Cornerstones of cost management 3rd edition hansen mowen chapter 14

COSTS OF QUALITY• Costs of quality are the costs that exist because poor quality may or does exist • Control activities are performed by an organization to prevent or detect poor quali

CHAPTER 14 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

CHAPTER 14 OBJECTIVES

5 Discuss how environmental costs can be

measured, reported, and reduced

6 Show how environmental costs can be

assigned to products and processes

COSTS OF QUALITY

• A quality product or service is one that meets or

exceeds customer expectations

• Quality of conformance measure of how a product meets its specifications

• Defective product is one that does not conform to

COSTS OF QUALITY

• Costs of quality are the costs that exist because

poor quality may or does exist

• Control activities are performed by an

organization to prevent or detect poor quality

• Failure activities are performed by an

organization or its customers in response to poor

quality

• Failure costs are the costs incurred by an

organization because failure activities are

performed

COSTS OF QUALITY

• The definitions of quality-related activities

imply four categories of quality costs

1 Prevention costs

2 Appraisal costs

3 Internal failure costs

4 External failure costs

COSTS OF QUALITY

• Prevention costs: incurred to prevent

poor quality

• Appraisal costs: incurred to determine

whether products and services are

conforming to their requirements or

customer needs

COSTS OF QUALITY

• Internal failure costs: incurred because

products and services do not conform to

specifications or customer needs

• External failure costs: incurred because

products and services fail to conform to

requirements or satisfy customer needs

after being delivered to customers

EXHIBIT 14.1—EXAMPLES OF QUALITY

COSTS BY CATEGORY

COSTS OF QUALITY

Quality Cost Measurement

• Observable quality costs: available from an

organization’s accounting records

• Hidden quality costs: opportunity costs

resulting from poor quality

• Three methods of estimating hidden quality costs

1 The multiplier method

2 The market research method

3 The taguchi quality loss function

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)

• The market research method: used to

assess the effect of poor quality on sales and

market share

• Used to project future profit

losses attributable to poor quality

COSTS OF QUALITY

• The taguchi quality loss function: assumes

that any variation from the target value of a

quality characteristic causes hidden quality costs

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

EXHIBIT 14.2—THE TAGUCHI QUALITY

LOSS FUNCTION

EXHIBIT 14.2—QUALITY LOSS COMPUTATION ILLUSTRATED

REPORTING QUALITY COSTS

• The first and simplest step in creating a quality

cost reporting system is assessing current

actual quality costs

• A detailed listing of actual quality costs by

category can provide two important insights

• Reveals the magnitude of the quality costs in

each category, allowing managers to assess their

financial impact

• Shows the distribution of quality costs by

category, allowing managers to assess the

relative importance of each category

REPORTING QUALITY COSTS

Optimal Distribution of Quality Costs:

Zero-Defects with Robust Quality View

• Take direct attack on failure costs in an attempt to

drive them to zero

• Invest in the “right” prevention activities to bring

about improvement

• Reduce appraisal costs according to results

achieved

• Continuously evaluate and redirect prevention

efforts to gain further improvement

EXHIBIT 14.4—QUALITY COST CATEGORIES:

RELATIVE CONTRIBUTION GRAPHS

EXHIBIT 14.5—ROBUST QUALITY AND

THE ZERO-DEFECTS QUALITY GRAPH

REPORTING QUALITY COSTS

Role of Activity-Based Cost

Management

• Activity-based costing (ABC) can be used to

calculate the quality costs per unit of a firm’s

products

• Classifies activities as value added and

non-value-added

• Keeps only those activities that add value

• Applies to quality-related activities

QUALITY COST INFORMATION

AND DECISION MAKING

• Reporting quality costs improves

managerial planning, control, and decision

QUALITY COST INFORMATION

AND DECISION MAKING

Certifying Quality Through ISO 9000

• Companies assess the quality of its supplies

through ISO 9000 international quality standards

• Standards are applied to the way in which a

company ensures quality

• For example, testing products, training employees,

keeping records, and fixing defects

CONTROLLING QUALITY COSTS

Choosing the Quality Standard

• The total quality approach

• Total quality management standard that will be used

is referred to as the robust zero-defects standard

• Total quality control implies the ultimate elimination

of failure costs

• Quantifying the quality standard

• Quality can be measured by its costs

• As the costs of quality decrease, higher quality

results

CONTROLLING QUALITY COSTS

Types of Quality Performance Reports

• Quality performance reports measure the progress

realized by an organization’s quality improvement

program

• Three types of progress measured and reported

• Progress with respect to a current-period standard or

goal (an interim standard report)

