Pritchett Enterprises manufactures hiking and outdoor equipment. The company's plan in western Colorado has recently seen dramatic changes in manufacturing process. Management is concerned that the current cost system no longer captures the impact of the diversity of activities involved in its production processes. As a result, management is evaluating whether activity-based costing many provide more accurate and meaningful cost data. The production environment includes the following primary activities and cost drivers:
Activity Overhead Cost Cost Driver Activity Volume
Purchase orders $200,000 Number of orders 10,000
Receiving orders 25,000 Number of orders 10,000
Setup costs 25,000 Number of setups 5,000
Testing costs 48,000 Number of tests 6,000
Machine maintenance 350,000 Machine hours 10,000
The company has decided to implement just-in-time inventory management techniques. Using JIT will reduce the amount of inventory on hand at any point in time and save approximately $50,000 annually on inventory carrying costs. In addition, there will be 70 percent fewer purchase orders for inventory issued, but twice as many setups for production runs. The company will also able to receive a 2 percent discount on raw materials purchases because of the long-term nature of the orders.
A. If raw materials purchases are $1,000,000 per year (that is, cost before the above changes are implemented), what quantitative impact will the change to JIT have on the overall costs for the company?
B. What qualitative factors will be impacted by the change to JIT?
C. Does it appear that the move to JIT will be positive or negative for the company? Why or why not?
This solution discusses the qualitative impact of change to JIT on overhead costs.