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Not quite: just in time inventories.

Much has been written about the Japanese concept of Just-In-Time (JIT) inventories, with particular emphasis placed on the benefits derived from its application. A review of the current literature might lead one to the conclusion that JIT is the panacea to all manufacturing problems. Still, there are costs associated with JIT as well--costs that might be difficult to quantify or even identify in many instances.

Sound business judgement requires the consideration of the costs as well as the benefits associated with a managerial decision. The decision to apply JIT is one such decision, and a thoughtful analysis of the costs and benefits associated with JIT might lead one to conclude that it is not appropriate for all firms in all instances.

By nature JIT is an "absolute" concept: "The goal of JIT is to produce and deliver goods just in time to be sold, subassemblies just in time to be assembled into finished goods, fabricated parts just in time to go into subassemblies and purchased materials just in time to be transported into fabricated parts."(1) If these goals are not met, there are inventories and JIT has not been accomplished. Many would argue that these goals are often unattainable, that zero inventories are to be strived for and that JIT is merely a philosophy. Again, it is possible that thorough analysis and sound judgement might lead to the conclusion that such goals should not be attained.

There are many benefits of JIT and a number of them are discussed in the following section. There are also a number of costs associated with JIT that need to be recognized. Some of these are presented later. Finally, a discussion of a more universally applicable, reasonably attainable goal of inventory management, Not Quite Just-In-Time, is provided.

Traditional Inventory Management

The traditional approach to inventory management centers around the economic order quantity (EOQ) formula that facilitates the determination of an "optimum" level of investment in inventory by minimizing the total costs of obtaining and carrying inventory. The costs of obtaining inventory (ordering costs) include costs of preparing purchase orders or production requests, receiving costs, administrative costs and "extra costs of numerous small production runs, overtime, setups and training."(2) Carrying costs include insurance, property tax, deterioration, spoilage, obsolescence, storage space and an investment cost.

EOQ computations focus on determining the size and number of orders, production runs or lots. The optimal order, or production run, lot size is determined by setting annual inventory carrying cost equal to annual ordering or setup, cost and solving for the unknown lot size. Annual inventory carrying cost is usually expressed as average inventory (unknown order size in units |not equal to~ 2) multiplied by the cost of holding one unit of inventory for one year. Annual ordering cost is expressed in terms of the number of orders per year (annual demand in units |not equal to~ unknown order size) multiplied by cost to place an order. Annual setup cost is expressed as the number of runs per year times setup cost per run.

To use the basic EOQ model, one must make certain assumptions:

* demand is constant throughout the year;

* the entire lot is received at the same time;

* lead time is constant;

* unit costs are constant; and

* inventory size has no limits.

However, the EOQ model can be modified to reflect many of these more complicated issues.

Traditional inventory management incorporates the utilization of reorder points and safety stock. The concept of reorder points entails establishing a quantity level that prompts a new order based on lead time from order placement to receipt and estimated quantity used in the interim. While reorder points signal when to place a new order, safety stock offers a buffer against day-to-day fluctuations in demand and against production and delivery delays. The amount of safety stock is determined by balancing storage costs against estimated stockout costs such as loss of customer goodwill, lost profits, idle equipment and work stoppage. The reorder point is at a higher quantity for the firm that maintains safety stock.

The focus of traditional inventory management is on the minimization of the total costs associated with inventory within "given" constraints rather than on

minimizing inventory. Ordering and setup costs are modeled as constraints and no consideration is given to reducing setup or lead times in the basic EOQ computations. However, such reductions would decrease the amount of inventory needed, causing investment in inventory to decrease and return on investment in inventory to increase.

Just-in-Time Inventories Benefits of JIT

Reduction of inventories is probably the most discussed benefit of the just-in-time philosophy. The use of smaller batches, with the ultimate batch size being one item, leads to the need for less inventory at any particular point in the production process. Cash flow is improved due to less capital investment in inventory. Less inventory on hand leads to savings in other areas such as smaller space requirements (less capital invested in plant or more room to increase production of current product or increase product line), decreased materials handling costs, decreased record-keeping costs, decreased insurance and tax obligations, less scrap and obsolescence, and cleaner facilities.(3)

