QUALITY COSTING

Quality Cost :The expenditure incurred by the

producer, by the user and by the community,
associated with product or service quality. (BS
4778-2)

Quality Related cost : The expenditure incurred

in defect prevention and appraisal activities plus
the losses due to internal and external failure.
(BS 4778-2)

QUALITY COSTING
THE ROLE OF QUALITY COSTING IN TOTAL
QUALITY MANAGEMENT

• What is TQM?

A management philosophy embracing all activities

through which the needs and expectations of the
customer and the community, and the objectives
of the organization are satisfied in the most
efficient and cost effective way by maximizing the
potential of all employees in a continuing drive
for improvement.( BS 4478: Part 2)
THE ROLE OF QUALITY COSTING IN TOTAL
QUALITY MANAGEMENT
Elements of TQM process

• Commitment and leadership of the CEO

• Planning and organization
• Using tools and techniques
• Education and training
• Involvement
• Teamwork
• Measurement and feedback
• Culture changes
THE ROLE OF QUALITY COSTING IN TOTAL
QUALITY MANAGEMENT

• The evolution of Quality

Management.

• The importance of Quality in a

Business context.

• The case for quality costing.

 QUALITY
MANAGEMENT
Coordinated activities to direct and control an organization with
regard to quality. (ISO 9000:2005)

QUALITY COSTING
 DEFINITIONS OF QUALITY

• Quality is fitness for use (Juran)

• Quality is conformance to requirements (Crosby)

• Quality should be aimed at the needs of the

consumer, present and future (Deming)

• Quality is the loss a product causes to society

after being shipped, other than any losses caused
by its intrinsic functions. (Taguchi)

QUALITY COSTING
 Definition of Quality (ISO
9000:2005)
• Degree to which a set of inherent characteristics
fulfils requirements

Note1. the term quality can be used with adjectives

such as poor, good or excellent.

Note2. ‘inherent’, as opposed to ‘assigned’, means

existing in something, especially as a permanent
characteristics.

Note3.requirement – need or expectation that is

stated, generally implied or obligatory
 What is a Quality product?
• Has the right configuration – according to
specifications

• Is reliable

• Is delivered on time

• Does what it is supposed to do

QUALITY COSTING
 WHY QUALITY?
• MORAL ASPECTS
We do not want to make products that will harm or kill someone

• TO COMPLY WITH EXTERNAL REQUIREMENTS

• TO AVOID PRODUCT LIABILITY

• LACK OF QUALITY COSTS MONEY

• MARKETING

QUALITY COSTING
 EVOLUTION OF QUALITY
• Inspection – Activities such as measuring, examining,
testing, gauging one or more characteristics of a product or
service and comparing these with specified requirements to
determine conformity

• Quality control – part of quality management focused on

fulfilling quality requirements

• Quality assurance – part of quality management focused on

providing confidence that quality requirements will be
fulfilled.

• Quality Management - Coordinated activities to direct and

control an organization with regard to quality
 EVOLUTION OF QUALITY
• TQM- A management philosophy embracing all
activities through which the needs and
expectations of the customer and the community,
and the objectives of the organization are
satisfied in the most efficient and cost effective
way by maximizing the potential of all employees
in a continuing drive for improvement.
( BS 4478: Part 2)
 EVOLUTION OF QUALITY
• QUALITY – INSPECTION / CONTROL
REWORK

INPUT PROCESS INSPECTION OUTPUT

• Too late
• 100% inspection do not work
SCRAP
• Expensive
– Inspector
– Scrap, rework, unhappy customers
• Creates a barrier between operator and customer

QUALITY COSTING
 EVOLUTION OF QUALITY
• QUALITY TOOLS – ASSURANCE

QUALITY
INPUT PROCESS TOOLS OUTPUT
(SPC)

“QUALITY CANNOT BE INSPECTED INTO A PRODUCT –

QUALITY
HAS TO BE BUILT INTO EACH PROCESS”

QUALITY COSTING
 INTRODUCTION

• What is the cost of quality?

• Does it raise the price of goods and

services?

• Are huge savings possible by

implementing continual improvement
efforts?

QUALITY COSTING
 MEANING OF QUALITY COSTS
• DIFFERENT INTERPRETATIONS:

– COSTS OF ATTAINING QUALITY

– COSTS OF RUNNING THE QUALITY

DEPARTMENT

– COST OF POOR QUALITY

QUALITY COSTING
DEFINITION - QUALITY COSTS
QUALITY COSTS are the total of the cost incurred by:
• Investing in the prevention of non-conformance to
requirements
• Appraising a product or service for conformance to
requirements
• Failing to meet requirements

Total Quality Costs= prevention costs+ failure costs +

appraisal costs

QUALITY COSTING
 WHY ZERO DEFECTS?
ASK YOURSELF

• IS IT NECESSARY TO GO FOR ZERO

DEFECTS?

• WHY ISN’T 99.9% GOOD ENOUGH?

