COST OF QUALITY

I. Quality as a competitive weapon

A. Focus on quality: reduces costs and increases customer
satisfaction
1. International quality standards developedISO 9
!. "reates e#pertise a$out products and processes
%. &enefits in preservin' revenues( not necessarily 'eneratin'
)i')er revenues
*. +nvironmentally responsi$le
&. ,wo $asic aspects of quality
1. Quality of design: )ow closely t)e c)aracteristics of a
product or service meet t)e needs and wants of customers
2. Conformance quality
a. -efinition: refers to t)e performance of a product or
service relative to its desi'n and product specifications
$. -ia'ram in te#ts illustrates interaction of two $asic
qualities and customer satisfaction
". Issues in mana'in' conformance quality
1. Costs of quality COQ!
a. Four cate'ories
i. "re#ention costscosts incurred to preclude t)e
production of products t)at do not conform to
specifications
ii. A$$raisal costscosts incurred to detect w)ic) of t)e
individual units of products do not conform to
specifications
iii. Internal failure costscosts incurred $y a
nonconformin' product $efore it is s)ipped to customers
iv. %&ternal failure costscosts incurred $y a
nonconformin' product detected after it is s)ipped to
customers
$. Seven.step activity.$ased costin' approac) to determine
costs of quality
i. Step 1: Identify t)e c)osen product
ii. Step !: Identify t)e product/s direct costs of
quality
iii. Step %: Select t)e cost.allocation $ases to use for
allocatin' indirect costs of quality to t)e product
iv. Step *: Identify t)e indirect costs of quality
associated wit) eac) cost.allocation $ase
v. Step 0: "ompute t)e rate per unit of eac) cost.
allocation $ase used to allocate indirect costs of
quality to t)e product
vi. Step 1: "ompute t)e indirect costs of quality
allocated to t)e product
vii. Step 2: "ompute t)e total costs of quality $y addin'
all direct and indirect costs of quality assi'ned to t)e
product
c. Opportunity costs e#cluded in cost of quality reports
i. For'one contri$ution mar'in and income from lost sales
ii. 3ost production
iii. 3ower prices as a result of poor quality
!. ,ec)niques used to analy4e quality pro$lems
a. Control c'arts
i. Statistical quality control 5SQ"6 or statistical process
control 5S7"6: formal means of distin'uis)in' $etween
random and nonrandom variation in an operatin' process
ii. Control c'art: 'rap) of a series of successive
o$servations of a particular step( procedure( or
operation ta8en at re'ular intervals of time
iii. O$servations outside control limits are ordinarily
re'arded as nonrandom and wort) investi'atin'
$. "areto diagrams
i. O$servations outside control limits serve as inputs to
7areto dia'rams
ii. "areto diagram: c)art t)at indicates )ow frequently
eac) type of defect occurs( ordered from t)e most
frequent to t)e least frequent
c. Cause(and(effect diagrams
i. -efinition: identifies potential causes of failures or
defects
ii. 9a:or cate'ories of potential causes of failure
identified wit) eac) cause noted wit) arrow wit)in
cate'ory: 'eneral appearance of $one structure of a fis)
iii. Analysis of quality pro$lems facilitated $y automated
equipment and computers t)at maintain records of num$er
and types of defects and operatin' conditions t)at
e#isted at time defects occurred
%. ;elevant costs and $enefits of quality improvement
a. ;elevant costs: incremental costs to implement quality
pro'ram
$. ;elevant $enefits: cost savin's and estimated increase in
contri$ution mar'in from )i')er sales due to quality
improvements
c. ;elevant cost and relevant revenue analysis i'nores
allocated amounts
d. <ey question: =ow will total costs and total revenues
c)an'e under eac) solution>
e. 3oo8 for opportunities to 'enerate )i')er total revenues
from quality improvements
f. ,rends compared over time in cost of quality 5"OQ6 reports
-. "osts of desi'n quality
1. -esi'nin' products t)at satisfy customer needs
!. Si'nificant component of t)ese costs is opportunity cost of
sales lost from not producin' a product t)at customers want
%. 9any of t)ese costs are very difficult to measure o$:ectively