From the Japanese standpoint, just-in-time is not only a system of inventory reduction, but "a system of production, based on the philosophy of total elimination of waste, that seeks the utmost in rationality in the way we make things."(4) The total elimination of waste entails the "elimination of all activities that do not add value to a product or service ... a commitment to a high level of quality ... a commitment to continuous improvement in the efficiency of an activity ... an emphasis on simplification and increased visibility to identify activities that do not add value."(5) Some consequent benefits are reduced throughput time, better quality built into the product, flexible workers and direct cost savings from the elimination of non-value-adding activities. Quality is of utmost importance when using small lots because, with no inventory buffer, the entire process comes to a halt until the problem is rectified. Additionally, built-in quality yields fewer inspection costs, less rework, less scrap and fewer returns.

"Within a JIT environment, a fundamental goal is the reduction of total product cost."(6) If the total cost per product is reduced, it may be possible to decrease price per unit of product. All other things held constant, lower price should lead to increased demand for the product. This translates into greater profit (assuming the contribution margin per product is not decreased too much). Higher quality will add to the demand for the product. This will generate more profit for the firm. Therefore, just-in-time increases the firm's ability to compete if total product cost is reduced, particularly if quality is improved.

In a just-in-time environment, workers who are basically responsible for non-bottleneck machinery or procedures should be cross-trained. These workers can be trained to do maintenance on machinery that is not being used momentarily or to help bottleneck workers in reducing bottleneck time. The need for flexibility arises also from the entire system's dependence on individual areas to maintain the flow (i.e., having workers trained to do multiple jobs allows for sickness and other unavoidable absences). The benefits to the company are lower labor costs due to a smaller work force and greater productivity due to teamwork and increased worker motivation.

To increase quality input and receive just-in-time input, firms use fewer suppliers. The cost of price negotiations is reduced with long-term contracts. This assures commitment of the firm and the supplier to each other. Since the supplier is reviewed ahead of the firm's production (even before the contract is signed), the manufacturer reduces its inspection costs, scrap costs and downtime.(7)

Just-in-time helps reduce the need for cost allocations. This leads to information that is more useful for decision-making. The "direct traceability of costs" is increased with materials-handling facilities dedicated to single manufacturing cells and line workers performing machine maintenance. As a result, control seems "to be moving ... closer to the point of production, and to be more clearly matching responsibility with controllability of costs."(8) Another accounting benefit is the elimination of the need to make the distinctions in costs of raw materials inventory, work in progress inventory, finished goods inventory and cost of goods sold.

Costs of JIT

A major cost of just-in-time is that of reworking the accounting system to depict the situation more accurately. Traditional cost accounting systems work against just-in-time philosophy by rewarding hidden managerial inefficiencies. Other costs of just-in-time include the following:

* higher compensation and training costs for flexible workers;

* higher orderings costs and higher cost per unit of certain inputs due to more frequent deliveries of smaller lots;

* costs of being locked-into long-term contracts when new technology causes suppliers' costs to decline;

* transaction costs and costs of manufacturing downtime due to a defective part;

* downtime costs due to shipments being late;

* downtime costs due to breakdown of machinery;

* cost from "reorganisation |reorganization~ of the factory layout and possibly the purchase of new machinery"(9);

* "false sense of security" due to low inventory-sales ratio(10);

* and research and development costs of simpler product designs.

No matter how much inefficiency one eliminates from the manufacturing process, when the product is unavailable to the customer "where it is needed precisely when required," the customer may look elsewhere. Additionally, future sales are endangered since the customer may be lost permanently and the customer's friends may be lost as customers. In other words, one wonders how beneficial it is to reduce product costs when there is no revenue to offset them.

Another requirement for a system to be truly just-in-time is that the raw material should arrive from the supplier in a one-unit lot size; otherwise, temporary storage area is needed until the material is used. For most items, suppliers are not willing to deliver in a lot size of one unit. If suppliers delivered in a lot size of one, their transportation costs would escalate rapidly. Manufacturers probably would not pay these costs unless there were no other options.