• The progress trend since the inception of the quality

improvement program (a multiple-period trend report)

• Progress with respect to the long-range standard or

goal (a long-range report)

CONTROLLING QUALITY COSTS

Interim Standard Report

• Compares the actual quality costs for the period

with the budgeted costs

• Measures the progress achieved within the period

relative to the planned level of progress for that

period

CONTROLLING QUALITY COSTS

Multiple-Period Trend Report

• By plotting quality costs as a percentage of sales

against time, the overall trend in the quality

program can be assessed

Long-Range Report

• Compares the current actual costs with the costs

that would be allowed if the zero-defects standard

were being met

• A variation of the value- and non-value-added cost

report

EXHIBIT 14.6—MULTIPLE-PERIOD TREND GRAPH: TOTAL QUALITY COSTS

EXHIBIT 14.7—MULTIPLE-PERIOD TREND GRAPH:

INDIVIDUAL QUALITY COST CATEGORIES

EXHIBIT 14.8—MULTIPLE-PERIOD TREND

GRAPH: RELATIVE QUALITY COSTS

CONTROLLING QUALITY COSTS

Incentives for Quality Improvement

• Nonmonetary incentives

• Monetary incentives

CONTROLLING QUALITY COSTS

Nonmonetary Incentives

• Participation helps employees internalize quality

improvement goals as their own

• One approach is the use of error cause

identification forms

• Program in which employees describe problems

that interfere with their ability to do the job

right the first time

CONTROLLING QUALITY COSTS

Monetary Incentives

• Gainsharing provides cash incentives for a

company’s entire workforce that are keyed to

quality or productivity gains

• Gainsharing provides an incentive by offering a

bonus to the employees equal to a percentage of

the cost savings

DEFINING, MEASURING, AND CONTROLLING ENVIRONMENTAL COSTS

The Ecoefficiency Paradigm

• Ecoefficiency: ability to produce competitively

priced goods and services that satisfy customer

needs while simultaneously reducing negative

environmental impacts, resource consumption, and

costs

• Sustainable development: development that

meets the needs of the present without

compromising the ability of future generations to

meet their own needs

EXHIBIT 14.9—ECOEFFICIENCY

RELATIONSHIPS

DEFINING, MEASURING, AND CONTROLLING ENVIRONMENTAL COSTS

Environmental Costs

• Costs that are incurred because poor

environmental quality exists or may exist

• Four categories

1 Environmental prevention costs

2 Environmental detection costs

3 Environmental internal failure costs

4 Environmental external failure costs

EXHIBIT 14.10—CLASSIFICATION OF

ENVIRONMENTAL COSTS BY ACTIVITY

TYPE

DEFINING, MEASURING, AND CONTROLLING ENVIRONMENTAL COSTS

Environmental Cost Report

• Reporting environmental

• Costs by category reveals two important outcomes

• The impact of environmental costs on firm

profitability

• The relative amounts expended in each category

EXHIBIT 14.11—RELATIVE DISTRIBUTION:

ENVIRONMENTAL COSTS

DEFINING, MEASURING, AND CONTROLLING ENVIRONMENTAL COSTS

Environmental Cost Reduction

• Investing more in prevention and detection

activities reduces environmental failure costs

• Zero damage is the lowest cost point for

environmental costs

DEFINING, MEASURING, AND CONTROLLING

ENVIRONMENTAL COSTS

An Environmental Financial Report

• Ecoefficiency suggests a possible modification to

environmental cost reporting

• Specifically, in addition to reporting environmental

costs, report environmental benefits

• Additional revenues

• Current savings

• Cost avoidance (ongoing savings)

EXHIBIT 14.12—ENVIRONMENTAL

FINANCIAL STATEMENT

ENVIRONMENTAL COSTING

Environmental Product Costs

• Full environmental costing: assignment of all

environmental costs, both private and societal, to

products

• Full private costing: assignment of only private

costs to individual products

• Each environmental activity is assigned costs,

activity rates are computed, and the rates are then

used to assign environmental costs to products

based on usage of the activity

• By assigning environmental cost to products,

management can classify products according to their degree of “dirtiness”

END OF CHAPTER 14