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Cost Accounting – I

Notes as buffers so that operations can proceed smoothly even if there are unanticipated disruptions.
Raw materials inventories provide insurance in case suppliers are late with deliveries. Work in
process inventories are maintained in case a work station is unable to operate due to a breakdown
or other reason. Finished goods inventories are maintained to accommodate unanticipated
fluctuations in demand. While these inventories provide buffers against unforeseen events, they
have a cost. In addition to the money tied up in the inventories, expert argue that the presence of
inventories encourages inefficient and sloppy work, results in too many defects, and dramatically
increase the amount of time required to complete a product.

Under ideal conditions a company operating at JIT manufacturing system would purchase only
enough materials each day to meet that days needs. Moreover, the company would have no
goods still in process at the end of the day, and all goods completed during the day would have
been shipped immediately to customers. As this sequence suggests, “just-in-time” means that
raw materials are received just in time to go into production, manufacturing parts are completed
just in time to be assembled into products, and products are completed just in time to be shipped
to customers. Although few companies have been able to reach this ideal, many companies have
been able to reduce inventories only to a fraction of their previous level. The result has been a
substantial reduction in ordering and warehousing costs, and much more efficient and effective
operations. In a just in time environment, the flow of goods is controlled by a pull approach.
The pull approach can be explained as follows. At the final assembly stage a signal is sent to
the preceding work station as to the exact amount of parts and materials that would be needed
over the next few hours to assemble products to fill customer orders, and only that amount of
materials and parts is provided. The same signal is sent back to each preceding workstation so
a smooth flow of parts and materials is maintained with no appreciable inventory buildup at
any point. Thus all workstations respond to the pull exerted by the final assembly stage, which
in turn respond to customer orders. As one worker explained, “Under just in time system you
don’t produce anything, anywhere, for anybody unless they ask for it somewhere downstream.
Inventories are evil that we are taught to avoid”.

The pull approach described above can be contrasted to the push approach used in conventional
manufacturing system. In conventional system, when a workstation completes its work, the
partially completed goods are pushed forward to the next work station regardless of whether
that workstation is ready to receive them. The result is an unintentional stockpiling of partially
completed goods that may not be completed for days or even weeks. This ties up funds and also
results in operating inefficiencies. For one thing, it becomes very difficult to keep track of where
everything is when so much is scattered all over the factory floor.

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