Problem:
Michael Chang, manager of AgriCo's Service Division, dialed the division controller's number on his phone "Janice, this is Mike Chang, How's that JIT program doing? Has it saved us any money? I've got to report to the president next week, and I'd like to know how our inventory efforts are coming along". "Give me a day or two, Mike, and I'll have some figures for you," responded Janice Patel, the division controller.
AgriCo is a manufacturer of farm equipment sold by a network of distributors throughout North America. A majority of the distributors are also repair centers for AgriCo Service Division to provide timely support of spare parts. In an effort to reduce the inventory costs incurred by the Service Division Chang implemented a just-in-time inventory program on January 2, 2xxx. JIT has now been in operation for a year. Grady has been able to document the following results of JIT implementation.
* The service Division's average inventory declined for $550,000 to $150,000
* Projected annual insurance costs of $80,000 declined by 60 percent due to the lower average inventory
* A leased, 8,000 square foot warehouse previously used for raw material storage, was not used at all during the year. The division paid $11,200 annual rent for the warehouse and was able to sublet three-quarters of the building to several tenants at $2.50 per square foot. The balance of the space remained idle.
* Two warehouse employees whose services were no longer needed were transferred on January 2, 2xxx, to the Purchasing Department to assist in the coordination of JIT program. The annual salary expense for these two employees totaled $38,000 and continued to be charged to the indirect labor portion of fixed overhead.
* Despite the use of overtime to manufacture 7,500 spare parts, lost sales due to stock outs totaled 3,800 spare parts. The overtime premium incurred amounted to $5.60 per part manufactured. The use of overtime to fill spare parts orders was immaterial prior to January 1, 2xxx.
Prior to the decision to implement the JIT inventory program, AgriCo's Service Division had completed its 2xxx budget. The division's budgeted income statement, without any adjustments for just-in-time inventory, follows. AgriCo's incremental borrowing rate for inventory is 15 percent. Taxes are ignored.
AGRIC SERVICE DIVISION
Budgeted Income Statement
For the Year Ended December 31, 2xxx (in thousands)
Sales (280,000 spare parts).................................... $6,160
Cost of goods old:
Variable.................................$2,660
Fixed....................................1,120 3,780
Gross margin.....................................................2,380
Selling and administrative expenses:
Variable.................................$700
Fixed.....................................555 1,255
Operating income................................................$1,125
Other income........................................................75
Income before interest and income taxes..........................$1200
Interest expense...................................................150
Income before income taxes.......................................$1050
Question 1. Calculate the cash saving (loss) for AgriCo's Service Division that resulted during 2xxx from the adoption of the JIT inventory program. Contribution margin is the sales revenue minus the variable cost.
Question 2. Discuss any factors, other than financial, that should be considered before company implements a JIT program.
Question 3. Build a spreadsheet: Construct an excel spreadsheet to solve requirement (1) above. Show how the solution will change if the following information changes: the Service Department's average inventory declined to $200,000 and projected annual insurance costs declined by 50 percent.