Peterson Corporation is considering implementing a JIT production system. The new system would reduce current average inventory levels of $2,000,000 by 75%, but it would require a much greater dependency on the company’s core suppliers for on-time deliveries and high-quality inputs. The company’s operations manager, John Leung, is opposed to the idea of a new JIT system. He is concerned that the new system (a) will be too costly to manage; (b) will result in too many stock outs; and (c) will lead to the layoff of his employees, several of whom are currently managing inventory. He believes that these layoffs will affect the morale of his entire production department. The management accountant, Susan Chow, is in favour of the new system, due to the likely result in cost savings. John wants Susan to revise her cost saving estimation because he is concerned that top management will give more weight to financial factors and not give due consideration to nonfinancial factors such as employee morale. In addition to the reduction in inventory described previously, Susan has gathered the following information for the upcoming year regarding the JIT system:
Annual insurance and warehousing costs for inventory would be reduced by 60% of the current budgeted level of $350,000.
Payroll expenses for current inventory management staff would be reduced by 15% of the budgeted total of $600,000.
Additional annual costs for JIT system implementation and management, including personnel costs, would equal $220,000
The additional number of stock outs under the new JIT system is estimated to be 5% of the total number of shipments annually. Ten thousand shipments are budgeted for the upcoming year. Each stock out would result in an average additional cost of $250.
Peterson’s required rate of return on inventory investments is 10% per year.
Required:
a. From a financial perspective, should Peterson adopt the new JIT system?
b. Is it ethical for Susan to revise her estimation?
c. How should Susan manage John’s concerns?