The RU Fitness Company (RU) makes home gym equipment that focuses on strength training. Due to the
Question:
The RU Fitness Company (RU) makes home gym equipment that focuses on strength training. Due to the COVID pandemic, the company has seen a rise in demand for their equipment as local gyms close or patrons are not comfortable working out at a gym. Diego Madruga, owner and CEO of the company expects the current level of demand will hold steady for the next five years as he learns more people are opting to work out at home.
RU manufactures their equipment at its plant in Langley, BC. To prepare for both the short term and the future, Diego wants to review current plant operations and explore ways in which the company can become more efficient. He has hired you, as consultant, to assess the company’s manufacturing and inventory practices and provide recommendations.
Current situation:
To assist with your analysis, Diego asked his cost accountant to summarize some of the key financial figures relating to inventory:
- Carbon steel makes up 85% of RU’s inventory value. Because of its strength, it is necessary to handle the long-term stress put on gym equipment. Annual requirements for carbon steel are 76,800 kilograms. It is purchased by the kilogram at an average cost of $0.71 per kg.
- Carbon steel is ordered on a monthly basis from Majuba Steel Inc., a local importer of steel from overseas. RU works with a purchasing agent who contracts with RU to order in the steel from Majuba. The agent, who works away from RU’s office, writes up the order on a paper document, faxes it to the supplier and follows up via phone to ensure the order is filled. She charges $390 per order. This is the only order cost incurred.
- Annual costs of warehouse leasing, insurance, utilities, and management are $8.80 per kilogram of carbon steel.
- RU’s opportunity cost is 12%
Proposed JIT:
Diego is also considering implementing a just-in-time (JIT) manufacturing system to reduce RU’s costs and be responsive to demand. He has already consulted with an industrial engineer to learn more about how to rearrange the shop floor to create a lean manufacturing environment. Costs and resulting benefits of implementing JIT (excluding inventory carrying and ordering costs) are as follows:
One-time cost to rearrange the shop floor to create manufacturing workstations is $440,000(continued on next page)
- Retrain existing workforce for the JIT required skills is $60,000
- Anticipated defect reduction is 30%. Currently there is a cost of quality defect assessment listed as $150,000 per year. This is considered to be an internal failure cost.
- RU manufactures its products using a batch process. The setup time for each of the batches will be reduced by 40% under a JIT system. Current annual setup costs are $350,000.
- A 20% premium on production supplies will be charged as supplies will be delivered on a more frequent schedule. Currently production supplies are $520,000 per year.
Required:
- CURRENT SITUATION: To begin this analysis, you decide to assess the current situation as it relates to RU’s ordering practices and carrying costs. Your initial thought is the company may be able to optimize its order and carrying costs using existing practices.
Given current ordering practices, what is the total annual relevant cost of ordering and carrying inventory. (4 marks)
Financial Accounting A User Perspective
ISBN: 978-0470676608
6th Canadian Edition
Authors: Robert E Hoskin, Maureen R Fizzell, Donald C Cherry