Farm Fresh Ltd is a manufacturer of farm equipment that is sold by a network of distributors across Australia and New Zealand. The Service Division manufactures spare parts for the various models of farm equipment and sells these through the distribution centres. In January last year, a JIT system vas implemented in the Service Division to reduce inventory costs. This has now been in place for a year and the results are as follows:
• The average inventory of spare parts has now reduced from $1 100 000 to $300 000.
• Projected annual insurance costs of 1160 000 have declined by 60 percent due to the lower average cost of inventory.
• A leased 8000 square metre warehouse, previously used for inventory storage, was not used all year. The division paid $22 400 annual rent for the warehouse and was able to sub-let three-quarters of the building to several tenants at $5 per square metre per year. The remainder of the space was not used.
• Two warehouse employees whose services were no longer needed were transferred to the purchasing department of the Service Division in January last year at the start of the JIT implementation, to assist in the coordination of the JIT program. Their total annual cost was $76 000 which continued to be allocated to the indirect labour portion of the fixed overhead.
• Even though employees needed to work overtime to manufacture 7500 spare parts, lost sales due to stock-outs totalled 3800 spare parts. The overtime premium amounted to $11.20 per part manufactured. The use of overtime to manufacture spare parts was virtually non-existent prior to the introduction of JIT.
Prior to the decision to implement JIT, the Service Division of Farm Fresh had completed its budget. The budgeted income statement, without any adjustments for the JIT system, is as follows- Farm Fresh is incremental cost of borrowing is15 percent per annum.
1. Calculate the cash savings (or loss) for the Service Division of Farm Fresh Ltd for the first year of operation of JIT.
2. Discuss any factors that should be considered before a company implements JIT, particularly any possible impacts on supplier and customer relationships.