QUALITY COSTING
 WHY ZERO DEFECTS?
• FIVE MINUTES OF UNSAFE DRINKING WATER
EVERY MONTH!

• TWO UNSAFE LANDINGS PER WEEK AT ONE OF

THE BUSIEST AIRPORT!

QUALITY COSTING
WHY ZERO DEFECTS?

SUDDENLY THE QUEST

FOR
ZERO DEFECTS
MAKES A LOT MORE SENSE!

QUALITY COSTING
 WHY QUALITY COSTS?
• SPEAK IN MONETARY TERMS
QUANTIFY THE SIZE OF THE QUALITY PROBLEM IN
A LANGUAGE THAT WILL HAVE AN IMPACT ON
TOP MANAGEMENT.

– THE OVERALL SIZE OF QUALITY COSTS

– THEIR PREVALENCE IN AREAS BEYOND MANUFACTURE

– THE MAJOR AREAS FOR IMPROVEMENT

QUALITY COSTING
 WHY QUALITY COSTS?
• IDENTIFY MAJOR OPPORTUNITIES FOR COST
REDUCTION

• IDENTIFY OPPORTUNITIES FOR REDUCING

CUSTOMER DISSATISFACTION AND ASSOCIATED
THREATS TO INCREASE SALES

• EXPAND BUDGETARY AND COST CONTROLS

• STIMULATE IMPROVEMENT THROUGH

PUBLICATION

QUALITY COSTING
 WHY QUALITY COSTS?

“More and more companies are

discovering that controlling the
cost of quality helps
eliminate problems, reduce excess
inventory and increase
communication”.
(P. Crosby)

QUALITY COSTING
CATEGORIES OF QUALITY
COSTS

QUALITY COSTING
 SIGNIFICANCE OF QUALITY
COSTS
• QUALITY COSTS COME RIGHT OFF
YOUR BOTTOM LINE

• QUALITY COSTS CAN BE UP TO 30%

OF COMPANY TURNOVER

• JURAN CALLS THIS AS “THE GOLD

IN THE MINE”

QUALITY COSTING
 CATEGORIES OF QUALITY
COSTS
Like all things there is a price to pay for
quality. This total cost can be split into two
fundamental areas:
– Non Conformance.
This area covers the price paid by not having
quality systems or a quality product.

– Conformance.
Conformance is an aim of quality assurance.
This aim is achieved at a price.

QUALITY COSTING
 CATEGORIES OF QUALITY
COSTS
NON-CONFORMANCE:

• INTERNAL FAILURE COSTS

• EXTERNAL FAILURE COSTS

QUALITY COSTING
 CATEGORIES OF QUALITY
COSTS
INTERNAL FAILURE COSTS

– SCRAP
– REWORK
– FAILURE ANALYSIS
– REINSPECTION / RETEST
– DOWNGRADING
– DOWNTIME

QUALITY COSTING
 CATEGORIES OF QUALITY
COSTS
EXTERNAL FAILURE COSTS

– WARRANTY CHARGES
– COMPLAINT ADJUSTMENT
– RETURNED MATERIAL
– ALLOWANCES
– RECALL

QUALITY COSTING
 CATEGORIES OF QUALITY
COSTS
CONFORMANCE:

• APPRAISAL COSTS

• PREVENTION COSTS

QUALITY COSTING
 CATEGORIES OF QUALITY
COSTS
APPRAISAL COSTS
(Costs incurred to determine the
degree of conformance to quality
requirements)
– Incoming inspection and test
– In-process inspection and test
– Final inspection and test
– Product quality audit
– Maintaining accuracy of test accuracy
– Inspection and test materials
QUALITY COSTING
 CATEGORIES OF QUALITY
COSTS
PREVENTION COSTS
(Costs incurred to keep failure and appraisal
costs to a minimum)
– Quality planning
– New products review
– Process planning
– Process control
– Quality audits
– Supplier quality evaluation
– Training
– Preventive maintenance
QUALITY COSTING
 Quality Cost Elements
Quality Cost Elements are the detailed functions,
tasks, or expenses which, when properly
combined, make up the quality cost categories.

For e.g. quality planning is an element of

prevention, in-process inspection is an element of
appraisal, rework is an element of (?), and
customer returns are an element of external
failure costs.
 Quality Cost Elements
The elements making quality cost categories are
different from industry to industry.

Quality Cost Elements in health care differ significantly

from those in manufacturing.
 Quality Cost Elements
In developing detailed elements for your organization,
the approach taken is to describe the activities or
work being performed, which can be considered
quality costs- i.e. work that would not have to be
performed if quality were, always would be, perfect.

Using the category definitions as a guide, fit these

tasks into proper categories. For e.g. if the task is
being accomplished to prevent poor quality, the cost
of the task is a prevention cost.
 Quality Cost Bases
The prime value of a quality cost system is identifying
opportunities for improvement and then providing a
measurement of that improvement over time.