59ost companies do not measure financial costs of desi'n
quality $ut rely on nonfinancial measures.6
+. ?onfinancial measures of quality and customer satisfaction
1. ?onfinancial measures of customer satisfaction
a. +#amples of routine nonfinancial measures of quality of
desi'n and e#ternal failure
i. 9ar8et researc) information on customer preferences and
customer satisfaction wit) specific product features
ii. ?um$er of defective units s)ipped to customers as a
percenta'e of total units s)ipped
iii. ?um$er of customer complaints
iv. 7ercenta'e of products t)at fail soon or often
v. -elivery delays
vi. On.time delivery rate
$. Surveys used to measure customer satisfaction: customer
e#periences and preferences a$out products and 'limpses of
features customers would li8e in future products
!. ?onfinancial measures of internal performance
a. +#amples of nonfinancial measures of prevention( appraisal(
and internal failure
i. ?um$er of defects for eac) product line
ii. 7rocess yield 5ratio of 'ood output to total output6
iii. +mployee turnover 5ratio of t)e num$er of employees
w)o leave t)e company to t)e avera'e total num$er of
employees6
iv. +mployee empowerment 5ratio of t)e num$er of processes
in w)ic) employees )ave ri')t to ma8e decisions wit)out
consultin' supervisors to t)e total num$er of processes6
v. +mployee satisfaction 5ratio of employees indicatin' )i')
satisfaction ratin's to t)e total num$er of employees
surveyed6
$. +#amine trends over time
c. ;ole of mana'ement accountant: review nonfinancial measures
for accuracy and consistency
F. +valuatin' quality performance
1. Advanta'es of costs of quality 5"OQ6 measures
a. "onsistent wit) attention.directin' role of mana'ement
accountin'( "OQ focuses mana'ers/ attention on cost of
poor quality
$. Financial "OQ measures assist in pro$lem solvin' $y
comparin' costs and $enefits of different quality.
improvement pro'rams and settin' priorities for cost
reduction
c. Financial "OQ measures provide a sin'le( summary measure of
quality performance for evaluatin' trade.offs amon'
prevention costs( appraisal costs( internal failure costs(
and e#ternal failure costs
!. Advanta'es of nonfinancial measures of quality
a. ?onfinancial measures of quality are often easy to quantify
and easy to understand
$. ?onfinancial measures direct attention to p)ysical
processes and )ence focus attention on t)e precise pro$lem
areas t)at need improvement
c. ?onfinancial measures provide immediate s)ort.run feed$ac8
on w)et)er quality improvement efforts )ave succeeded
d. ?onfinancial measures are useful indicators of future lon'.
run performance
C)A"T%* QUI+
1. ,)e four cost cate'ories in a cost of quality pro'ram are
a. product desi'n( process desi'n( internal success( and e#ternal
success.
$. prevention( appraisal( internal failure( and e#ternal failure.
c. desi'n( conformance( control( and process.
d. desi'n( process specification( on.time delivery( and customer
satisfaction.
!. is a formal means of distin'uis)in'
$etween random and nonrandom variation in an operatin' process.
a. Statistical process control 5S7"6
$. A 7areto dia'ram
c. A cause.and.effect dia'ram
d. A fis)$one dia'ram
%. A 8ey question in relevant cost and relevant revenue analysis is
a. @&y )ow muc) can sales $e increased and costs reduced>A
$. @B)at purpose is $est served for cost allocation and w)ic)
criterion is most appropriate>A
c. @=ow will total costs and total revenues c)an'e under eac)
solution>A
d. @B)at are t)e amounts of incremental costs and incremental
revenues under eac) alternative>A
*. B)ic) of t)e followin' is not a nonfinancial performance measure for
customer satisfaction>
a. ?um$er of defective units s)ipped to customers as a percenta'e of
t)e total units of product s)ipped
$. ?um$er of customer complaints
c. On.time delivery
d. ?um$er of defects for eac) product line
0. ?onfinancial measures for internal quality performance include all
$ut w)ic) of t)e followin'>
a. employee empowerment
$. process yields
c. feed$ac8
d. product defect levels
1. An advanta'e of financial cost of quality measures is t)at t)ey
a. are often easy to quantify and understand.