An Inventory Continuum

As previously mentioned, the goal of JIT is to obtain or produce an item precisely when needed. Failure to attain this goal results in the existence of inventory if the item is available too soon or in a production delay or lost sale if the item is available too late. Thus, JIT can be thought of as one point on a continuum of possible inventory positions:
Delivery: Too Late When Required Too Soon
 |down arrow~
 |up arrow~
Inventory Negative JIT Positive

The costs associated with negative inventories are generally referred to as "stock out" costs, whereas the costs associated with positive inventories are generally referred to as inventory carrying costs. Since the maintenance of no inventories is an ideal and since the costs associated with production bottlenecks or lost sales are likely to be greater than the costs resulting from the maintenance of small inventories, the most beneficial "target" inventory position is likely to be near--but "not quite"--JIT (NQJIT):
Delivery: Too Late When Required Too Soon
 |down arrow~
 |up arrow~
Inventorry Negative JIT Positive
 |down arrow~

'Not Quite' JIT

In a manufacturing process, the maintenance of small work-in-process inventories allows flexibility in the process without requiring the investment and storage costs required under some traditional approaches to inventory management. Small lot sizes can facilitate modification or customization without greatly increasing costs. Processing points can be close together and materials need not be moved from centralized or remote facilities since the small inventories can be located along the process line. Small raw materials and in-process inventories facilitate the processing flow by providing a buffer between manufacturing functions and small finished goods inventories to help avoid lost sales. Losses associated with the maintenance of large inventories, such as obsolescence, spoilage, deterioration and investment, can be greatly reduced with the maintenance of small inventories.


The benefits of JIT can be largely attained even with the maintenance of some inventories. Most of the costs of JIT can be eliminated with the maintenance of inventories. Thus, the most appropriate strategy for many companies might be to adopt a system that allows the maintenance of small inventories of raw materials, work in process and finished goods. In other words, a "not quite" JIT philosophy (NQJIT) may be more realistic and cost effective. NQJIT can include most of the goals of JIT: emphasis on quality, throughput, cross-training and value-added activity. Unlike JIT, NQJIT allows for, and in fact seeks to establish and maintain, optimal levels of inventory. Thus, problems with unrealistic goals, production bottlenecks and lost sales can be avoided.

Traditional inventory management techniques may underemphasize the costs of maintaining large inventories. JIT may underemphasize the costs of not maintaining inventories, particularly since such costs are often difficult to identify and measure. It may be time to identify a "happy medium" in inventory management--Not Quite JIT.


1 R. J. Schonberger, Japanese Manufacturing Techniques (The Free Press, 1982), p. 16.

2 Charles T. Horngren, Introduction to Management Accounting, 5th ed. (Prentice-Hall, 1981), p. 449.

3 R. A. Howell and S. R. Soucy, "The New Manufacturing Environment: Major Trends for Management Accounting," Management Accounting (July 1987), p. 22.

4 T. Ohno, Lecture for the Japan Management Association, 1986. Quoted in Lance Heiko, "Just-In-Time and Fermat's Principle of Least Time," Industrial Management (July-August 1989), pp. 19-20.

5 T. Foster and C. T. Horngren, "JIT: Cost Accounting and Cost Management Issues," Management Accounting (June 1987), p. 19.

6 R. D. McIlhattan, "How Cost Management Systems can Support the JIT Philosophy," Management Accounting (September 1987), p. 24

7 M. A. Robinson and J. E. Timmerman, "How Vendor Analysis Supports JIT Manufacturing," Management Accounting (December 1987), pp. 20-24.

8 C. J. McNair and W. Mosconi, "Measuring Performance in an Advanced Manufacturing Environment," Management Accounting (July 1987), p. 31.

9 C. Drury, "Counting the Cost of AMT Investment," Accountancy (April 1990), p. 137.

10 M. J. Mandel, M. Schroeder and J. B. Treece, "Are Inventories Really Under Control?," Business Week (July 31, 1989), p. 71.

Gene H. Johnson, PhD, CPA, CMA, is an Assistant Professor of Accounting at Louisiana Tech University. Since completing his graduate studies at Texas Tech University, he has presented a number of development seminars for CPAs and other professionals who offer financial advice to clients. He is a member of the American Accounting Association and the Institute of Management Accountants.

James A. Smith is a doctoral student at Louisiana Tech University where he teaches accounting principles. He is a part-time staff accountant for Radian L. Hennigan, CPA, a local firm. Smith is a member of the Institute of Management Accountants and the American Association of Accountants.
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Author:Johnson, Gene H.; Stice, James D.
Publication:The National Public Accountant
Date:Mar 1, 1993
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