Since the volume of business in total, or in any particular

product or service line, will vary with time, real
differences (improvements) in the cost of quality can
best be measured as a percent of, or in relation to a
base.

The base should be representative of, and sensitive to,

fluctuations in business activity.
 Quality Cost Bases
Measurement bases against which quality costs
may be compared

• A labour base- such as total labour, direct labour

• A sales base – such as net sales billed or sales value

of finished goods/services

• A unit base – such as the number of units produced,

the number of services performed, or the volume of
output
 Quality Cost Bases
For effective use of a quality cost system, it is preferable to have
more than one base. For long-range planning purposes, total
quality costs as a percent of net sales is used. For current,
ongoing applications, the bases selected should be related to
the specific areas for improvement.

• Internal failure costs as a percent of total production/service

costs
• External failure costs as an average of net sales

• Procurement appraisal costs as a percent of total purchased

material costs.
 Quality Cost

YEAR
1999 2000 2001 2002
Quality Costs
Prevention $ 27,000 41,500 74,600 112,300
Appraisal 155,000 122,500 113,400 107,000
Internal failure 386,400 469,200 347,800 219,100
External failure 242,000 196,000 103,500 106,000
Total $ 810,400 829,200 639,300 544,400

Accounting Measures
Sales $ 4,360,000 4,450,000 5,050,000 5,190,000
Mfg costs 1,760,000 1,810,000 1,880,000 1,890,000
 Quality Costs and Index

total quality costs

Quality index = (100)
base
$810,400(100)
Quality cost per sale = = 18.58
4,360,000
QUALITY QUALITY MANUFACTURING
YEAR SALES INDEX COST INDEX
1999 18.58 46.04
2000 18.63 45.18
2001 12.66 34.00
2002 10.49 28.80
 HOW DO WE IMPROVE?
• EFFICIENCY – Relationship between
the result achieved and the
resources used.(ISO 9000:2005)
– DOING THE SAME THINGS WE DO NOW, BUT WITH FEWER RESOURCES

• EFFECTIVENESS- Extent to which

planned activities are realized and
planned results achieved. (ISO 9000:2005)
– DOING THINGS WHICH ARE MORE SUITED TO THE NEEDS OF THE BUSINESS
THAN THE ONES WE DO NOW.

QUALITY COSTING
 Quality–Cost Relationship
9 Increased prevention costs lead to
decreased failure costs
9 Improved quality leads to
increased sales and market share
9 Quality improvement at the design
stage
9 Higher quality products can
command higher prices
 Quality costs reduction
It helps business
to:

• Satisfy the
requirements of
their customers.

• Makes the work

of their
employees more
interesting.
 Summary
• Quality cost cannot eliminate the
costs of non-conformance, it is only a
tool to measure.

• Quality cost is measure of

effectiveness and efficiency of a
Quality Improvement Programme
 EXERCISE 1
COMPARE THE EXTERNAL FAILURE COSTS BORNE BY THE BUYER
AND THE SELLER
Technical support calls
Preparation of support answer books
fix releases
Shipping of updated product
Added expense of supporting multiple versions of the product in the field
Wasted time
Lost data
Investigation of customer complaints
Refunds and recalls
Coding / testing of interim bug
Lost business
Embarrassment
Frustrated employees quit
Demos or presentations to potential customers fail because of the software
Failure when attempting other tasks that can only be done once

QUALITY COSTING
 SOLUTION
Seller: external failure costs
These are the types of costs absorbed by
the seller that releases a defective
product.
Customer: failure costs
These are the types of costs absorbed by
the customer who buys a defective
product.
QUALITY COSTING
 EXERCISE 2
ASSIGNING QUALITY COSTS TO THE APPROPRIATE CATEGORY

A textile manufacturer was attempting to calculate its quality-related costs for the first time. The
managers decided that the following activities were quality costs:
•Administration, audit and improvement
•Air conditioning
•Calibration and maintenance of production equipment used to evaluate quality
•Colour matching
•scrap
•Complaints handling
•Downgrading
•Inspection and test
•Production operators
How would you classify each of these elements?

A prevention cost? (P)

An appraisal cost? (A)
An internal failure cost?( I)
An external failure cost? (E)
Not a quality cost at all? (N)

Write the code for your answer(P, A, I, E or E) against each element.

 EXERCISE 3
RANKING PRIORITIES FOR ACTION

An organisation obtains this failure cost information on its

different product lines:

PRODUCT FAILURE COSTS $ MANUFACTURING FAILURE COSTS AS

COST $ % MANUFACTURING
COSTS
A 45,000 1,350,000 3.3

B 30,000 400,000 7.5

C 5,600 100,000 5.6

D 5,000 27,500 18.2

E 3,300 300,000 1.1

Which product line(s) should be given top priority for investigating and
Reducing failure costs? Ring your choice(s) in the ‘product’ column.

Give explanations for your answers.

Thank You for your attention.