$. provide immediate s)ort.run feed$ac8 on w)et)er quality
improvement efforts )ave( in fact( succeeded in improvin'
quality.
c. direct attention to p)ysical processes and t)erefore focus
attentions on t)e precise pro$lem areas needin' improvement.
d. provide a sin'le( summary measure of quality performance.
2. Quality mana'ement provides an important competitive ed'e $ecause
it
a. reduces costs.
$. increases customer satisfaction.
c. often results in su$stantial savin's and )i')er revenues in
t)e s)ort run.
d. does all of t)e a$ove.
C. Quality of desi'n measures )ow closely t)e c)aracteristics of
products or services matc) t)e needs and wants of customers.
"onformance quality
a. measures t)e same t)in's.
$. is t)e performance of a product or service accordin' to desi'n
and product specifications.
c. is ma8in' t)e product accordin' to desi'n( en'ineerin'( and
manufacturin' specifications.
d. focuses on fitness of uses from a customer perspective.
9. B)ic) of t)e followin' fail to satisfy conformance quality>
a. 9ac)ines t)at fail to meet t)e needs of customers
$. 9ac)ines t)at $rea8 down
c. -epositin' a customerDs c)ec8 into t)e correct account
d. All of t)e a$ove fail to satisfy conformance quality.
1. "osts incurred in precludin' t)e production of products t)at do
not conform to specifications are
a. prevention costs.
$. appraisal costs.
c. internal failure costs.
d. e#ternal failure costs.
11. "osts incurred in detectin' w)ic) of t)e individual units of
products do not conform to specifications are
a. prevention costs.
$. appraisal costs.
c. internal failure costs.
d. e#ternal failure costs.
1!. "osts incurred $y a nonconformin' product detected $efore it is
s)ipped to customers are
a. prevention costs.
$. appraisal costs.
c. internal failure costs.
d. e#ternal failure.
1%. 7reventive equipment maintenance is an e#ample of
a. prevention costs.
$. appraisal costs.
c. internal failure costs.
d. e#ternal failure costs.
1*. Spoila'e is an e#ample of
a. prevention costs.
$. appraisal costs.
c. internal failure costs.
d. e#ternal failure costs.
10. 3ia$ility claims is an e#ample of
a. prevention costs.
$. appraisal costs.
c. internal failure costs.
d. e#ternal failure costs.
11. 9ount Eernon Furniture manufactures e#pensive ta$les. Its
varnis)in' department is fully automated and requires su$stantial
inspection to 8eep t)e mac)ines operatin' properly. An improperly
varnis)ed ta$le is very e#pensive to correct. Inspection )ours for
t)e 1( ta$les varnis)ed in Septem$er totaled !(0 )ours $y 11
employees. +i')t quarts of varnis) were used( on avera'e( for eac)
ta$le. ,)e standard amount of varnis) per ta$le is nine quarts.
,)e cost of inspection for Septem$er was equal to t)e $ud'eted
amount of 721(.
,)e 721( represents
a. an activity cost pool.
$. a possi$le cost allocation $ase.
c. an internal failure cost.
d. a wor8.in.process control.
12. 9ount Eernon Furniture manufactures e#pensive ta$les. Its
varnis)in' department is fully automated and requires su$stantial
inspection to 8eep t)e mac)ines operatin' properly. An improperly
varnis)ed ta$le is very e#pensive to correct. Inspection )ours for
t)e 1( ta$les varnis)ed in Septem$er totaled !(0 )ours $y 11
employees. +i')t quarts of varnis) were used( on avera'e( for eac)
ta$le. ,)e standard amount of paint per ta$le is ten quarts. ,)e
cost of inspection for Septem$er was equal to t)e $ud'eted amount
of 721(.
B)at is t)e inspection cost per unit>
a. 7%.*
$. 72.1
c. 7%(C
d. 7*(
1C. "ost of quality reports usually do not consider
a. e#ternal failure costs.
