems, research and development, and others? a) General and administrative expenses b) Accrued expenses c) Prepaid expenses d) Operating expenses
c) Owners' Equity = Assets - Liabilities Rationale: "Owners' Equity = Assets - Liabilities" is a variant of the correct balance sheet equation: Assets = Liabilities + Owners' Equity. "Assets = Liabilities - Owners' Equity" incorrectly subtracts owners' equity from this equation. "Income = Revenue - Liabilities" is incorrect because the income statement equation is as follows: Income = Revenue - Expenses, not Revenue - Liabilities. "Revenue = Cost of Goods Sold - General and Administrative Expenses" is incorrect because the cost of goods sold and general and administrative expenses are subtracted from revenue to determine net income (or profit) before taxes.
Which is a correct financial accounting equation? a) Assets = Liabilities - Owners' Equity b) Income = Revenue - Liabilities c) Owners' Equity = Assets - Liabilities d) Revenue = Cost of Goods Sold - General and Administrative Expenses
d) Protective packaging Rationale: The activities of physical distribution include transportation, distribution inventory, warehousing, material handling, and protective packaging.
Which is a function of physical distribution? a) Physical supply b) Purchasing c) Production control d) Protective packaging
d) Raw material inventory levels held at the plant for decoupling purposes can be reduced. Rationale: Inventory can decouple supply from demand at the supply chain level by, for example, allowing raw materials to be pulled from inventory rather than relying on order lead times or maintaining inventories of finished goods rather than producing based on actual orders. If the lead time for raw materials can be reduced by a full day, up to one day's worth of raw materials inventory held for decoupling purposes can be eliminated with no impact on production.
Which is a positive benefit that can be realized by implementing a new raw material ordering system that reduces the total lead time of in-transit inventory by a full day? a) The plant should experience lower overall setup costs and produce higher numbers of units overall. b) Fewer raw material transportation vehicles will need to be used. c) Anticipation inventory levels at the plant can be reduced. d) Raw material inventory levels held at the plant for decoupling purposes can be reduced.
c) Labor, materials, and overhead immediately become accounts payable or wages payable. Rationale: WIP inventory represents a cash outflow for materials, labor, and overhead that is said to be absorbed by the materials produced. However, these first become accounts payable or wages payable, since organizations have a certain amount of time to pay all of these things. They become cash outflows fairly quickly, so increasing WIP inventory will negatively impact cash flows.
Which is true in relation to cash flows and work-in-process (WIP) inventory? a) WIP inventory becomes an asset that increases cash flow. b) WIP inventory is not recognized as an expense until it is finished and sold, so it has no impact on cash flow immediately. c) Labor, materials, and overhead immediately become accounts payable or wages payable. d) Labor, materials, and overhead must be paid for immediately.
d) Days of supply Rationale: Days of supply is an inventory-on-hand metric converted from units to how long the units will last.
Which metric measures the amount of inventory on hand? a) Obsolescence list b) ABC classification c) Inventory velocity d) Days of supply
income statement
a financial statement showing the net income for a business over a given period of time
balance sheet
a financial statement showing the resources owned, the debts owed, and the owner's share of a company at a given point in time.
generally accepted accounting principles (GAAP)
accounting practices that conform to conventions, rules, and procedures that are generally accepted by the accounting profession.
anticipation inventories
additional inventory above basic pipeline stock to cover projected trends of increasing sales, planned sales promotion programs, seasonal fluctuations, plant shutdowns, and vacations.
owners' equity
an accounting/financial term (balance sheet classification of accounts) representing the residual claim by the company's owners or shareholders, or both, to the company's assets less its liabilities.
seasonal inventory
inventory built up to smooth production in anticipation of a peak seasonal demand.
Chase Production Strategy
minimize inventories while increasing costs related to high variability in production
Service parts
those modules, components, and elements that are planned to be used without modification to replace an original part.
unit cost
total labor, material, and overhead cost for one unit of production (e.g., one part, one gallon, one pound).
