Just In Time Costing Naveen Kumar, PRN-10020241070 30/01/2011

Just-in-Time Costing

Just-in-time (JIT) purchasing is the purchase of materials (or goods) so that they are delivered
just as needed for production (or sales). Companies moving toward JIT purchasing is to reduce
their costs of carrying inventories (parameter C in the EOQ model as described below)1. At the
same time, the cost of placing a purchase order (parameter P in the model) is decreasing
because:

Companies are establishing long-term purchasing agreements that define price and
quality terms over an extended period.
Companies are using electronic links, such as the Internet, to place purchase orders at a
cost that is estimated to be a small fraction of the cost of placing orders by telephone or
by mail.
Companies are using purchase-order cards.2 As long as purchasing personnel stay within
preset total and individual-transaction dollar limits, traditional labor-intensive
procurement-approval procedures are not required.

Just-in-time (JIT) production, which is also called lean production, is a “demand-pull”

manufacturing system that manufactures each component in a production line as soon as, and
only when, needed by the next step in the production. JIT production systems aim to
simultaneously (1) meet customer demand in a timely way, (2) with high-quality products, and
(3) at the lowest possible total cost.

A JIT production system has these features:

• Production is organized in manufacturing cells, a grouping of all the different types of

equipment used to make a given product.
• Workers are hired and trained to be multi-skilled and capable of performing a variety of
operations and tasks, including minor repairs and routine maintenance of equipment.
• Defects are aggressively eliminated. Because of the tight links between workstations in the
production line and the minimal inventories at each workstation, defects arising at one
workstation quickly affect other workstations in the line. JIT creates urgency for solving
problems immediately and eliminating the root causes of defects as quickly as possible.
• Setup time is reduced.
•Suppliers are selected on the basis of their ability to deliver quality materials in a timely
manner. Most companies implementing JIT production also implement JIT purchasing.
The success of JIT production system hinges on the speed of information flows from customers
to manufacturers to suppliers. The Enterprise Resource Planning (ERP) system comprises a
single database that collects data and feeds it into software applications supporting all of a
company’s business activities.

1
The economic order quantity (EOQ) is a decision model that, under a given set of assumptions,
calculates the optimal quantity of inventory to order. The formula used is EOQ =√(2DP/C)
Just In Time Costing Naveen Kumar, PRN-10020241070 30/01/2011

• JIT encourages the manufacturing department to stop production immediately when a quality
problem is discovered, which signifies that JIT costing emphasizes a lot on quality and processes.

The performance measures and control in a JIT production:

1. Financial performance measures, such as inventory turnover ratio, 3 which is expected to be

improved.
2. Nonfinancial performance measures of time, inventory, and quality, such as:
• Manufacturing lead time, expected to decrease
• Units produced per hour, expected to increase
• Number of days of inventory on hand, expected to decrease

•Total setup time for machine

Total manufacturing time , expected to decrease

•Number of units requiring rework or scarp

Total number of units started and completed , expected to decrease

Back flush Costing:

Traditional normal and standard-costing systems use sequential tracking, which is a costing
system in which recording of the journal entries occurs in the same order as actual purchases
and progress in production.

Under normal costing, Unit cost = (Direct Labor + Overhead Expenses) / Number of units
produced
Under JIT Costing, Cycle time cost = (Direct Labor + Overhead Expenses) / Cycle time in
hours
This clearly signifies that the JIT method uses time as a basis to absorb costs. Also, when we
consider JIT costing following parameters hold true:
 Only a single cost driver is used i.e. cycle time.
 Direct labor is considered as an overhead cost.
 Cycle time cost formula is considered instead of unit cost formula.

Naveen Kumar
10020241070
MBA-IB-Div-B