$. opportunity costs.
c. internal failure costs.
d. appraisal costs.
19. +#amples of opportunity costs include
a. lost sales.
$. for'one contri$ution mar'in.
c. lower production.
d. all of t)e a$ove.
!. A 'rap) of a series of successive o$servations of a particular
step( procedure( or operation ta8en at re'ular intervals of time
is a
a. control c)art.
$. 7areto dia'ram.
c. cause.and.effect dia'ram.
d. fis)$one dia'rams.
!1. Statistical quality control includes a control c)art t)at
a. 'rap)s a series of random events of a process.
$. plots eac) o$servation relative to specified ran'es t)at
represent t)e e#pected distri$ution.
c. plots control o$servations over various periods of time.
d. plots only t)ose o$servations outside specified limits.
!!. B)en usin' a control c)art( a mana'er does not investi'ate t)e
activity w)en
a. all o$servations are outside t)e preset ran'e.
$. some o$servations are outside t)e preset ran'e.
c. all o$servations are wit)in t)e ran'e of preset standard
deviations.
d. almost all o$servations are wit)in t)e ran'e of two standard
deviations.
!%. A tool w)ic) indicates )ow frequently eac) type of defect occurs
is a
a. control c)art.
$. 7areto dia'ram.
c. cause.and.effect dia'ram.
d. fis)$one dia'rams.
!*. A tool w)ic) identifies potential causes of failures or defects is
a. a control c)art.
$. a 7areto dia'ram.
c. a cause.and.effect dia'ram.
d. none of t)e a$ove.
9etropolitan 9anufacturin' e#pects to spend 7*( in !#* in
appraisal costs if it does not c)an'e its incomin' materials
inspection met)od. If it decides to implement a new receivin' met)od(
it will save 7*( in fi#ed appraisal costs and varia$le costs of
7.* per unit of finis)ed product. ,)e new met)od involves 71( in
trainin' costs and an additional 711( in annual equipment rental.
It ta8es two units of material for eac) finis)ed product.
Internal failure costs avera'e 7C per failed unit of finis)ed 'oods.
-urin' !#%( 0F of all completed items )ad to $e rewor8ed. +#ternal
failure costs avera'e 7! per failed unit. ,)e companyDs avera'e
e#ternal failures are 1F of units sold. ,)e company carries no endin'
inventories( $ecause all :o$s are on a per order $asis and a :ust.in.
time inventory orderin' met)od is used.
!0. B)at is t)e net effect on appraisal costs for !#*( assumin' t)e
new receivin' met)od is implemented and t)at C( material
units are received>
a. 7!( increase
$. 7!( decrease
c. 7!( decrease
d. 7!!( increase
!1. =ow muc) will internal failure costs c)an'e( assumin' C(
units of materials are received and t)at t)e new receivin' met)od
reduces t)e amount of unaccepta$le product units in t)e
manufacturin' process $y 1F>
a. 7 !( increase
$. 7 !0( decrease
c. 7C( decrease
d. 711( decrease
!2. =ow muc) will e#ternal failure costs c)an'e assumin' C( units
of materials are received and t)at product failures wit) customers
are cut in )alf wit) t)e new receivin' met)od>
a. 71( increase
$. 7!( decrease
c. 7%!( decrease
d. 7*( decrease
;e'al 7roducts )as a $ud'et of 79( in !#% for prevention costs.
If it decides to automate a portion of its prevention activities( it
will save 71( in varia$le costs. ,)e new met)od will require
71C( in trainin' costs and 71!( in annual equipment costs.
9ana'ement is willin' to ad:ust t)e $ud'et for an amount up to t)e
cost of t)e new equipment. ,)e $ud'eted production level is 10(
units.
Appraisal costs for t)e year are $ud'eted at 71(. ,)e new
prevention procedures will save appraisal costs of 7%(. Internal
failure costs avera'e 710 per failed unit of finis)ed 'oods. ,)e
internal failure rate is e#pected to $e %F of all completed items. ,)e
proposed c)an'es will cut t)e internal failure rate $y one.t)ird.
