(c) 2013 Cengage Learning

Quality and
Environmental Cost
Management
 Chapter 14 Objectives
1. Define quality, describe the four types of quality costs, and
discuss the approaches used for quality cost measurement.
2. Prepare a quality cost report and explain its use.
3. Explain why quality cost information is needed and how it is
used.
4. Describe and prepare three different types of quality
performance reports.
5. Discuss how environmental costs can be measured,
reported, and reduced.
6. Show how environmental costs can be assigned to products
and processes.
 Quality

• Improving quality may actually be the key to survival for many

firms.
• Improving process quality and the quality of products and
services is a fundamental strategic objective.
• If quality is improved, then customer satisfaction
increases.
• If customer satisfaction increases, then market share will
increase.
• If market share increases, then revenues will increase.
• If quality improves, then operating costs will also decrease.

4
 Costs of Quality
A quality product or service is one that meets or exceeds
customer expectations.

A defective product is one that does not conform to specifications.

Quality is customer satisfaction.

Quality of conformance is a measure of how a product meets is

specifications.

Zero defects means all products conform to specifications.

Robustness means exact conformance to target value.

Objective 1
14-5
 Costs of Quality

• Costs of quality – costs that exist because poor quality may or

does exist
• Control activities: performed by an organization to
prevent or detect poor quality
• Prevention and appraisal activities
• Control Costs: costs of performing control activities
• Failure activities: performed by an organization or its
customers in response to poor quality
• Failure costs: costs incurred by an organization because
failure activities are performed

Objective 114-6
 Costs of Quality

Defining Quality Costs:

1)Prevention costs

2)Appraisal costs

3)Internal failure costs

4)External failure costs

Objective 114-7
Costs of Quality

Objective 114-8
 Costs of Quality

• Observable Quality Costs are those costs that are available

from an organization’s accounting records.
• Hidden Quality Costs are opportunity costs resulting from
poor quality
• Methods for estimating hidden quality costs:
• The Multiplier Method
• The Market Research Method
• The Taguchi Quality Loss Function

Objective 114-9
 Costs of Quality

The multiplier method assumes that the total failure cost is

simply some multiple of measured failure costs:

Total external failure cost = k(Measured external failure

costs)
Where k is the multiplier effect

Objective 114-10
 Costs of Quality
The market research method uses formal market research
methods to assess the effect of poor quality on sales and
market share.

Customer surveys and interviews with members of a

company’s sales force can provide significant insights into
the magnitude of a company’s hidden costs.

Market research results can be used to project future profit

losses attributable to poor quality.

Objective 114-11
 Costs of Quality

The Taguchi loss function assumes any variation from the

target value of a quality characteristic causes hidden
quality costs

Furthermore, the hidden quality costs decrease quadratically

as the actual value deviates from the target value.

Objective 114-12
 Costs of Quality

The Taguchi Quality Loss Function

L(y) = k(y-T)2
Where:
K= A proportionally constant dependent upon the
organization’s external failure cost structure
Y = Actual value of quality characteristic
T = Target value of quality characteristic
L = Quality loss
Objective 114-13
Costs of Quality

Objective 114-14
Reporting Quality Costs

Objective 2
Reporting Quality Costs

Objective 214-16
 Reporting Quality Costs

Strategy to reduce quality costs recommended by the American

Society for Quality Control:
The strategy for reducing quality costs is quite simple: (1) take
direct attack on failure costs in an attempt to drive them to
zero; (2) invest in the ‘right’ prevention activities to bring
about improvement; (3) reduce appraisal costs according to
results achieved; and (4) continuously evaluate and redirect
prevention efforts to gain further improvement.
This strategy is based on the premise that:
• For each failure, there is a root cause.
• Causes are preventable.
• Prevention is always cheaper.
Objective 214-17
 Quality Cost Information and
Decision Making
Reporting quality costs improves
•Managerial planning
•Control
•Decision making

Managers need quality cost information for

•Strategic Planning
•Cost-Volume-Profit Analysis

Companies may also assess the quality of its supplies through ISO
9000 international quality standards
• apply to the way a company ensures quality – like testing products,
training employees, keeping records, fixing defects.

Objective 314-18
 Controlling Quality Costs

The Total Quality Approach

Zero-defect standards reflects a philosophy of total quality

control and calls for products and services to be produced and
delivered that meet the targeted value.

Objective 414-19
 Controlling Quality Costs

The Total Quality Approach

Standard referred to as the robust zero-defects standard.

Three types of progress can be measured and reported:

1) Progress with respect to a current-period standard or goal
(an interim standard report)
2) The progress trend since the inception of the quality-
improvement program (a multiple-period trend report)
3) Progress with respect to the long-range standard or goal (a
long-range report)

Objective 414-20
Controlling Quality Costs

Objective 414-21
Controlling Quality Costs

Objective 414-22
Controlling Quality Costs

Objective 414-23
 Controlling Quality Costs
Incentives for Quality Improvement

1. Nonmonetary Incentives
• Participation helps employees internalize quality
improvement goals as their own
• Error Cause Identification is a program in which
employees describe problems that interfere with their
ability to do the job right the first time

2. Monetary Incentives Gainsharing

• Provides cash incentives for a company’s entire
workforce that are keyed to quality or productivity gains
• Gainsharing provides an inventive by offering a bonus to
the employees equal to a percentage of the cost savings
Objective 414-24
 Defining, Measuring, and
Controlling Environmental Costs
Ecoefficiency is the ability to produce competitively priced goods and
services that satisfy needs while simultaneously reducing negative
environmental impacts, resource consumption and costs.

Sustainable development is defined as development that meets the

needs of the present without compromising the ability of future
generations to meet their own needs.

Producing more goods and services using less materials, energy, water,
and land, while at the same time, minimizing air emissions, water
discharges, waste disposal and the dispersion of toxic substances.

Complementary and supportive to sustainable development –

development that meets the needs of the present without
compromising the ability of future generations to meet their own
needs.
Objective 514-25
 Defining, Measuring, and
Controlling Environmental Costs

The Ecoefficiency Paradigm

1) Reduce the consumption of resources

2) Reduce the environmental impact
3) Increase product value
4) Reduce environmental liability

Objective 514-26
Defining, Measuring, and Controlling Environmental Costs

Objective 514-27
 Defining, Measuring, and
Controlling Environmental Costs
• Environmental costs: costs that are incurred because poor
environmental quality exists or may exist

• Environmental costs can be classified in four categories

• Prevention costs
• Detection costs
• Internal failure costs
• External failure costs

Objective 514-28
Defining, Measuring, and Controlling Environmental
Costs

Objective 514-29
 Defining, Measuring, and
Controlling Environmental Costs

Objective 514-30
 Defining, Measuring, and
Controlling Environmental Costs
An Environmental Financial Report

Three types of Benefits:

1) Additional revenues: revenues that flow into
the organization due to environmental
actions
2) Current savings: refer to ongoing savings of
costs that had been paid in prior years
3) Cost avoidance (ongoing savings): refer to
reductions in environmental costs achieved
in the current year
Objective 514-31
Defining, Measuring, and Controlling Environmental
Costs

Objective 514-32
 Environmental Costing

Full environmental costing: the assignment of all environmental

costs, both private and societal, to products.

Full private costing: the assignment of only private costs to

individual products

Objective 614-33
End of Chapter 14