Internal failure units are destroyed. +#ternal failure costs avera'e
70* per failed unit. ,)e companyDs avera'e e#ternal failures avera'e
%F of units sold. ,)e new proposal will reduce t)is rate $y 0F.
Assume all units produced are sold and t)ere are no endin'
inventories.
!C. B)at is t)e net c)an'e in t)e $ud'et of prevention costs if t)e
procedures are automated in !#*> Bill mana'ement a'ree wit) t)e
c)an'es>
a. 71( decrease( yes
$. 72C( increase( yes
c. 71( increase( no
d. 71%C( increase( no
!9. =ow muc) will appraisal costs c)an'e assumin' t)e new prevention
met)ods reduce material failures $y *F in t)e appraisal p)ase>
a. 7!*( decrease
$. 71( increase
c. 7%( decrease
d. 71!( decrease
%. =ow muc) will internal failure costs c)an'e if t)e internal
product failures are reduced $y 0F wit) t)e new procedures>
a. 7%%(20 decrease
$. 712(0 decrease
c. 70( decrease
d. 720( decrease
%1. =ow muc) does e#ternal failure costs c)an'e if all c)an'es are as
anticipated wit) t)e new prevention procedures> Assume all units
produced are sold and t)ere are no endin' inventories.
a. 71!1(0 decrease
$. 71!1(0 increase
c. 7!*%( decrease
d. ?one of t)e a$ove
%!. 9ana'ement )as offered to allow t)e prevention c)an'es if all
c)an'es ta8e place as anticipated and t)e amounts netted are less
t)an t)e cost of t)e equipment. B)at is t)e net impact of all t)e
c)an'es created $y t)e preventive c)an'es>
a. 72C(
$. 75%%(206
c. 759%(026
d. 75119(26
%%. An important difference $etween financial measures of quality and
nonfinancial measures of quality is
a. financial measures of quality tend to $e useful indicators of
future lon'.term performance( w)ile nonfinancial measures )ave
more of a s)ort.term focus.
$. nonfinancial measures of quality tend to $e useful indicators
of future lon'.term performance( w)ile financial measures of
quality )ave more of a s)ort.term focus
c. nonfinancial measures are 'enerally too su$:ective to )ave any
lon'.term value.
d. t)ere is no su$stantive difference $etween t)e financial and
nonfinancial measures of quality.
%*. +#amples of nonfinancial measures of quality include
a. percenta'e of defective units s)ipped to customers as a
percenta'e of total units s)ipped.
$. t)e num$er of customer complaints.
c. percent of products t)at e#perience early or e#cessive
failure.
d. all of t)e a$ove are nonfinancial measures of quality.
7;O&3+9 SO3EI?G
1. Ga'non "ompanyDs quality cost report is to $e $ased on t)e
followin' data:
9aintenance of test equipment........... 71C(
,est and inspection of incomin'
materials............................. 2%(
Systems development..................... !9(
7roduct recalls......................... 91(
Quality trainin'........................ !0(
-isposal of defective products.......... 00(
Supervision of testin' and inspection
activities............................ !*(
Barranty repairs and replacements....... 0C(
?et cost of scrap....................... !%(
;equired:
7repare a Quality "ost ;eport in 'ood form wit) separate sections
for prevention costs( appraisal costs( internal failure costs(
and e#ternal failure costs.
!. Ga'net "ompanyDs quality cost report is to $e $ased on t)e
followin' data:
3ia$ility arisin' from defective
products
....................................... 7C!(
Final product testin' and inspection.... *(
;eturns arisin' from quality pro$lems. . . !*(
,ec)nical support provided to suppliers. 0!(
-isposal of defective products.......... 9C(
9aintenance of test equipment........... 0%(
Systems development..................... 12(
-epreciation of test equipment.......... 11(
-e$u''in' software errors............... C2(
;equired:
7repare a Quality "ost ;eport in 'ood form wit) separate sections
for prevention costs( appraisal costs( internal failure costs(
and e#ternal failure costs.